**SECURITIES
      AND EXCHANGE COMMISSION**


WASHINGTON,
      DC 20549




**FORM
      10-K**




**(Mark
      One)**


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


**SECURITIES
      EXCHANGE ACT OF 1934 [FEE REQUIRED]**


**For
      the fiscal year ended** **December
      31, 2006**





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


**SECURITIES
      EXCHANGE ACT OF 1934 [NO FEE REQUIRED]**


**Commission
      file number** **1-8191**




**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)





R egistrant'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 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: $1,206,434 as of June 30, 2006.





Indicate
      the number of shares outstanding of each of the registrant's class of common
      stock, as of the latest practicable date: 10,075,561 shares of Common Stock,
      par
      value $.01 per share, as of March 12, 2007.





**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:





Telecommunications
      connection and protection equipment .
      These
      systems are used to connect copper-wired telecommunications networks and to
      protect telecommunications equipment from voltage surges. We market our copper
      connection equipment and systems to telephone operating companies and customer
      premise systems providers in the United States and foreign
      countries.





Signal
      processing equipment .
      These
      products, which we sell principally for use in defense and aerospace
      applications, support copper wire-based communications systems.





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. We
      currently limit our OSS activities to the performance of contractual maintenance
      and warranty services which are anticipated to expire in June 2007 (see Note
      10
      to the Consolidated Financial Statements). T he
      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 . We are
      also seeking to sell our existing OSS inventory, and we do not plan to add
      additional inventory. In addition, we continue to pursue the sale of the OSS
      technology and remaining inventory. We hope to complete the sale in 2007, but
      we
      give no assurances that we will be successful. We do not expect OSS operations
      to be material in 2007.





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, 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 Equipment .
      Our
      copper connection/protection equipment is used by domestic and international
      telephone operating companies, by owners of private telecommunications equipment
      and manufacturers and suppliers of telephone central office and customer
      premises equipment. Products of the types comprising our telecommunications
      connection equipment are included as integral parts of all domestic and foreign
      telephone and telecommunications systems.





Our
      connection equipment consists of connection/protection blocks, building entrance
      terminals and protection modules. These products are used by telephone companies
      and installers of communications and data transmission equipment to interconnect
      copper-based subscriber lines to switching equipment lines. The protector
      modules protect central office and customer premises personnel and equipment
      from electrical surges. The need for protection products has increased as a
      result of the worldwide move to digital technology, which is extremely sensitive
      to damage by electrical overloads, and private owners of telecommunications
      equipment now have the responsibility to protect their equipment, personnel
      and
      buildings from damage caused by electrical surges. Line connection/protection
      equipment usually incorporates protector modules to safeguard equipment and
      personnel from injury due to power surges. Currently, these products include
      a
      variety of connector blocks, protector modules, building entrance terminals
      and
      frames used in telephone central switching offices, PBX installations, multiple
      user facilities and customer premise applications.





We
      also
      have developed a range of frames for use in conjunction with our traditional
      line of connecting/protecting products. Frames for the interconnection of copper
      circuits are specially designed structures which, when equipped with connector
      blocks and protectors, interconnect and protect telephone lines and distribute
      them in an orderly fashion allowing access for repairs and changes in line
      connections. One of our frame products, the CAM frame, is designed for the
      optimum placement of connections for telephone lines and connector blocks
      mounted on the frame.





Our
      copper connection/protection products are used by many of the regional Bell
      and
      international operating companies as well as independent telephone operating
      companies in the United States, and 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 .
      Our
      signal processing products include data bus systems and wideband transformers.
      Data bus systems, which are the communication standard for military and
      aerospace systems, require an extremely high level of reliability and
      performance. Wideband transformers are required for ground noise elimination
      in
      video imaging systems and are used in the television and broadcast, medical
      imaging and industrial process control industries.  Page
            2 of 35


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 31,2006
            
            2005
            
            2004(Dollars
                in thousands)Line
                Connecting/Protecting Equipment
            
            $
            27,188
            
            
            83
            %
            $
            21,982
            
            
            79
            %
            $
            21,545
            
            
            79
            %Signal
                Processing
            
            
            5,292
            
            
            16
            %
            
            5,710
            
            
            21
            %
            
            5,551
            
            
            21
            %Other
            
            
            338
            
            
            1
            %
            
            127
            
            
            0
            %
            
            69
            
            
            0
            %Total
            
            $
            32,818
            
            
            100
            %
            $
            27,819
            
            
            100
            %
            $
            27,165
            
            
            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 sy stems
      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 we anticipated will expire by June 30,
      2007 .
      Although we are trying to sell the OSS technology and our remaining OSS
      inventory, we hope to complete the sale in 2007, but we can give no assurance
      that these efforts will be successful. Additionally, we do not expect OSS
      operations to be material in 2007. Effective
      as of June 30, 2006, t he
      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 .
      Sales
      of OSS products and related services were $333,000 for 2006, $785,000 for 2005
      and $2,003,000 for 2004.





**Markets**





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.





During 2006,
      approximately 83% of our sales were made to customers in this
      category.  Page
            3 of 35




Our
      line
      of signal processing products is supplied to customers in the military and
      aerospace industry as well as manufacturers of medical equipment and video
      systems. The primary communication standard in new military and aerospace
      systems is the MIL-STD-1553 Command Response Data Bus, an application which
      requires an extremely high level of reliability and performance. 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 2006,
      signal processing equipment accounted for approximately 16% of our
      sales.





**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. We also continue to employ few personnel primarily to perform
      maintenance and warranty services on OSS systems.





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 $9,614,000 (29% of sales) in 2006, $5,641,000 (20% of sales) in 2005,
      and $2,259,000 (8% of sales) in 2004. 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 $8,609,000 (26%
      of
      sales) in 2006, $3,170,000 (11% of sales) in 2005, and $4,772,000 (18% of sales)
      in 2004.





Our
      signal processing products are sold primarily to United States military and
      aerospace prime contractors, and domestic original equipment manufacturers
      and
      end users.  Page
            4 of 35




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 31,2006
            
            2005
            
            2004(Dollars
                in thousands)North
                America
            
            $
            12,093
            
            
            37
            %
            $
            13,277
            
            
            48
            %
            $
            12,761
            
            
            47
            %United
                Kingdom
            
            
            20,725
            
            
            63
            %
            
            14,542
            
            
            52
            %
            
            14,217
            
            
            52
            %Asia/Pacific
            
            
            0
            
            
            0
            %
            
            0
            
            
            0
            %
            
            0
            
            
            0
            %Other
                -- Europe
            
            
            0
            
            
            0
            %
            
            0
            
            
            0
            %
            
            29
            
            
            less
                than 1
            %Latin
                America (excl. Mexico)
            
            
            0
            
            
            0
            %
            
            0
            
            
            0
            %
            
            158
            
            
            less
                than 1
            %Total
                Sales
            
            $
            32,818
            
            
            100
            %
            $
            27,819
            
            
            100
            %
            $
            27,165
            
            
            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 periodically
      explore the feasibility of conducting operations at lower cost manufacturing
      facilities located abroad. We are no longer manufacturing or purchasing new
      inventory for OSS products.


Page
          5 of 35





**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 five
      largest customers, consisting of British Telecommunications, Fujitsu and
      Marconi, systems integrators for British Telecommunications, Teléfonos
      de Mexico S.A. de C.V. (Telmex) and
      Graybar, accounted for sales of $23,333,000, or approximately 70% of sales,
      for
      2006; $17,431,000, or approximately 61% of sales, for
      2005;
      and $15,443,000,
      or approximately 53% of sales, for
      2004.
      Total sales to British Telecommunications, consisting of direct sales and sales
      to systems integrators for British Telecommunications (including Fujitsu) were
      $20,313,000 (62% of sales) for 2006, $14,046,000 (50%) for 2005 and $13,662,000
      (50%) for 2004. Direct sales to British Telecommunications (exclusive of sales
      to systems integrators for British Telecommunications), our largest customer
      for
      2006 and 2005, were $9,614,000, or approximately 29% of sales
      in 2006, $5,641,000, or approximately 20% of sales in 2005, and $2,259,000,
      or
      8% of sales, in 2004 .
      All of
      these sales to British Telecommunications were sales of connection/protection
      products. Sales to Telmex were $2,435,000, or approximately 7% of sales, for
      2006, $3,157,000, or approximately 11% of sales, for 2005 and $3,139,000, or
      approximately 11% of sales, for 2004. No other customers account for 10% or
      more
      of our sales in 2006, 2005 or 2004.





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.





**Backlog**





At
      December 31, 2006, our backlog was approximately $4,050,000 compared with
      approximately $4,188,000 at December 31, 2005. Of the December 31, 2006 backlog,
      approximately $2,552,000 represented orders from British Telecommunications.
      We
      expect to ship substantially all of our December 31, 2006 backlog during 2007.





**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, 2006.





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.  Page
            6 of 35


**Competition**





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





We
      compete directly with a number of large and small telephone equipment
      manufacturers in the United States, with CommScope, Inc., which acquired the
      business in 2005 from Lucent Technologies, being our principal United States
      competitor. CommScope’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, CommScope and
      a
      number of companies with greater financial resources than we 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 compete 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 connecting/protecting equipment,
      we
      have met with significant competition from United States and foreign
      manufacturers of comparable equipment and we expect this competition to
      continue. In addition to CommScope, a number of our overseas competitors have
      significantly greater resources than we do.





