SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


FORM
10-Q


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


SECURITIES
EXCHANGE ACT OF 1934





For the
quarterly period ended September 30, 2009





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


SECURITIES
EXCHANGE ACT OF 1934





For the
transition period from_____________to_____________


Commission
file number 0-8460





PORTA SYSTEMS
CORP.


(Exact
name of registrant as specified in its charter)





Delaware
              11-2203988(State
      or other jurisdiction of
              (I.R.S.
      Employerincorporation
      or organization)
              Identification
      No.)





6851 Jericho Turnpike, Suite
170, Syosset, New York 11791


(Address
of principal executive offices, including ZIP Code)





516-364-9300


(Company’s
telephone number, including area code)





Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 of 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 whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).    ̈
Yes   ̈
No.





Indicate
by a 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 Exchange Act. Check
one:


Large accelerated filer ̈Accelerated
filer ̈Non-accelerated
filer ̈      Smaller reporting companyx





Indicate
by a check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).  Yes  ̈No
x





Indicate
the number of shares outstanding of each of the issuer’s classes of common stock
as of the latest practicable date:





Common
stock (par value $0.01) 9,954,569 shares as of November 10, 2009.









PART
I.- FINANCIAL INFORMATION


Item
1- Financial
Statements


PORTA
SYSTEMS CORP. AND SUBSIDIARIES


Consolidated
Balance Sheets


(In
thousands, except shares and par value)


UnauditedSeptember
      30,2009
                                                        
                                                        
                                                        December
      31,2008AssetsCurrent
      assets:Cash
      and cash equivalents
                                                        
                                                        $
                                                        222
                                                        
                                                        
                                                        $
                                                        292Accounts
      receivable - trade, less allowance for doubtful accounts of $20 in 2009
      and $30 in 2008
                                                        
                                                        
                                                        3,095
                                                        
                                                        
                                                        
                                                        4,554Inventories
                                                        
                                                        
                                                        5,119
                                                        
                                                        
                                                        
                                                        6,110Prepaid
      expenses and other current assets
                                                        
                                                        
                                                        352
                                                        
                                                        
                                                        
                                                        202Total
      current assets
                                                        
                                                        
                                                        8,788
                                                        
                                                        
                                                        
                                                        11,158Property,
      plant and equipment, net
                                                        
                                                        
                                                        1,539
                                                        
                                                        
                                                        
                                                        1,564Goodwill
                                                        
                                                        
                                                        2,961
                                                        
                                                        
                                                        
                                                        2,961Other
      assets
                                                        
                                                        
                                                        78
                                                        
                                                        
                                                        
                                                        78Total
      assets
                                                        
                                                        $
                                                        13,366
                                                        
                                                        
                                                        $
                                                        15,761Liabilities and Stockholders’
      DeficitCurrent
      liabilities:Senior
      debt including interest
                                                        
                                                        $
                                                        1,355
                                                        
                                                        
                                                        $
                                                        1,500Subordinated
      notes including interest
                                                        
                                                        
                                                        191
                                                        
                                                        
                                                        
                                                        1916%
      subordinated debentures, principal
                                                        
                                                        
                                                        385
                                                        
                                                        
                                                        
                                                        385Accounts
      payable
                                                        
                                                        
                                                        4,208
                                                        
                                                        
                                                        
                                                        5,529Accrued
      expenses and other
                                                        
                                                        
                                                        2,036
                                                        
                                                        
                                                        
                                                        2,390Accrued
      interest payable
                                                        
                                                        
                                                        912
                                                        
                                                        
                                                        
                                                        336Total
      current liabilities
                                                        
                                                        
                                                        9,087
                                                        
                                                        
                                                        
                                                        10,331Long
      term liabilities:Senior
      Debt including interest
                                                        
                                                        
                                                        17,764
                                                        
                                                        
                                                        
                                                        18,056Subordinated
      notes including interest
                                                        
                                                        
                                                        2,624
                                                        
                                                        
                                                        
                                                        2,767Deferred
      compensation and other long term liabilities
                                                        
                                                        
                                                        621
                                                        
                                                        
                                                        
                                                        651Total
      long term liabilities
                                                        
                                                        
                                                        21,009
                                                        
                                                        
                                                        
                                                        21,474Total  liabilities
                                                        
                                                        
                                                        30,096
                                                        
                                                        
                                                        
                                                        31,805Commitments
      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 9,957,354 at
      September 30, 2009 and December 31, 2008
                                                        
                                                        
                                                        100
                                                        
                                                        
                                                        