**Research
      and Development Activities**





We
      spent
      approximately $1,500,000 in 2006, $1,400,000 in 2005, and $1,000,000 in 2004
      on
      research and development activities from continuing operations. Most of the
      research and development expenses in 2006 related to copper
      connection/protection products, and were oriented toward development of new
      products.  All
      research and development was Company-sponsored and is expensed as incurred.
      During 2006, we increased our research and development efforts in the
      connection/protection business.





**Employees**





As
      of
      December 31, 2006 we had 355 employees, of which 48 were employed in the United
      States, 297 in Mexico, 7 in the United Kingdom, and 3 in China. We believe
      that
      our relations with our employees are good, and we have never experienced a
      work
      stoppage.  Our
      employees are not covered by collective bargaining agreements except for our
      hourly employees in Mexico who are covered by a collective bargaining agreement
      that expires on May 20, 2007.


Page
          7 of 35





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





We
      require substantial financing to meet our working capital requirements andwe
      have
      no access to suchfinancing.




We
      had a
      working capital deficit at December 31, 2006 of $31,646,000. As of December
      31,
      2006, our current liabilities included $23,513,000 due to the holder of our
      senior debt. We do not have sufficient resources to pay the senior debt or
      to
      pay principal and interest of $12,120,000 which was due at December 31, 2006
      on
      the outstanding subordinated notes that became due on July 3, 2001, and we
      do
      not expect to generat e
      the
      necessary cash from our operations to enable us to make those
      payments. As of
      December 31, 2006 we had no other source of outside financing .
      The
      holder of our senior debt is not advancing funds to us; 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. purchased our senior
      debt
      of approximately $23,400,000 from SHF IX, LLC and subsequently extended the
      maturity of the senior debt to October 1, 2007. If the senior debt holder does
      not extend the maturity of our senior debt beyond October 1, 2007, 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.





**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 $27,823,000, our working capital deficit of
      $31,646,000 as of December 31, 2006 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 $20,313,000 (62% of sales) for 2006,
      $14,046,000 (50% of sales) for 2005 and $13,662,000 (50%) for 2004. Almost
      all
      of such sales were sales of copper connection 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.  Page
            8 of 35


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




Approximately
      63% of our sales in 2006, 52% of our sales in 2005 and 52% of our sales in
      2004,
      were made to foreign telephone operating companies, particularly British
      Telecommunications. 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 CommScope, Inc., which acquired the
      connection/protection business from Lucent Technologies, 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 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.




**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.  Page
            9 of 35




**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 and 4,200 square feet of manufacturing space
      in Syosset, New York. These facilities represent substantially all of our
      office, plant and warehouse space in the United States. The Syosset, New York
      leases expire February 2008 and May 2007, respectively. The annual rental
      payable under these leases is approximately
      $305,000 and is
      subject to customary escalation clauses.





Our
      wholly-owned United Kingdom subsidiary leases an approximately 11,000 square
      foot facility in Coventry, England, which facility comprises all of our office,
      plant and warehouse space. The lease expires in 2011. The
      aggregate current annual rental is approximately $91,000 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 2006, no matters were submitted to a vote of our security
      holders.


Page
          10 of
          35




**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 2005 and 2006, 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.


2005
            
            2006High
            
            Low
            
            High
            
            LowFirst
                quarter
            
            $
            0.19
            
            $
            0.12
            
            $
            0.17
            
            $
            0.09Second
                quarter
            
            
            0.54
            
            
            0.14
            
            
            0.15
            
            
            0.09Third
                quarter
            
            
            0.23
            
            
            0.14
            
            
            0.15
            
            
            0.06Fourth
                quarter
            
            
            0.26
            
            
            0.15
            
            
            0.18
            
            
            0.11





The
      last
      reported bid price of our common stock on March 12, 2007 was $0.18 per
      share.




We
      did
      not declare or pay any cash dividends in 2006 or 2005, 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 2006.





**Equity
      Compensation Plan Information**





The
      following table summarizes the equity compensation plans under which our
      securities may be issued as of December 31, 2006.





Equity
      Compensation Plan Information as of December 31, 2006





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
            
            
            322,280
            
            $
            1.33
            
            
            977,720Equity
                compensation plan not approved by security holders
            
            
            -0-
            
            
            -0-
            
            
            -0-322,280
            
            $
            1.33
            
            
            977,720








**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, 2006. 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 Item 8 of this report. All current and prior years
      financial data below has been restated to reflect the discontinued operations
      of
      our OSS business.  Page
            11 of
            35




Year
                Ended December 31,2006
            
            2005
            
            2004
            
            2003
            
            2002(In
                thousands, except per share data)Income
                Statement Data:Sales
            
            $
            32,818
            
            $
            27,819
            
            $
            27,165
            
            $
            16,341
            
            $
            15,003Income
                (loss) from continuing operations
            
            
            2,511
            
            
            1,855
            
            
            4,336
            
            
            (284
            )
            
            (
                4,340
            )(Loss)
                income from discontinued operations, net of zero tax
            
            
            (329
            )
            
            (1,045
            )
            
            (1,661
            )
            
            (3,073
            )
            
            226Net
                income (loss)
            
            
            2,182
            
            
            810
            
            
            2,675
            
            
            (3,357
            )
            
            (4,114
            )Per
                share: Basic net income (loss) from continuing operations
            
            $
            0.25
            
            $
            0.18
            
            $
            0.43
            
            $
            (0.08
            )
            $
            (0.44
            )Basic
                income (loss) from discontinued operations
            
            
            (0.03
            )
            
            (0.10
            )
            
            (0.17
            )
            
            (0.31
            )
            
            0.02Diluted
                income (loss) from continuing operations
            
            
            0.25
            
            
            0.18
            
            
            0.43
            
            
            (0.08
            )
            
            (0.44
            )Diluted
                net income (loss) from discontinued operations
            
            
            (0.03
            )
            
            (0.10
            )
            
            (0.17
            )
            
            (0.31
            )
            
            0.02Number
                of shares used in calculating net income (loss) per share:Basic
            
            
            10,076
            
            
            10,054
            
            
            9,972
            
            
            9,972
            
            
            9,972Diluted
            
            
            10,103
            
            
            10,093
            
            
            9,988
            
            
            9,972
            
            
            9,972





At
                December 31,2006
            
            2005
            
            2004
            
            2003
            
            2002(In
                thousands)Total
                assets
            
            $
            17,784
            
            $
            14,661
            
            $
            14,438
            
            $
            12,355
            
            $
            14,228Working
                capital (deficit)
            
            $
            (31,646
            )
            $
            (33,777
            )
            $
            (34,150
            )
            $
            (36,825
            )
            $
            (34,199
            )Current
                debt maturities, including accrued interest
            
            $
            36,169
            
            $
            36,384
            
            $
            36,736
            
            $
            35,479
            
            $
            34,238Long-term
                debt, excluding current maturities
            
            $
            -0-
            
            $
            -0-
            
            $
            -0-
            
            $
            -0-
            
            $
            -0-Stockholders'
                deficit
            
            $
            (27,823
            )
            $
            (30,185
            )
            $
            (30,661
            )
            $
            (33,238
            )
            $
            (29,935
            )





Page
            12 of
            35




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 in our consolidated financial statements
      as a discontinued operation. Currently,
      our OSS operating activities are limited to the performance of
      contractual maintenance and warranty services. In addition, we continue to
      pursue the sale of the OSS technology and remaining inventory. We hope to
      complete the sale in 2007, but we give no assurances that we will be successful.
      We do not expect OSS operations to be material in 2007.





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





**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. A t
      December 31, 2006, we had outstanding senior debt of approximately $23,500,000
      and subordinated debt of approximately $12,100,000. Although we have received
      an
      extension to October 1, 2007, 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
      1 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 $27,823,000 and working
      capital deficit
      of $31,646,000 as of December 31, 2006, 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,
      percentage of completion for long-term contracts, 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.  Page
            13 of
            35


**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, 2006 and 2005, 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 2006.





**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**





Senior
      Debt





Our
      senior debt matures on October 1, 2007. On
      February 7, 2007, Cheyne Special Situations Fund L.P purchased our senior debt
      of approximately $23,400,000 from SHF IX, LLC and subsequently extended the
      maturity of the senior debt to October 1, 2007.  If
      the
      senior debt is not extended beyond October 1, 2007, 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





Interest





Under
      the
      terms of our senior debt agreements, we have not paid or accrued interest on
      $22,600,000 of senior debt since March 2002. As a result, our statement of
      operations does not reflect any interest charges on the senior debt for 2006,
      2005 and 2004. The holder of the senior debt has the right at any time to
      require us to pay interest at a rate of 12%, and in the case of a default,
      14%;
      however, our obligation to pay interest will not require
      us to pay interest on such senior debt for periods prior to the date that we
      were required to commence interest payments. We continue to accrue interest
      on
      obligations to the holder of our senior debt which were incurred subsequent
      to
      March 2002. In addition, our current extension of our senior noteprovides
      for interest payments to the senior debt holder of $181,000 on May 1, 2007,
      $312,500 on July 1, 2007 and $312,500 on October 1, 2007.


Page
            14 of
            35




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. Currently,
      the OSS operating activities are limited to the performance of
      contractual maintenance and warranty services under contracts that expire by
      June 30, 2007. We anticipate that the operations of this division will be
      entirely phased out by June 30, 2007. We continue to pursue the sale of the
      OSS
      technology and remaining inventory. We hope to complete the sale in 2007, but
      we
      give no assurances that we will be successful. We do not expect OSS operations
      to be material in 2007.





Recent
      Increase in Copper Sales; Dependence on British
      Telecommunications





Since
      the
      fourth quarter of 2003, we have experienced an increase in our copper connection
      business primarily as a result of the requirements of British Telecommunications
      to provide increased DSL service in the United Kingdom and, in 2005, as a result
      of British Telecommunications’ implementation of the local loop unbundling
      program, demanded by regulators to enable third party providers of telephone
      service to gain access to British Telecommunications’ systems. We anticipate
      that British Telecommunications will continue to require our copper connection
      products while it is expanding its DSL service and providing the required local
      loop unbundling services. During the past three years, sales to British
      Telecommunications, consisting of both direct sales and sales to systems
      integrators for British Telecommunications (including Fujitsu), represented
      an
      increasing percentage of our total sales, accounting for 62% of sales for 2006,
      50% of sales for 2005 and 50% of sales for 2004. Almost all of such sales were
      sales of copper connection products. We cannot predict how long British
      Telecommunications will continue to place orders with us. If British
      Telecommunications and its systems integrators cease or significantly reduce
      purchases from us, we may be unable to operate profitably, and it may be
      necessary for us to seek protection under the Bankruptcy Code.





**Results
      of Operations**




The
      following table sets forth our consolidated statements of operations for the three years ended December 31,
      2006, 2005 and 2004, as a percentage of sales:


Years
                Ended December 31,2006
            
            2005
            
            2004Sales
            
            
            100
            %
            
            100
            %
            
            100
            %Cost
                of sales
            
            
            67
            %
            
            63
            %
            
            59
            %Gross
                profit
            
            
            33
            %
            
            37
            %
            
            41
            %Selling,
                general and administrative expenses
            
            
            17
            %
            
            18
            %
            
            16
            %Research
                and development expenses
            
            
            5
            %
            
            5
            %
            
            4
            %Reorganization
                expenses
            
            
            —
            
            
            3
            %
            
            —Operating
                income
            
            
            11
            %
            
            11
            %
            
            21
            %Interest
                expense (net)
            
            
            (3
            )%
            
            (4
            %)
            
            (5
            %)Income
                from continuing operations before income taxes
            
            
            8
            %
            
            7
            %
            
            16
            %Income
                tax expense
            
            
            (1
            %)
            
            (1
            %)
            
            (1
            %)Income
                from continuing operations before discontinued operations
            
            
            8
            %
            
            7
            %
            
            16
            %Loss
                from discontinued operations
            
            
            (1
            %)
            
            (4
            %)
            
            (6
            %)Net
                income
            
            
            7
            %
            
            3
            %
            
            10
            %




*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
      $10,700,000, 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.  Page
            15 of
            35




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.





Even
      though we were profitable in 2006, we cannot assure you that we will be able
      to
      operate profitably in the future. If we are unable to operate profitably, it
      may
      be necessary for us to seek protection under the Bankruptcy Code.








*Years
      Ended December 31, 2005 and 2004*





Our
      sales
      for 2005 were $27,819,000 compared to $27,165,000 in 2004, an increase of
      $654,000 (2%).  Page
            16 of
            35


Line
      connection/protection equipment sales for 2005 increased approximately $437,000
      (2%) from $21,545,000 in 2004 to $21,982,000 in 2005. The slight increased
      sales
      level resulted
      primarily from an increased level of sales to British Telecommunications and
      systems integrators for British Telecommunications, as a result of British
      Telecommunications increasing the availability of DSL lines in the United
      Kingdom. Direct sales to British Telecommunications increased 150% from
      $2,259,000 to $5,641,000. Sales to systems integrators for British
      Telecommunications decreased from $11,403,000 to $8,406,000, or 26%, from 2004
      to 2005. Sales increased in the U.S. and other international
      markets.





Signal
      processing revenue for 2005 compared to 2004 increased slightly by $159,000
      (3%)
      from $5,551,000 to $5,710,000. The increase in sales in 2005 reflects shipments
      from the 2004 backlog that we were unable to ship timely in 2004 due to our
      weak
      cash position.





Gross
      profit decreased from 41% in 2004 to 37% in 2005. The
      line
      protection/connection margin decreased while signal processing margin stayed
      the
      same. The decrease is directly 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 during the second half of 2005.





Selling,
      general and administrative expenses increased by $893,000 (21%) from $4,227,000
      in 2004 to $5,120,000 in 2005. This increase relates primarily to the recording
      of the lease termination in the UK of approximately $715,000.







Research
      and development expenses increased by $340,000 (33%) from $1,019,000 in 2004
      to
      $1,359,000 in 2005. This increase was primarily due to increased spending by
      our
      line connection/protection division to enhance our existing line products and
      develop new products.




In
      2005,
      reorganization expenses were $877,000. The expenses were for investment banking,
      legal and accounting, including payment of legal fees and other expenses of
      the
      holder of our senior debt, resulting from the requirement of the holder of
      our
      senior debt that we restructure our company to provide payments on account
      of
      the senior debt.





As
      a
      result of the above, we had an operating income of $3,066,000 in 2005 versus
      an
      operating income of $5,815,000 in 2004.





Interest
      expense, net, for 2005 decreased by $237,000 from $1,317,000 for 2004 to
      $1,080,000 in 2005 primarily because of an interest adjustment for interest
      expense accrued in prior periods. Such interest excludes interest on our old
      term loan, in the principal amount of approximately $24,700,000, 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
      provision for 2005 and 2004 is lower than the statutory tax rate principally
      as
      a result of the utilization of available net operating loss carryforwards.




The
      loss
      from discontinued operations decreased from $1,661,000 in 2004 to $1,045,000
      in
      2005 as a result of the reduction in the scope of these operations reflecting
      the scaling down of these operations which commenced in 2004, as well as
      increased difficulty in generating OSS business which is reflected in our
      decision to scale back these operations.  Page
            17 of
            35


As
      the
      result of the foregoing, the 2005 net income was $810,000, $0.08 per share
      (basic and diluted), compared with a net income of $2,675,000, $0.26 per share
      (basic and diluted) for 2004.




**Liquidity
      and Capital Resources**




At
      December 31, 2006, we had cash and cash equivalents of $2,102,000 compared
      with
      $1,253,000 at December 31, 2005. Our working capital deficit was $31,646,000
      at
      December 31, 2006, compared to a working capital deficit of $33,777,000 at
      December 31, 2005 .  During
      2006 our operations generated net cash of $2,462,000 as compared with 2005,
      in
      which we generated cash of $1,097,000 from our operations.  Of
      this
      amount, we made principal payments of $1,163,000 on account of our senior debt.
      Our cash flow from operations reflects interest payments of $169,400 on our
      senior debt and $25,000 on account of the senior lender’s expenses.  Since
      late 2003, our present senior lenders did not advance us any funds. Since we
      do
      not have any borrowing capability as a result of our senior debt position,
      our
      only source of funds has been from our operations. 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, 2006, our debt includes $23,513,000 of senior debt which, as a
      result of an extension effective February 7, 2007, matures on October 1, 2007,
      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 $5,976,000 which represents interest accrued from July 2000
      through December 2006. As
      of
      December 31, 2006, 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, 2006 was approximately
      $151,000. At
      December 31, 2006, 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 and 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 October 1, 2007 or if the holder of our senior debt demands
      payment of all or a significant portion of the senior debt when due, whether
      on
      October 1, 2007 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.





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, 2006, 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.  Page
            18 of
            35




The
      following table summarizes our principal contractual obligations as of December
      31, 2006 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
            
            $
            36,169
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            36,169Operating
                leases
            
            
            591
            
            
            823
            
            
            792
            
            
            1,652
            
            
            3,858Deferred
                compensation Obligations
            
            
            109
            
            
            290
            
            
            216
            
            
            703
            
            
            1,318Purchase
                obligations
            
            
            4,694
            
            
            —
            
            
            —
            
            
            —
            
            
            4,694Total
            
            $
            41,563
            
            $
            1,113
            
            $
            1,008
            
            $
            2,355
            
            $
            46,039





**Recently
      Issued Accounting Standards**





See
      Note
      1 to the consolidated financial statements.




**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 2006 and 2005, 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.**





**Evaluation
      of disclosure controls and procedures**




An
      evaluation was performed, under the supervision of, and with the participation
      of, our management, including our chief executive officer and chief financial
      officer, of the effectiveness of the design and operation of our disclosure
      controls and procedures. Based on that evaluation, our management, including
      the
      chief executive officer and chief financial officer, concluded that our
      disclosure controls and procedures were not effective for the reasons discussed
      below related to the weaknesses in our internal control over financial
      reporting. Disclosure controls and procedures are defined as controls
      and other procedures that are designed to ensure
      that information required to be disclosed by us in the reports that we file
      or
      submit under the Securities Exchange Act of 1934, as amended, is recorded,
      processed, summarized and reported, within the time periods specified in the
      Commission’s rules and forms. Disclosure controls and procedures include,
      without limitation, controls and procedures designed to ensure that information
      required to be disclosed by us in these reports is accumulated and communicated
      to our management, including our principal executive and principal financial
      officers, as appropriate to allow timely decisions regarding required
      disclosure.  Page
            19 of
            35




Our
      management is responsible for establishing and maintaining effective internal
      controls. Because of its inherent limitations, internal controls may not prevent
      or detect misstatements. A control system, no matter how well designed and
      operated, can only provide reasonable, not absolute, assurance that the control
      system’s objectives will be met. Also, projections of any evaluation of
      effectiveness as 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.