                                                        100Additional
      paid-in capital
                                                        
                                                        
                                                        76,244
                                                        
                                                        
                                                        
                                                        76,244Accumulated
      deficit
                                                        
                                                        
                                                        (85,464
                                                        )
                                                        
                                                        
                                                        (85,307
                                                        )Accumulated
      other comprehensive loss:Foreign
      currency translation adjustment
                                                        
                                                        
                                                        (5,672
                                                        )
                                                        
                                                        
                                                        (5,143
                                                        )(14,792
                                                        )
                                                        
                                                        
                                                        (14,106
                                                        )Treasury
      stock, at cost, 2,785 shares
                                                        
                                                        
                                                        (1,938
                                                        )
                                                        
                                                        
                                                        (1,938
                                                        )Total
      stockholders’ deficit
                                                        
                                                        
                                                        (16,730
                                                        )
                                                        
                                                        
                                                        (16,044
                                                        )Total
      liabilities and stockholders’ deficit
                                                        
                                                        $
                                                        13,366
                                                        
                                                        
                                                        $
                                                        15,761





See
accompanying notes to consolidated financial statements





Page 1 of
22





PORTA
SYSTEMS CORP. AND SUBSIDIARIES


Unaudited
Consolidated Statements of Operations and Comprehensive (Loss)
Income


(In
thousands, except per share amounts)


Nine months endedSeptember 30,
                              
                              
                              September 30,2009
                              
                              
                              2008Sales
                              
                              $
                              21,163
                              
                              
                              $
                              19,527Cost
      of sales
                              
                              
                              15,485
                              
                              
                              
                              14,779Gross
      profit
                              
                              
                              5,678
                              
                              
                              
                              4,748Selling,
      general and administrative expenses
                              
                              
                              3,927
                              
                              
                              
                              3,847Research
      and development expenses
                              
                              
                              1,014
                              
                              
                              
                              1,136Total
      expenses
                              
                              
                              4,941
                              
                              
                              
                              4,983Operating
      income (loss)
                              
                              
                              737
                              
                              
                              
                              (235
                              )Interest
      expense, net
                              
                              
                              (705
                              )
                              
                              
                              (1,393
                              )Other
      income, net
                              
                              
                              19
                              
                              
                              
                              26Income
      (loss) before income taxes and extraordinary gain
                              
                              
                              51
                              
                              
                              
                              (1,602
                              )Income
      tax expense
                              
                              
                              (208
                              )
                              
                              
                              (53
                              )Net
      loss before extraordinary gain
                              
                              
                              (157
                              )
                              
                              
                              (1,655
                              )Extraordinary
      gain on troubled debt restructure (net of zero tax)
                              
                              
                              -
                              
                              
                              
                              17,645Net
      (loss) income
                              
                              $
                              (157
                              )
                              
                              $
                              15,990Other
      comprehensive loss:Foreign
      currency translation adjustments
                              
                              
                              (529
                              )
                              
                              
                              (362
                              )Comprehensive
      (loss) income
                              
                              $
                              (686
                              )
                              
                              $
                              15,628Basic
      (loss) income per share of common stock:Continuing
      operations
                              
                              $
                              (0.02
                              )
                              
                              $
                              (0.57
                              )Extraordinary
      item
                              
                              
                              -
                              
                              
                              
                              6.05$
                              (0.02
                              )
                              
                              $
                              5.48Weighted
      average shares outstanding
                              
                              
                              9,955
                              
                              
                              
                              2,916Diluted
      (loss) income per share of common stock:Continuing
      operations
                              
                              $
                              (0.02
                              )
                              
                              $
                              (0.54
                              )Extraordinary
      item
                              
                              
                              -
                              
                              
                              
                              5.79$
                              (0.02
                              )
                              
                              $
                              5.25Weighted
      average shares outstanding
                              
                              
                              9,955
                              
                              
                              
                              3,043




See
accompanying notes to unaudited consolidated financial statements.