A
      material weakness is a control deficiency or combination of control
      deficiencies, that results in more than a remote likelihood that a material
      misstatement of the annual or interim financial statements will not be prevented
      or detected. As a result of our evaluation of our disclosure controls and
      procedures described above, we concluded that there were weaknesses in our
      disclosure controls and procedures. To address these weaknesses described below,
      we performed additional analysis and performed other procedures to ensure the
      consolidated financial statements were prepared in accordance with generally
      accepted accounting principles. Accordingly, management believes that the
      consolidated financial statements included in this Annual Report on
      Form 10-K, fairly present, in all material respects, our financial
      condition, results of operations and cash flows for the periods presented in
      accordance with generally accepted accounting principles.




Management’s
      assessment identified the following weaknesses at December 31, 2006 in our
      internal control over financial reporting and, subsequent to December 31, 2006,
      we took the following steps to address those weaknesses.




-
      Our
      United Kingdom subsidiary has identified a weakness in the segregation of
      duties, specifically as they relate to cash management. We are implementing
      measures to segregate certain functions and otherwise improve cash management
      functions including a division of the function of authorizing and issuing
      payments. In addition, as a result of a change in personnel in our main office,
      we were unable to fully implement our existing internal cash management
      functions at our main office during a portion of 2006, which has been remedied
      by implementing our preexisting internal control polices.




-
      As a
      result of the audit performed by our independent registered public accounting
      firm, BDO Seidman, LLP, we recorded journal entries which, individually and
      in
      the aggregate, were material and evidenced a weakness in our internal control
      reporting procedures. To address this weakness, we have initiated a review
      of
      our training and supervision policies and procedures, particularly with respect
      to the functions in which adjustment had been made, which includes an evaluation
      of the specific knowledge and skills required to perform each function, an
      assessment of the personnel training necessary to perform such function
      adequately, a plan to ensure that all personnel receive the appropriate level
      of
      training, and a review and modification of the supervisory procedures over
      such
      personnel.




We
      believe that the measures we have taken have addressed each matter identified
      as
      a material weakness by management and our independent registered public
      accounting firm. We will continue to monitor the effectiveness of our internal
      controls and procedures on an ongoing basis and will take further actions,
      as
      appropriate.  Page
            20 of
            35


The
      certification of our chief executive officer and chief financial officer, which
      is included as Exhibit 31.1 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.




Except
      as
      otherwise discussed herein, there have been no significant changes in our
      internal control over financial reporting during the most recently completed
      fiscal quarter that has materially affected, or is reasonably likely to
      materially affect, our internal control over financial reporting. In addition,
      we are continuing to implement the enhancements to our internal control over
      financing reporting to address the material weaknesses described
      above.




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




None




**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 chieffinancial
                officer
            
            63William
                V. Carney1
            
            Chairman
                of the board and director
            
            70Michael
                A. Tancredi
            
            Senior
                vice president, secretary, treasurer and director
            
            77Warren
                H. Esanu1,2
            
            Director
            
            64Herbert
                H. Feldman1,2
            
            Director
            
            73Marco
                M. Elser2
            
            Director
            
            48





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.  Page
            21 of
            35





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.




**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 meeting. 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.  Page
            22 of
            35




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.




**Board
      and Committee Attendance**




The
      Board
      and its committees held the following number of meetings during the
      2006:




Board
                of directors
            
            
            10Audit
                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 2006.


Page
            23 of
            35




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




**SUMMARY
      COMPENSATION TABLES**




The
      following tables s et
      forth
      below a summary of the dollar values of the total annual compensation provided
      to each person who served as our chief executive officer and our chief financial
      officer during (i) 2006 and (ii) 2005 and 2004. During 2006, Mr. Kornfeld served
      as chief financial officer for the entire year and chief executive officer
      for a
      portion of the year, and Mr. Carney served as chief executive officer for part
      of 2006. No other officer who received compensation of $100,000 or more during
      2006.




Information
      for 2006




Name
            
            Year
            
            Salary
            
            Bonus
            
            Stock
                Awards
            
            Option
              Awards
            
            Non-Equity
                Incentive Plan Compensation
            
            All
                Other Compensation
            
            TotalEdward
                B. Kornfeld
              chief
                executiveofficer
                and chief financialofficer
            
            
            2006
            
            $
            256,250
            
            $
            60,000
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            $
            6,865
            
            $
            323,115William
                V. Carney,
              chief
                executive officer
            
            
            2006
            
            
            25,500
            
            
            -0-
            
            
            -0-
            
            $
            219
            
            
            -0-
            
            
            98,544
            
            
            124,263





Compensation
      to Mr. Kornfeld does not include fees of $48,000 paid in 2006 to Tatum CFO
      Partners, of which Mr. Kornfeld is a partner, for services rendered to us by
      Mr.
      Kornfeld. In addition, Mr. Kornfeld received, included on All Other
      Compensation, 401K match ($3,300) and supplemental insurance ($3,565).





All
      Other
      Compensation to Mr. Carney, our Chief Executive Officer through March 13, 2006,
      includes consulting fees ($37,500) and fees paid to Mr. Carney as a non-employee
      member of our board of directors ($59,855) for March through December. In
      addition, he received 401K match ($383) and Supplemental Insurance ($806).  Page
            24 of
            35


Information
      for 2005 and 2004


Annual
                Compensation
            
            Long-Term
                Compensatio
              (Awards)Name
                and Principal Position
            
            Year
            
            Salary
            
            Bonus
            
            Restricted
                Stock Awards (Dollars)
            
            Options,
                SARs
              (Number)
            
            All
                other
              CompensationWilliam
                V. Carney, chief executive officer
            
            
            2005
            
            $
            128,000
            
            $
            10,000
            
            
            —
            
            
            —
            
            $
            6,2562004
            
            
            122,000
            
            
            5,000
            
            
            —
            
            
            —
            
            
            6,101Edward
                B. Kornfeld, President, chief operating officer and chief financial
                officer
            
            
            2005
            
            
            237,000
            
            
            50,000
            
            
            —
            
            
            —
            
            
            6,7142004
            
            
            206,000
            
            
            15,000
            
            
            —
            
            
            —
            
            
            6,639





Compensation
      to Mr. Kornfeld does not include fees of $36,000 paid in each of 2005 and 2004
      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.




Set
      forth
      below is a chart that shows, for 2005 and 2004, the components of “All Other
      Compensation” listed in the Summary Compensation Table.





2005
            
            2004Mr.
                Carney
            
            M.
                Kornfeld
            
            Mr.
                Carney
            
            Mr.
                Kornfeld401(k)
                Match
            
            $
            2,065
            
            $
            3,150
            
            $
            1,910
            
            $
            3,075Supplemental
                Insurance
            
            
            4,191
            
            
            3,564
            
            
            4,191
            
            
            3,564




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.




**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


Page
            25 of
            35




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.”




During
      the past years, our business was in a state of flux. Prior to 2004, our
      financial condition, inability to raise funds for our operations, uncertainty
      about our future and the problems facing the telecommunications industry as
      a
      result of overbuilding in the 1990s made it difficult to develop incentive
      programs for our executive officers. Further, prior to February 2007, we were
      under pressure from the holder of our senior debt to restructure the senior
      debt
      and/or sell one or more divisions to provide funds to pay the senior lender.
      As
      a result, during this period we reduced our senior management and, at present,
      we have two executive officers, with the positions of chief executive and
      financial officer being held by one person since March 2006.




During
      the past three years, we have generated both net income and cash flow from
      operations on increased revenue. However, because of the uncertainties described
      in the preceding paragraph, we were limited in the incentives that we could
      make
      available to our executive officers and we did not grant options to any of
      our
      officers. We expect, however, that in 2007, 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.  Page
            26 of
            35




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




*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. 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.


Page
            27 of
            35




**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.




In
      March
      2006, the committee approved a 6.0% salary increase for Mr. Kornfeld from
      $245,000 to $260,000, effective April 1, 2006. This increase also recognized
      Mr.
      Kornfeld’s additional responsibilities as our chief executive officer while
      continuing to serve as our chief financial officer.




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.




**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, 2006, there were
      outstanding options to purchase 207,280 shares of common stock from the 1996
      plan and 115,000 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 an 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 2006, we did not grant either of the
      named executive officer any options, and neither of the named executive officer
      exercised any options to purchase shares of our common stock.





We
      did
      not make any stock grants to our officers during 2006. The following table
      sets
      forth information as to outstanding options held by the officers named in the
      summary compensation table. No stock appreciation rights were
      granted.





OPTION
                AWARDSName
            Number
                of Securities Underlying Unexercised Options (#)
              Exercisable
            Number
                of Securities Underlying Unexercised Options (#)
              Unexercisable
            Equity
                Incentive Plan Awards: Number of Securities Underlying
                Unexercised
              Unearned
                Options
              (#)
            Option
                Exercise Price
              ($)
            Option
                Expiration DateMr.
                Kornfeld
            23,000
            -0-
            -0-
            $1.50
            5/7/07Mr.
                Carney
            86,250
            -0-
            -0-
            $1.50
            5/7/07


Page
            28 of
            35




During
      2005, we did not grant Mr. Carney or Mr. Kornfeld any options, and neither
      of
      them exercised any options to purchase shares of our common stock. As of
      December 31, 2005, Mr. Carney held options to purchase 86,250 shares of common
      stock and Mr. Kornfeld held options to purchase 23,000 shares of common stock.
      All of these options are currently exercisable and, because the exercise price
      is greater than the market price of the common stock, they were not in-the-money
      options and, accordingly, their options had nominal value at December 31,
      2005.





**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.





The
      table
      below summarized the compensation we paid to our non-employee directors for
      the
      year ended December 31, 2006:




Directors’
      Summary Compensation Table




Name
            
            Fees
                Paid in Cash
            
            Option
                Award(1)
            
            TotalHerbert
                H. Feldman
            
            $
            55,424
            
            $
            218
            
            $
            55,642Marco
                M. Elser
            
            $
            55,424
            
            $
            218
            
            $
            55,642William
                V. Carney
            
            $
            97,405(2
            )
            $
            218
            
            $
            97,623Warren
                H. Esanu
            
            $
            55,424
            
            $
            218
            
            $
            55,642





(1)
            Reflects
                the dollar amount recognized for financial statement reporting purposes
                for 2006 in accordance with FAS 123R and thus includes amounts from
                awards
                granted prior to 2006.


(2)
            Represents
                directors fees of $ 59,855 and consulting fees of $37,550 paid to
                Mr.
                Carney during 2006, and does not include compensation to Mr. Carney
                of
                $25,500 for services as our chief executive officer through April,
                2006.




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, 2006.




As
      of
      December 31, 2006, each director has the following outstanding options: Messrs.
      Esanu and Feldman, 40,000 each; Mr. Elser, 30,000; and Mr. Carney,
      5,000.


Page
            29 of
            35




**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 August 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. 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.





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  Page
            30 of
            35


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
      $92,500.




**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, 2007,  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
                BeneficiallyOwned
            
            Percentage
                of Outstanding
              Common
                StockWilliam
                V. Carney
            
            
            209,272
            
            
            2.1
            %Michael
                A. Tancredi
            
            
            81,768
            
            
            *Warren
                H. Esanu
            
            
            59,000
            
            
            1.4
            %Herbert
                H. Feldman
            
            
            115,631
            
            
            1.1
            %Marco
                M. Elser
            
            
            341,376
            
            
            3.4
            %Edward
                B. Kornfeld
            
            
            49,317
            
            
            *All
                directors and executiveofficers
                as a group(6
                individuals)
            
            
            856,364
            
            
            8.5
            %





*
            Less
                than 1%





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, 2007 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.


Page
          31 of
          35




Name
            
            SharesWilliam
                V. Carney
            
            
            86,250Michael
                A. Tancredi
            
            
            42,530Warren
                H. Esanu
            
            
            54,000Herbert
                H. Feldman
            
            
            56,000Marco
                M. Elser
            
            
            25,000Edward
                B. Kornfeld
            
            
            23,000All
                officers and directorsas
                a group
            
            
            286,780





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





During
      2006, Warren H. Esanu, a director, served as a member of our audit and
      compensation committees. During 2006, 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 $310,000. Katsky Korins LLP is continuing to render legal
      services to us during 2007.





**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, 2006 and December 31, 2005:




FeesFee
                  Category
              
              2006
              
              2005Audit
                  fees
              
              $
              239,400
              
              $
              177,623Audit-related
                  fees
              
              
              12,500
              
              
              15,031Tax
                  fees
              
              
              30,000
              
              
              55,899Total
                  Fees
              
              $
              281,900
              
              $
              248,553




*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.




*All
      other fees.* BDO
      Seidman, LLP did not perform any services other than the services described
      above.




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




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.  Page
            32 of
            35




**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





ExhibitNo.
            Description
                of
                Exhibit




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





3.2
            
            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.




Page
          33 of
          35




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
            34 of
            35




SIGNATURES





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




PORTA
      SYSTEMS CORP.


Dated: 
      March 29, 2007




By: /s/
      Edward B. Kornfeld


Edward
      B.
      Kornfeld


Chief
      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
                  29, 2007Edward
                  B. Kornfeld
              
              (Principal
                  Executive, Financial and Accounting Officer)/s/William
                  V. Carney
              
              Director
              
              March
                  29, 2007William
                  V. Carney/s/Warren
                  H. Esanu
              
              Director
              
              March
                  29, 2007Warren
                  H. Esanu/s/Michael
                  A. Tancredi
              
              Director
              
              March
                  29, 2007Michael
                  A. Tancredi/s/Herbert
                  H. Feldman
              
              Director
              
              March
                  29, 2007Herbert
                  H. Feldman/s/Marco
                  Elser
              
              Director
              
              March
                  29, 2007Marco
                  Elser




Page
          35 of
          35




**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, 2006 and 2005
            F-3Consolidated
                Statements of Income and Comprehensive Income, Years Ended December
                31,
                2006, 2005 and 2004
            F-4Consolidated
                Statements of Stockholders’ Deficit, Years Ended December 31, 2006, 2005
                and 2004
            F-5Consolidated
                Statements of CashFlows
                forthe Years Ended December 31, 2006, 2005 and2004
            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, 2006 and 2005, and the related consolidated
      statements of income and comprehensive income, stockholders’ deficit, and cash
      flows for each of the three years in the period ended December 31, 2006. These
      financial statements are the responsibility of the Company’s management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audits.





We
      conducted our audits 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, 2006 and 2005, and the results of their
      operations and their cash flows for each of the three years in the period ended
      December 31, 2006, 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, 2006, has a stockholders’ deficit of $27,823,000 and a working
      capital deficit of $31,646,000 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, LLP





BDO
      SEIDMAN, LLP








Melville,
      New York


March
      23,
      2007


F-2




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Consolidated
      Balance Sheets


December
      31, 2006 and 2005


(in
      thousands, except shares and par value)





Assets
            
            2006
            
            2005Current
                assets:Cash
                and cash equivalents
            
            $
            2,102
            
            
            1,253Accounts
                receivable - trade, less allowance for doubtful accountsof
                $13 in 2006 and 2005
            
            
            5,417
            
            
            3,471Inventories
            
            
            4,591
            
            
            4,541Prepaid
                expenses and other current assets
            
            
            697
            
            
            447Current
                assets of discontinued operations
            
            
            383
            
            
            530Total
                current assets
            
            
            13,190
            
            
            10,242Property,
                plant and equipment, net
            
            
            1,571
            
            
            1,352Goodwill
            
            
            2,961
            
            
            2,961Other
                assets
            
            
            51
            
            
            48Long
                term assets of discontinued operations
            
            
            11
            
            
            58Total
                assets
            
            $
            17,784
            
            
            14,661Liabilities
                and Stockholders’ DeficitCurrent
                liabilities:Senior
                debt, including accrued interest
            
            $
            23,513
            
            
            24,675Subordinated
                notes
            
            
            6,144
            
            
            6,1446%
                Convertible subordinated debentures
            
            
            385
            
            
            385Accounts
                payable
            
            
            6,106
            
            
            4,011Accrued
                expenses and other
            
            
            2,136
            
            
            1,591Other
                accrued interest payable
            
            
            6,127
            
            
            5,180Liabilities
                of discontinued operations
            
            
            425
            
            
            2,033Total
                current liabilities
            
            
            44,836
            
            
            44,019Deferred
                compensation
            
            
            771
            
            
            827Total
                liabilities
            
            
            45,607
            
            
            44,846Commitments
                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
                10,084,577 shares in 2006 and 2005
            
            
            101
            
            
            101Additional
                paid-in capital
            
            
            76,125
            
            
            76,124Accumulated
                deficit
            
            
            (97,713
            )
            
            (99,895
            )Accumulated
                other comprehensive loss:Foreign
                currency translation adjustment
            
            
            (4,398
            )
            
            (4,577
            )(25,885
            )
            
            (28,247
            )Treasury
                stock, at cost, 30,940 shares
            
            
            (1,938
            )
            
            (1,938
            )Total
                stockholders’ deficit
            
            
            (27,823
            )
            
            (30,185
            )Total
                liabilities and stockholders’ deficit
            
            $
            17,784
            
            
            14,661






See
      accompanying notes to consolidated financial statements


F-3




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Consolidated
      Statements of Income and Comprehensive Income


Years
      ended December 31, 2006, 2005 and 2004


(in
      thousands, except per share amounts)





2006
            
            2005
            
            2004Sales
            
            $
            32,818
            
            
            27,819
            
            
            27,165Cost
                of sales
            
            
            21,984
            
            
            17,397
            
            
            16,104Gross
                profit
            
            
            10,834
            
            
            10,422
            
            
            11,061Selling,
                general and administrative expenses
            
            
            5,515
            
            
            5,120
            
            
            4,227Research
                and development expenses
            
            
            1,505
            
            
            1,359
            
            
            1,019Reorganization
                expense
            
            
            —
            
            
            877
            
            
            —Total
                expenses
            
            
            7,020
            
            
            7,356
            
            
            5,246Operating
                income
            
            
            3,814
            
            
            3,066
            
            
            5,815Interest
                expense
            
            
            (1,217
            )
            
            (1,080
            )
            
            (1,317
            )Interest
                income
            
            
            30
            
            
            24
            
            
            —Other
                income, net
            
            
            2
            
            
            5
            
            
            7Income
                from continuing operations before income taxes
            
            
            2,629
            
            
            2,015
            
            
            4,505Income
                tax expense
            
            
            (118
            )
            