Page 2 of
22




PORTA
SYSTEMS CORP. AND SUBSIDIARIES


Unaudited
Consolidated Statements of Operations and Comprehensive Income


(In
thousands, except per share amounts)





Three Months EndedSeptember 30,
                
                
                September 30,2009
                
                
                2008Sales
                
                $
                7,088
                
                
                $
                6,305Cost
      of sales
                
                
                4,911
                
                
                
                5,239Gross
      profit
                
                
                2,177
                
                
                
                1,066Selling,
      general and administrative expenses
                
                
                1,294
                
                
                
                1,222Research
      and development expenses
                
                
                348
                
                
                
                341Total
      expenses
                
                
                1,642
                
                
                
                1,563Operating
      income (loss) income
                
                
                535
                
                
                
                (497
                )Interest
      expense, net
                
                
                (240
                )
                
                
                (213
                )Other
      income, net
                
                
                4
                
                
                
                17Income
      (loss) before income taxes
                
                
                299
                
                
                
                (693
                )Income
      tax expense
                
                
                (60
                )
                
                
                (16
                )Net
      income (loss) before extraordinary gain
                
                
                239
                
                
                
                (709
                )Extraordinary
      gain on troubled debt restructure (net of zero tax)
                
                
                -
                
                
                
                17,645Net
      income
                
                $
                239
                
                
                $
                16,936Other
      comprehensive loss:Foreign
      currency translation adjustments
                
                
                (218
                )
                
                
                (240
                )Comprehensive
      income (loss)
                
                $
                21
                
                
                $
                16,696Basic
      income per share of common stock:Continuing
      operations
                
                $
                0.02
                
                
                $
                (0.10
                )Extraordinary
      item
                
                
                -
                
                
                
                2.54$
                0 .02
                
                
                $
                2.44Weighted
      average shares outstanding
                
                
                9,955
                
                
                
                6,937Diluted
      income per share of common stock:Continuing
      operations
                
                $
                0.02
                
                
                $
                (0.10
                )Extraordinary
      item
                
                
                -
                
                
                
                2.53$
                0.02
                
                
                $
                2.43Weighted
      average shares outstanding
                
                
                10,121
                
                
                
                6,966




See
accompanying notes to unaudited consolidated financial statements.





Page 3 of
22





PORTA
SYSTEMS CORP. AND SUBSIDIARIES


Unaudited
Consolidated Statements of Cash Flows


(In
thousands)





Nine months endedSeptember 30,
                          
                          
                          September 30,2009
                          
                          
                          2008Cash
      flows from operating activities of continuing operations:Net
      income (loss)
                          
                          $
                          (157
                          )
                          
                          $
                          15,990Adjustments
      to reconcile net income (loss) to net cash provided by(used
      in) operating activities of continuing operations:Extraordinary
      gain on debt restructuring
                          
                          
                          -
                          
                          
                          
                          (16,287
                          )Stock
      based compensation expense
                          
                          
                          -
                          
                          
                          
                          7Depreciation
      and amortization
                          
                          
                          222
                          
                          
                          
                          249Inventory
      reserve
                          
                          
                          25
                          
                          
                          
                          (384
                          )Allowance
      for bad debt
                          
                          
                          (10
                          )
                          
                          
                          (30
                          )Changes
      in operating assets and liabilities:Accounts
      receivable
                          
                          
                          1,630
                          
                          
                          
                          360Inventories
                          
                          
                          1,012
                          
                          
                          
                          (290
                          )Prepaid
      expenses and other current assets
                          
                          
                          (75
                          )
                          
                          
                          (195
                          )Other
      assets
                          
                          
                          (44
                          )
                          
                          
                          (3
                          )Accounts
      payable, accrued expenses and other liabilities
                          
                          
                          (1,185
                          )
                          
                          
                          309Net
      cash provided by (used in) operations
                          
                          
                          1,418
                          
                          
                          
                          (274
                          )Cash
      flows from investing activities:Capital
      expenditures, net
                          
                          
                          (202
                          )
                          
                          
                          (103
                          )Net
      cash used in investing activities
                          
                          
                          (202
                          )
                          
                          
                          (103
                          )Cash
      flows from financing activities:Borrowings
      of senior debt
                          
                          
                          -
                          
                          
                          
                          600Repayment
      of debt
                          
                          
                          (584
                          )
                          
                          
                          (274
                          )Net
      cash (used in) provided by financing activities
                          
                          
                          (584
                          )
                          
                          
                          326Effect
      of exchange rate changes on cash
                          
                          
                          (702
                          )
                          
                          
                          (71
                          )Decrease
      in cash and cash equivalents
                          
                          
                          (70
                          )
                          
                          
                          (122
                          )Cash
      and cash equivalents - beginning of the year
                          
                          
                          292
                          
                          
                          
                          494Cash
      and cash equivalents - end of the period
                          
                          $
                          222
                          
                          
                          $
                          372Supplemental
      cash flow disclosure:Cash
      paid for interest expense
                          
                          $
                          274
                          
                          
                          $
                          5Cash
      paid for income taxes
                          
                          $
                          176
                          
                          
                          $
                          4Non-Cash
      Financing and Investing:Non-cash
      exchange of common stock issued in debt restructure
                          
                          $
                          -
                          
                          
                          $
                          100Interest
      accrued and forgiven in accordance withSFAS
      15 (FASB ASC 470-60 and 310-40)“Troubled
      Debt Restructure" during the period
                          
                          $
                          -
                          
                          
                          $
                          (1,358
                          )




See
accompanying notes to unaudited consolidated financial statements.