            (160
            )
            
            (169
            )Income
                from continuing operations
            
            
            2,511
            
            
            1,855
            
            
            4,336Loss
                from discontinued operations (net of zero tax)
            
            
            (329
            )
            
            (1,045
            )
            
            (1,661
            )Net
                income
            
            $
            2,182
            
            
            810
            
            
            2,675Other
                comprehensive income:Foreign
                currency translation adjustments
            
            
            179
            
            
            (400
            )
            
            (98
            )Net
                comprehensive income
            
            $
            2,361
            
            
            410
            
            
            2,577Basic
                income (loss) per share of common stock:Continuing
                operations
            
            $
            0.25
            
            
            0.18
            
            
            0.43Discontinuing
                operations
            
            
            (0.03
            )
            
            (0.10
            )
            
            (0.17
            )$
            0.22
            
            
            0.08
            
            
            0.26Weighted
                average of shares outstanding
            
            
            10,076
            
            
            10,054
            
            
            9,972Diluted
                income (loss) per share of common stock:Continuing
                operations
            
            $
            0.25
            
            
            0.18
            
            
            0.43Discontinuing
                operations
            
            
            (0.03
            )
            
            (0.10
            )
            
            (0.17
            )$
            0.22
            
            
            0.08
            
            
            0.26Weighted
                average shares of common stock outstanding
            
            
            10,103
            
            
            10,093
            
            
            9,988






See
      accompanying notes to consolidated financial statements


F-4




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Consolidated
      Statements of Stockholders’ Deficit


Years
      ended December 31, 2006, 2005 and 2004


(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, 2003
            
            
            10,003
            
            $
            100
            
            $
            76,059
            
            $
            (4,079
            )
            $
            (103,380
            )
            $
            (1,938
            )
            
            30,940
            
            $
            (33,238
            )Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            2,675
            
            
            —
            
            
            —
            
            
            2,675Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            (98
            )
            
            —
            
            
            —
            
            
            —
            
            
            (98
            )Balance
                at December 31, 2004
            
            
            10,003
            
            
            100
            
            
            76,059
            
            
            (4,177
            )
            
            (100,705
            )
            
            (1,938
            )
            
            30,940
            
            
            (30,661
            )Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            810
            
            
            —
            
            
            —
            
            
            810Common
                stock issued
            
            
            81
            
            
            1
            
            
            65
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            66Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            (400
            )
            
            —
            
            
            —
            
            
            —
            
            
            (400
            )Balance
                at December 31, 2005
            
            
            10,084
            
            
            101
            
            
            76,124
            
            
            (4,577
            )
            
            (99,895
            )
            
            (1,938
            )
            
            30,940
            
            
            (30,185
            )Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            2,182
            
            
            —
            
            
            —
            
            
            2,182Stock
                compensation expense
            
            
            —
            
            
            —
            
            
            1
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            1Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            179
            
            
            —
            
            
            —
            
            
            —
            
            
            179Balance
                at December 31, 2006
            
            
            10,084
            
            $
            101
            
            $
            76,125
            
            $
            (4,398
            )
            $
            (97,713
            )
            $
            (1,938
            )
            
            30,940
            
            $
            (27,823
            )






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, 2006, 2005 and 2004


(In
      thousands)





2006
            
            2005
            
            2004Cash
                flows from operating activities:Net
                income
            
            $
            2,182
            
            
            810
            
            
            2,675Loss
                from discontinued operations
            
            
            329
            
            
            1,045
            
            
            1,662Stock
                compensation expense
            
            
            1
            
            
            —
            
            
            —Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:Depreciation
                and amortization
            
            
            414
            
            
            410
            
            
            278Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (1,945
            )
            
            (611
            )
            
            (1,336
            )Inventories
            
            
            (50
            )
            
            (320
            )
            
            (1,811
            )Prepaid
                expenses
            
            
            (250
            )
            
            (118
            )
            
            462Other
                assets
            
            
            (3
            )
            
            20
            
            
            (24
            )Accounts
                payable, accrued expenses and other liabilities
            
            
            3,532
            
            
            1,164
            
            
            3,158Net
                cash provided by continuing operations
            
            
            4,210
            
            
            2,400
            
            
            5,064Net
                cash used in operations of discontinued operations
            
            
            (1,748
            )
            
            (1,303
            )
            
            (3,455
            )Net
                cash provided by (used in) operations
            
            
            2,462
            
            
            1,097
            
            
            1,609Cash
                flows from investing activities:Capital
                expenditures, net
            
            
            (585
            )
            
            (415
            )
            
            (228
            )Net
                cash provided by (used in) investing of discontinued
                operations
            
            
            5
            
            
            (172
            )
            
            —Net
                cash used in investing activities
            
            
            (580
            )
            
            (587
            )
            
            (228
            )Cash
                flows from financing activities:Increase
                in senior debt
            
            
            —
            
            
            337
            
            
            287Repayments
                of senior debt
            
            
            (1,163
            )
            
            (1,336
            )
            
            —Net
                cash (used in) provided by financing activities
            
            
            (1,163
            )
            
            (999
            )
            
            287Effect
                of exchange rate changes on cash and cash equivalents
            
            
            130
            
            
            (298
            )
            
            (97
            )Increase
                (decrease) in cash and cash equivalents
            
            
            849
            
            
            (787
            )
            
            1,571Cash
                and equivalents - beginning of year
            
            
            1,253
            
            
            2,040
            
            
            469Cash
                and cash equivalents - end of year
            
            $
            2,102
            
            
            1,253
            
            
            2,040






See
      accompanying notes to consolidated financial statements.


F-6




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements


December
      31, 2006 and 2005





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





Nature
      of Operations and Principles of Consolidation





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




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




Revenue
      Recognition




Revenue,
      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.


F-7




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
        to
        Consolidated Financial Statements, continued


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.




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, 2006 and 2005, related only
      to
      the Company’s signal processing division. The Company determined that there was
      no goodwill impairment for 2006 or 2005.




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 carryforwards. 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.)


F-8




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued






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 Per Share




Basic
      net
      income 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




The
      Company had previously 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.




In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS
      123R, “Share-Based Payment,” a revision of SFAS 123 which supercedes 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.


F-9




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
        to
        Consolidated Financial Statements, continued


For
      the
      fiscal year ended December 31, 2006, the Company recognized approximately $1,000
      of non-cash compensation expense included in Selling, General and Administrative
      expense in the Consolidated Statement of Income attributable to stock options
      granted or vested subsequent to December 31, 2005. The Company used the
      Black-Scholes valuation model and straight-line amortization of compensation
      expense over the requisite service period of the grant.





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




Shares
            
            Weighted
                Average Exercise Price
              (per
                share)
            
            Weighted-Average
                Remaining Contractual Term
              (Years)
            
            Aggregate
              Intrinsic
              ValueOptions
                outstanding at beginning of period
            
            $
            337,780
            
            $
            1.39Granted
            
            
            20,000
            
            
            0.11Exercised
            
            
            —
            
            
            —Forfeited
            
            
            35,500
            
            
            3.30Options
                outstanding at end of period
            
            
            322,280
            
            
            1.33
            
            
            2.71
            
            $
            4,290Options
                exercisable at end of period
            
            
            322,280
            
            
            1.33
            
            
            2.71
            
            $
            4,290Options
                available for future grants
            
            
            977,720





The
      weighted average grant-date fair value of stock options granted during the
      period ended December 31, 2006 was $0.11 per share. As of December 31, 2006,
      there were no unrecognized stock-based compensation costs related to options
      granted under our plans as all options vested during the year.


F-10


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


Awards
      granted 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, 2005
            
            December
                31, 2004Net
                Income (loss) reported
            
            $
            810
            
            $
            2,675Deduct:
                Total stock-based employee Compensation expense determined under
                Far value
                based method
            
            
            (2
            )
            
            (1
            )Pro-forma
                net income
            
            $
            808
            
            $
            2,674Earnings
                (loss) per share:Basic
                - as reported
            
            $
            0.08
            
            $
            0.27Basic
                pro-forma
            
            
            0.08
            
            
            0.27Diluted
                - as reported
            
            $
            0.08
            
            $
            0.27Diluted
                - pro-forma
            
            
            0.08
            
            
            0.27




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%. For the fiscal year ended December 31, 2004: term of 5 years,
      dividend yield of 0.00%, volatility of 50% and risk-free interest rate of
      4.22%.




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 to provide payments on account of the senior
      debt.




Use
      of
      Estimates




The
      preparation of financial statements in accordance with generally accepted
      accounting principles


F-11




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
        to
        Consolidated Financial Statements, continued


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, stock based compensation and the deferred tax asset valuation
      allowance. Actual results could differ from the estimates.




New
      Accounting Pronouncements




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 is not expected to have a material effect on our financial
      position or results of operations.




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. . The adoption of this statement is not expected to have a material
      effect on our financial position or results of operations.




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





As
      of
      December 31, 2006, the Company ’s
      debt
      included (a) $23,513,000 of senior debt, as a result of a February 7, 2007
      extension, which matures on October 1, 2007; (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 ($5,976,000) on the subordinated
      notes or the principal ($385,000) or interest ($151,000) on the 6% Debentures.
      Accordingly, the senior debt and subordinated debt are classified as current
      liabilities (Notes 7, 8 and 9).




Although
      the Company has realized profits from operations in each of the last three
      years, after incurring losses in several previous years, its liquidity is
      impaired by both its working capital deficit, which was $31,646,000 at December
      31, 2006, 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.