Page 4 of
22




PORTA
SYSTEMS CORP. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





Note
      1:
            Management’s
      Responsibility for Interim Financial Statements Including AllAdjustments
      Necessary for Fair Presentation





Management
acknowledges its responsibility for the preparation of the accompanying interim
consolidated financial statements which reflect all adjustments, consisting of
normal recurring adjustments, considered necessary in its opinion for a fair
presentation of its consolidated financial position and the results of its
operations for the interim period presented.  These consolidated
financial statements should be read in conjunction with the summary of
significant accounting policies and notes to consolidated financial statements
included in the Company’s Form 10-K annual report for the year ended December
31, 2008. 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 in
the financial statements.  The audit opinion included in the December
31, 2008 Form 10-K annual report contained an explanatory paragraph regarding
the Company’s ability to continue as a going concern.  The factors
which resulted in the explanatory paragraph are continuing. Results for the
third quarter or the first nine months of 2009 are not necessarily indicative of
results for the year. Certain reclassifications have been made to the prior
consolidated financial statements to conform to the current year
presentation.





On July
31, 2008, the Company amended its certificate of incorporation to effect a
one-for-11.11 reverse split pursuant to which each share of common stock was
converted into 0.0900090009 shares of common stock.  Neither the par value nor
the number of authorized shares was changed as a result of the reverse
split.The financial statements give retroactive effect to the
reverse split.





For
purposes of determining whether a post-balance sheet event should be evaluated
to determine whether it has an effect on the financial statements for the period
ending September 30, 2009, subsequent events were evaluated by the Company as of
November 12, 2009, the date on which the Form 10-Q, which included the unaudited
consolidated financial statements at and for the quarter ended September 30,
2009, was available to be issued.





Note 2:
Inventories





Inventories are stated at the lower of
cost (on the average or first-in, first-out method) or market.  The
composition of inventories at the end of the respective periods is as follows
(net of reserve of $1,904,000 for September 30, 2009 and $1,876,000 for December
31, 2008):





September 30, 2009
                            
                            
                            December 31, 2008Parts
      and components
                            
                            $
                            3,532,000
                            
                            
                            $
                            3,735,000Work-in-process
                            
                            
                            833,000
                            
                            
                            
                            1,176,000Finished
      goods
                            
                            
                            754,000
                            
                            
                            
                            1,199,000$
                            5,119,000
                            
                            
                            $
                            6,110,000




Page 5 of
22




Note
3: Senior and Subordinated Debt





During
the quarter ended September 30, 2008, the Company issued common stock and
restructured the senior debt as part of a troubled debt restructuring under SFAS
15 (FASB ASC 470-60 and 310-40), “Accounting by Debtors and Creditors for
Troubled Debt Restructuring.”  Accordingly, the interest accrued
through maturity was included in the amount of the note reflected on the
September 30, 2008 balance sheet. The convertible debentures were not changed as
a result of the troubled debt restructuring.  On January 1, 2009, the
payment terms for the senior notes were revised and extended, and on May 1,
2009, June 1, 2009, August 1, 2009 and September 1, 2009, the payment terms for
the floating rate working capital senior note were revised.  The five
modifications in 2009 were treated as troubled debt
restructurings.  Since these modifications did not reduce the future
cash payments below the carrying amount of the liability on the balance sheet as
of the date of the modification, as required by the Troubled Debt Restructuring
by Debtors topic of FASB ASC 470-60 and 310-40, the additional interest
resulting from the revised payment schedule is to be accounted for under the
interest method and amortized to effectuate a consistent yield over the
remaining term of the senior note.  (See Note 8-Subsequent
Event)




The
following table sets forth information as to the Company’s senior and
subordinated debt as of September 30, 2009 and December 31, 2008.





September 30, 2009
                
                
                December 31, 200812.5%
      senior note payable in installments through September 30, 2016, including
      interest of $6,165,000 at September 30, 2009 and December 31, 2008
      (1)(2)
                
                $
                17,766,000
                
                
                $
                17,766,000Floating
      rate working capital senior note, including interest of $0 at September
      30, 2009 and $54,000 at December 31, 2008 (1)(3)
                
                
                1,353,000
                
                
                
                1,790,00010%
      Subordinated notes due in installments through January 31, 2016, including
      interest of $1,082,000 at September 30, 2009 and $1,256,000 at December
      31, 2008 (4)
                
                
                2,815,000
                
                
                
                2,958,000Subordinated
      debentures (5)
                
                
                385,000
                
                
                
                385,000





(1)
            The
      senior debt is secured by a security interest in substantially all of the
      Company’s and its subsidiaries’
assets.




(2)
            This
      note initially provided for a maturity of March 31, 2015 with scheduled
      payments over the term of the note.  As a result of a January 1,
      2009 modification, the maturity date and the payment schedule were
      revised.  At September 30, 2009, the note provides for twelve
      quarterly installments each in the amount of $375,000, with the first
      payment being due on June 30, 2010, followed by 13 quarterly installments
      of principal and interest each in the amount of $500,000, with a final
      payment of all remaining principal and accrued interest on September 30,
      2016.  Payments are applied first to accrued interest and any
      remainder to principal.




(3)
            These
      notes bear interest at the six-month LIBOR rate plus 10% per annum, which
      was 10.6% per annum at September 30, 2009 and 11.7% at December 31,
      2008.  Effective September 1, 2009, the working capital senior
      note was replaced with a new working capital note in the amount of
      $1,401,522.  The new note provides for monthly payments of
      $62,500 commencing September 30, 2009, with a final payment of the
      remaining principal and interest on December 31, 2010.  Payments
      are applied first to accrued interest and any remainder to
      principal.  During the third quarter of 2009 and for the nine
      months ended September 30, 2009, the Company made payments of $175,000,
      and $550,000, of which $53,000 and $128,000 was interest and $122,000 and
      $422,000 was principal, respectively. The new working capital note is
      collateralized by all of the assets of the Company which also secures the
      existing senior debt. (See Note 8-Subsequest
  Event)




(4)
            These
      notes are payable based upon a 25-year amortization schedule and mature
      January 31, 2016.




Page 6 of
22




(5)
            At
      September 30, 2009 and December 31, 2008, accrued interest on these notes
      was $352,000 and $326,000, respectively, and the interest is included in
      accrued interest payable.  The trustee of the debentures gave
      notice to the Company that the non-payment caused an event of default. The
      convertibility feature associated with the debentures expired upon their
      stated maturity date, which was July 1, 2002.  The holder of the
      senior debt precluded the Company from making payments on the debentures,
      except that, pursuant to the debt restructuring, the Company offered the
      holders of the debentures the right to exchange their debentures for their
      proportionate shares of (a) subordinated notes in the principal amount of
      $100,000, (b) 100,546 shares of common stock, and (c) the Company may make
      the payments provided in the new notes.  As of September 30,
      2009, no holders of the debentures had accepted the Company’s
      offer.




The
holder of the senior debt has no obligation to make any further loans or
modification of the loans to the Company.  Any adverse events,
including declines in business, could cause a default on the debt and could
affect the decision of the senior debt holder to extend or demand
payment.  If the senior debt holder demands payment of all or a
significant portion of the senior debt when due, the Company will not be able to
continue in business.





Note
4: Accounting for Stock Based Compensation





For the
nine months ended September 30, 2009, the Company issued nonqualified stock
options to purchase 20,000 shares of common stock at an exercise price of $0.022
per share to non-management directors under its 2009
Plan.   Options under this Plan have a term of 10 years. The
Company uses the Black-Scholes valuation model and straight-line amortization of
compensation expense over the requisite service period when granting stock
options.  All options previously granted are fully vested. Based on
the Black-Scholes valuation model there is a diminimus non-cash compensation
expense attributable to stock options granted during the quarter which is not
reflected in the consolidated statements of operations. Stock compensation
expense for all vested options to date is immaterial.





As part
of the debt restructuring which occurred in the third quarter of 2008, the board
of directors determined that the number of shares subject to outstanding options
and the exercise prices, which range from $2.03 per share to $0.03 per share,
were not affected by the reverse split.  Options under the prior plan
have a term of 10 years from the original date of grant.  The Company
uses the Black-Scholes valuation model and straight-line amortization of
compensation expense over the requisite service period when granting stock
options.  All options previously granted are fully vested. Based on
the Black-Scholes valuation model there is a diminimus non-cash compensation
expense attributable to stock options granted during the second quarter which is
not reflected in the consolidated statements of operations. Stock compensation
expense for all vested options was immaterial.