F-12




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
        to
        Consolidated Financial Statements, continued


At
      December 31, 2006, 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 $23,400,000 from SHF IX, LLC and
      subsequently extended the maturity of the senior debt to October 1, 2007. The
      Company can not give any assurance that the holder of its senior debt will
      extend the loan beyond October 1, 2007. 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
      October 1, 2007 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 and the hiring of lower wage personnel in
      its
      Mexico facility. 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 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, 2006 is adequate. However, actual write-offs may differ from the
      recorded allowance.


F-13


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







The
      allowance for doubtful accounts receivable was $13,000 as of
      December 31, 2006 and 2005. The 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 $2,345,000 in
      reserve for 2006 and $2,583,000 for 2005):




December
                31,2006
            
            2005Parts
                and component
            
            $
            3,637,000
            
            
            3,022,000Work-in-process
            
            
            543,000
            
            
            460,000Finished
                goods
            
            
            411,000
            
            
            1,059,000$
            4,591,000
            
            
            4,541,000





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
            
            Estimated2006
            
            2005
            
            useful
                livesLand
            
            $
            132,000
            
            
            132,000
            
            
            —Buildings
            
            
            850,000
            
            
            850,000
            
            
            20
                yearsMachinery
                and equipment
            
            
            1,584,000
            
            
            1,209,000
            
            
            3-8
                yearsFurniture
                and fixtures
            
            
            307,000
            
            
            276,000
            
            
            5-10
                yearsTransportation
                equipment
            
            
            63,000
            
            
            33,000
            
            
            4
                yearsTools
                and molds
            
            
            1,353,000
            
            
            1,099,000
            
            
            8
                yearsLeasehold
                improvements
            
            
            251,000
            
            
            200,000
            
            
            Lesser
                of term of lease or estimated useful life of asset4,540,000
            
            
            3,799,000Less
                accumulated depreciation and amortization
            
            
            2,969,000
            
            
            2,447,000$
            1,571,000
            
            
            1,352,000





Total
      depreciation and amortization expense for 2006, 2005 and 2004 amounted to
      approximately $414,000 ,
      $410,000 and $359,000 respectively.


F-14


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


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, 2006 and 2005, 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, 2006 and 2005, the Company’s senior debt consisted of debt in the
      amount of $23,513,000 and $24,675,000, 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 October 1, 2007
      and,
      accordingly, the senior debt has been classified as a current liability. (See
      Note 2.)




In
      March
      2002, the senior lender agreed to an amended and restated loan and security
      agreement whereby a new term loan was established with a maximum principal
      amount of $1,500,000 and subsequently increased in May 2002 to $2,250,000.
      The
      agreement provides that all indebtedness prior to March 1, 2002 is reflected
      as
      an old term loan in the amount of $22,610,000, which includes the principal
      balance due at December 31, 2001 plus accrued interest through March 1, 2002.
      The old term loan bears no interest until such time as the holder of the senior
      debt, in its sole discretion, notifies the Company that interest shall be
      payable at a rate of 12%, or a default rate of 14% on a going-forward basis.
      Additionally, 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, 2006 and 2005, 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, 2006 and 2005, accrued interest on the
      debentures was $151,000 and $127,000, 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 maturity.





F-15


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


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





As
      of
      December 31, 2006 and 2005, subordinated notes in the principal amount of
      $6,144,000 were outstanding. As of December 31, 2006, $5,976,000 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 $5,976,000 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).





**(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. Currently,
      its operating activities are limited to the performance of
      contractual maintenance and warranty services which expire by June 30, 2007.
      The
      Company anticipates that all OSS operations will cease by June 30, 2007. The
      Company continues to pursue the sale of the OSS business technology and the
      remaining inventory. The Company hopes to complete the sale in 2007, but the
      Company gives no assurances that it will be successful. We do not expect OSS
      operations to be material in 2007.





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, 2006
            
            December
                31, 2005Assets
                of discontinued operations:Prepaid
                expenses
            
            $
            13,000
            
            $
            35,000Accounts
                receivable
            
            
            18,000
            
            
            184,000Inventories
            
            
            352,000
            
            
            311,000Property,
                plant and equipment
            
            
            11,000
            
            
            57,000Other
                assets
            
            
            —
            
            
            1,000Total
                assets of discontinued operations
            
            $
            394,000
            
            $
            588,000Liabilities
                of discontinued operations:Accounts
                payable and accrued expenses
            
            $
            425,000
            
            $
            2,033,000Total
                liabilities of discontinued operations
            
            $
            425,000
            
            $
            2,033,000





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








December
                31, 2006
            
            December
                31, 2005
            
            December
                31, 2004Revenues
            
            $
            333,000
            
            $
            785,000
            
            $
            2,003,000Loss
                from discontinued operations
            
            $
            (329,000
            )
            $
            (1,045,000
            )
            $
            (1,661,000
            )




F-16


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, 2006 and 2005, before discounting at a rate of 6.5%, were
      $1,317,000 .




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, 2006, 2005 and 2004, the Company’s contribution amounted to
      $44,000, $41,000 and $38,000, 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 2006, 2005 and 2004.


F-17




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
        to
        Consolidated Financial Statements, continued






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.
      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 450,000 options outstanding under this plan for future
      grants.




The
      Company’s 1999 Incentive and Non-Qualified Stock Option Plan (“1999 Plan”)
      covers 400,000 shares of common stock. Incentive stock options cannot be issued
      subsequent to ten years from the date the 1999 Plan was approved. Options under
      the 1999 Plan may be granted to key employees, including officers and directors
      of the Company and its subsidiaries, except that members and alternate members
      of the stock option committee are not eligible for options under the 1999 Plan.
      The exercise prices for all options granted were equal to the fair market value
      at the date of grant and vest as determined by the board of directors. In
      addition, the 1999 Plan provides for the automatic grant to non-management
      directors of non-qualified options to purchase 5,000 shares on May 1st of each
      year commencing May 1, 1999, based upon the average closing price of the last
      ten trading days of April of each year. Currently there are 285,000 options
      outstanding for future grants.




The
      weighted-average fair values of options granted were $0.07 per share for options
      granted in 2004, $0.14 per share for options granted in 2005 and $0.11 per
      share
      for options granted in 2006. 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 2006, 2005 and 2004:





2006
            
            2005
            
            2004Dividends:
            
            $
            0.00
                per share
            
            $
            0.00
                per share
            
            $
            0.00
                per shareVolatility:
            
            
            50
            %
            
            50
            %
            
            50
            %Risk-free
                interest:
            
            
            4.35
            %
            
            4.35
            %
            
            4.22
            %Expected
                term:
            
            
            5
                years
            
            
            5
                years
            
            
            5
                years





A
      summary
      of the status of the Company’s stock option plans as of December 31, 2006, 2005,
      and 2004, and changes during the years ending on those dates is presented below:





2006
            
            2005
            
            2004Shares
            
            Weighted
            
            Shares
            
            Weighted
            
            Shares
            
            WeightedUnder
            
            Average
            
            Under
            
            Average
            
            Under
            
            AverageOption
            
            Exercise
                Price
            
            Option
            
            Exercise
                Price
            
            Option
            
            Exercise
                PriceOutstanding
                beginning of year
            
            
            337,780
            
            $
            1.39
            
            
            322,780
            
            $
            1.45
            
            
            552,530
            
            $
            2.27Granted
            
            
            20,000
            
            
            0.11
            
            
            15,000
            
            
            0.14
            
            
            15,000
            
            
            0.07Exercised
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Forfeited
            
            
            35,500
            
            
            —
            
            
            —
            
            
            —
            
            
            (244,000
            )
            
            3.23Outstanding
                end of year
            
            
            322,280
            
            $
            1.33
            
            
            337,780
            
            $
            1.39
            
            
            322,780
            
            $
            1.45Options
                exercisable at year-end
            
            
            322,280
            
            
            
            
            
            337,780
            
            
            
            
            
            318,780





F-18


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




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





The
      provision for income taxes consists of the following:




2006
            
            2005
            
            2004Current
            
            Deferred
            
            Current
            
            Deferred
            
            Current
            
            DeferredFederal
            
            $
            —
            
            
            —
            
            
            32,000
            
            
            —
            
            
            —
            
            
            —State
                and foreign
            
            
            118,000
            
            
            —
            
            
            128,000
            
            
            —
            
            
            169,000
            
            
            —Total
            
            $
            118,000
            
            
            —
            
            
            160,000
            
            
            —
            
            
            169,000
            
            
            —





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


2006
            
            2005
            
            2004United
                States
            
            $
            1,146,000
            
            
            782,795
            
            
            2,513,000Foreign
            
            
            1,483,000
            
            
            1,231,205
            
            
            1,992,000Income
                from continuing operations before discontinued operations
            
            $
            2,629,000
            
            
            2,015,000
            
            
            4,505,000





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
      $48,350,000 expiring at various dates between 2008 and 2026. 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 $6,511,000 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, 2006 and 2005 are as
      follows:





2006
            
            2005Deferred
                tax assets:Inventory
            
            $
            933,000
            
            
            1,254,000Allowance
                for doubtful accounts receivable
            
            
            5,000
            
            
            99,000Benefits
                of tax loss carryforwards
            
            
            20,568,000
            
            
            20,361,000Benefit
                plans
            
            
            412,000
            
            
            421,000Accrued
                commissions
            
            
            88,000
            
            
            77,000Other
            
            
            2,957,000
            
            
            2,762,000Depreciation
            
            
            253,000
            
            
            364,00025,216,000
            
            
            25,338,000Valuation
                allowance
            
            $
            (25,216,000
            )
            
            (25,338,000
            )$
            —
            
            
            —




F-19




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
        to
        Consolidated Financial Statements, continued


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.




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, 2006, undistributed earnings of the foreign subsidiaries amounted
      to approximately $2,692,000. 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, 2006, the Company and its subsidiaries leased manufacturing and
      administrative facilities, equipment and automobiles under a number of operating
      leases. The Company is required to pay increases in real estate taxes on the
      facilities in addition to minimum rents. Total rent expense for 2006, 2005,
      and
      2004 amounted to approximately $614,000, $594,000 and $581,000, respectively.
      Minimum rental commitments, exclusive of future escalation charges,
      for each of the next five years are as follows:





2007
            
            $
            591,0002008
            
            
            294,0002009
            
            
            264,0002010
            
            
            264,0002011
            
            
            264,000Thereafter
            
            
            2,181,000$
            3,858,000





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





Porta’s five **** largest
      customers accounted for sales of $23,333,000, or approximately 70% of sales, for
      2006, $17,431,000
      or approximately 61% of sales, for
      2005 and
      $15,443,000 or approximately 53% of sales, for
      2004. British
      Telecommunications PLC was
      Porta’s largest customer for 2006, accounting for sales of $9,614,000 or
      approximately 29%. For 2005, British Telecommunications was also Porta’s largest
      customer accounting for sales of $5,641,000 or approximately 20% of sales.
      Fujitsu Telecommunications Europe LTD was the largest customer for 2004,
      accounting for sales of $4,772,000,
      or approximately 16%
      of
      sales. A
      significant amount of sales of the Company’s products for use by British
      Telecommunications was sold to Fujitsu as purchasing agent for British
      Telecommunications. As a result, most of the sales
      to
      Fujitsu Telecommunications were for use by British Telecommunications. Direct
      sales to British Telecommunications were $2,259,000, or 8% of sales, for
      2004


F-20


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


**(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.





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





In
      both
      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 257,280, 292,780 and 277,780,
      shares of common stock for 2006, 2005 and 2004, respectively, with exercise
      prices ranging from $0.32 to $3.85, $0.30 to $3.85 and $0.02 to $3.85 for 2006,
      2005 and 2004, 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, 2006 is as
      follows:





2006
            
            2005
            
            2004Cash
                paid for interest
            
            $
            169
            
            $
            1,130
            
            $
            116Cash
                paid for income taxes
            
            $
            0
            
            $
            115
            
            $
            69





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-21




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.




2006
            
            2005
            
            2004**Revenue:**Line
            
            $
            27,188,000
            
            $
            21,982,000
            
            $
            21,545,000Signal
            
            
            5,292,000
            
            
            5,710,000
            
            
            5,551,000$
            32,480,000
            
            $
            27,692,000
            
            $
            27,096,000**Segment
                profit (loss):**Line
            
            $
            4,688,000
            
            
            4,345,000
            
            
            5,784,000Signal
            
            
            1,640,000
            
            
            2,134,000
            
            
            2,124,000$
            6,328,000
            
            $
            6,479,000
            
            $
            7,908,000**Depreciation
                and amortization:**Line
            
            $
            315,000
            
            
            310,000
            
            
            263,000Signal
            
            
            34,000
            
            
            31,000
            
            
            27,000$
            349,000
            
            
            341,000
            
            
            290,000**Total
                identifiable assets:**Line
            
            $
            9,667,000
            
            
            7,626,000
            
            
            6,525,000Signal
            
            
            5,159,000
            
            
            4,775,000
            
            
            4,562,000$
            14,826,000
            
            
            12,401,000
            
            
            11,087,000**Capital
                expenditures:**Line
            
            $
            517,000
            
            
            357,000
            
            
            132,000Signal
            
            
            60,000
            
            
            37,000
            
            
            72,0000
            
            
            0
            
            
            0$
            577,000
            
            
            394,000
            
            
            204,000






F-22




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
        to
        Consolidated Financial Statements, continued


The
      following table reconciles segment totals to consolidated totals:




2006
            
            2005
            
            2004**Revenue:**Total
                revenue for reportable segments
            
            $
            32,480,000
            
            
            27,692,000
            
            
            27,096,000Other
                revenue
            
            
            338,000
            
            
            127,000
            
            
            69,000Consolidated
                total revenue
            
            $
            32,818,000
            
            
            27,819,000
            
            
            27,165,000**Operating
                income :**Total
                segment income for reportable segments
            
            $
            6,328,000
            
            
            6,479,000
            
            
            7,908,000Corporate
                and unallocated
            
            
            (2,514,000
            )
            
            (3,413,000
            )
            
            (2,093,000
            )Consolidated
                total operating income
            
            $
            3,814,000
            
            
            3,066,000
            
            
            5,815,000**Depreciation
                and amortization:**Total
                for reportable segments
            
            $
            349,000
            
            
            341,000
            
            
            290,000Corporate
                and unallocated
            
            
            65,000
            
            
            69,000
            
            
            69,000Consolidated
                total deprecation and amortization
            
            $
            414,000
            
            
            410,000
            
            
            359,000**Total
                assets:**Total
                for reportable segments
            
            $
            14,826,000
            
            
            12,401,000
            
            
            11,087,000Corporate
                and unallocated
            
            
            2,564,000
            
            
            1,672,000
            
            
            2,564,000Assets
                of discontinued operations
            
            
            394,000
            
            
            588,000
            
            
            787,000Consolidated
                total assets
            
            $
            17,784,000
            
            
            14,661,000
            
            
            14,438,000**Capital
                expenditures:**Total
                for reportable segments
            
            $
            577,000
            
            
            394,000
            
            
            204,000Corporate
                and unallocated
            
            
            8,000
            
            
            21,000
            
            
            24,000Consolidated
                total capital expenditures
            
            $
            585,000
            
            
            415,000
            
            
            228,000





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





2006
            
            2005
            
            2004**Revenue:**United
                States
            
            $
            9,625,000
            
            
            10,120,000
            
            
            9,809,000United
                Kingdom
            
            
            20,725,000
            
            
            14,542,000
            
            
            14,217,000Other
                Europe
            
            
            0
            
            
            0
            
            
            29,000Latin
                America
            
            
            0
            
            
            0
            
            
            158,000Other
                North America
            
            
            2,468,000
            
            
            3,157,000
            
            
            2,952,000Consolidated
                total revenue
            
            $
            32,818,000
            
            
            27,819,000
            
            
            27,165,000**Consolidated
                long-lived assets**:United
                States
            
            $
            4,241,000
            
            
            4,055,000
            
            
            3,843,000United
                Kingdom
            
            
            44,000
            
            
            77,000
            
            
            169,000Other
                North America
            
            
            298,000
            
            
            288,000
            
            
            352,0004,583,000
            
            
            4,420,000
            
            
            4,364,000Current
                and other assets
            
            
            13,201,000
            
            
            10,241,000
            
            
            10,074,000Consolidated
                total assets
            
            $
            17,784,000
            
            
            14,661,000
            
            
            14,438,000





F-23




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
        to
        Consolidated Financial Statements, continued


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





The
      following presents certain unaudited quarterly financial data:





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
            )
            
            (83,000
            )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
            )








Quarter
                EndedMarch
                31, 2005
            
            June
                30, 2005
            
            September
                30, 2005
            
            December
                31, 2005Net
                sales
            
            $
            7,407,000
            
            $
            8,223,000
            
            $
            6,875,000
            
            $
            5,314,000Gross
                profit
            
            
            3,158,000
            
            
            3,275,000
            
            
            2,446,000
            
            
            1,543,000Loss
                from discontinued operations
            
            
            (273,000
            )
            
            (263,000
            )
            
            (166,000
            )
            
            (343,000
            )Net
                income (loss)
            
            
            1,203,000
            
            
            887,000
            
            
            107,000
            
            
            (1,387,000
            )Income
                per share from continuing operations
            
            
            0.14
            
            
            0.11
            
            
            0.03
            
            
            (0.10
            )(Loss)
                per share from discontinued operations
            
            
            (0.03
            )
            
            (0.02
            )
            
            (0.02
            )
            
            (0.03
            )




During
      the first three quarters of 2005, the Company had incurred approximately
      $450,000 in reorganization expenses attributed to investment banking, legal
      and
      accounting expenses, as well as legal and other expenses incurred by the holder
      of our senior debt. The expenses were included in *“Prepaid
      expenses and other current assets.”* In
      the
      fourth quarter of 2005 the Company incurred additional expenses of $427,000.
      At
      December 31, 2005, the Company expensed the $877,000.


F-24




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 23, 2007, 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, 2006. 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, LLP


BDO
      Seidman, LLP






Melville,
      New York


March
      23,
      2007


F-25




Schedule
      II


**PORTA
                SYSTEMS CORP****VALUATION
                AND QUALIFYING ACCOUNTS**




**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, 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
            
            
            2,583YEAR
                ENDED DECEMBER 31, 2004Allowance
                for doubtful accounts
            
            $
            848
            
            $
            34
            
            $
            80
            
            $
            802Inventory
                reserve
            
            
            2,936
            
            
            515
            
            
            825
            
            
            2,626





F-26