The
Company issued 603,277 shares of common stock, representing 6% of the common
stock outstanding after giving effect to the reverse split and the issuances of
all shares issued and issuable pursuant to the debt restructuring, to key
employeesas part of
the debt restructuring on July 31, 2008.  The value of the
stock compensation of approximately $7,000 was based on the Company’s common
stock price on the date the stock was granted.





Warrants
to purchase 201,093 shares of common stock were granted in the quarter ended
September 30, 2008 at an exercise price equal to the average closing price of
the common stock on the five trading days commencing August 31, 2008 which was
$0.10.  The warrants have an exercisable life of five
years.   Based on the Black-Scholes
valuation model the value of the warrants was $12,100.The
volatility of the Company’s common stock was estimated by management based on
the historical volatility of the Company’s common stock, the risk-free interest
rate was based on the US Treasury Rates published by the U.S. Federal Reserve
for periods applicable to the estimated life of the warrant, and the expected
dividend yield was based on the current and expected dividend
policy.





Page 7 of
22




Note 5: Segment
Data





The
Companydevelops,
designs, manufactures and markets a range of standard and proprietary
telecommunications equipment and signal processing equipment for sale
domestically and internationally. Our core products, focused on ensuring
communications for providers worldwide, fall principally into two
categories:





Voice and
Data Connection and Protection Equipment.These
products, which we refer to as our connection /protection equipment, are used to
connect copper wire lines, automated digital subscriber lines (“ADSL”), wireless
networks, fiber connection/protection lines (“FTTX”), and security networks, and
to protect equipment from voltage surges. We market our connection and
protection products to telephone operating companies, customer premise providers
and installers and security providers and installers throughout the
world.





Signal
Processing Equipment.Signal
processing products are sold principally for use in defense and aerospace
applications and support copper wire-based communications systems. Our signal
processing products provide network infrastructure in data-transmission
applications.  Customers for signal processing equipment are major
U.S. aircraft, naval ship and ground-based vehicle manufacturers, as well as
their systems integrators.





The
factors used to determine the 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 other, and management evaluates
segment performance based on operating income.





There has
been no significant change, from December 31, 2008, in the basis of measurement
of segment revenues and profit or loss, and no significant change in the
Company’s assets for the connection /protection and signal reporting segments
(dollars in thousands).





Nine Months ended
                
                
                Three Months EndedSeptember 30,
                
                
                September 30,
                
                
                September 30,
                
                
                September 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Sales:Line
                
                $
                16,724
                
                
                $
                15,992
                
                
                $
                5,615
                
                
                $
                5,145Signal
                
                
                4,439
                
                
                
                3,535
                
                
                
                1,473
                
                
                
                1,160Total
                
                $
                21,163
                
                
                $
                19,527
                
                
                $
                7,088
                
                
                $
                6,305Segment
      profit:Line
                
                $
                1,216
                
                
                $
                637
                
                
                $
                700
                
                
                $
                (260
                )Signal
                
                
                1,350
                
                
                
                724
                
                
                
                416
                
                
                
                220Total
                
                $
                2,566
                
                
                $
                1,361
                
                
                $
                1,116
                
                
                $
                (40
                )





Page 8 of
22




The
following table reconciles segment totals to consolidated totals (dollars in
thousands):





Nine Months ended
                      
                      
                      Three Months EndedSeptember 30,
                      
                      
                      September 30,
                      
                      
                      September 30,
                      
                      
                      September 30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Operating
      income:Total
      segment income (loss)for
      reportable segments
                      
                      $
                      2,566
                      
                      
                      $
                      1,361
                      
                      
                      $
                      1,116
                      
                      
                      $
                      (40
                      )Corporate
      and unallocated
                      
                      
                      (1,829
                      )
                      
                      
                      (1,596
                      )
                      
                      
                      (581
                      )
                      
                      
                      (457
                      )Consolidated
      totaloperating
      income (loss)
                      
                      $
                      737
                      
                      
                      $
                      (235
                      )
                      
                      $
                      535
                      
                      
                      $
                      (497
                      )





Note
6: Significant
Customers




Sales to
British Telecommunications and its systems integrators and Teléfonos de Mexico
S.A. de C.V. (Telmex) accounted for approximately 59% of sales in the nine
months of 2009, and 56% of sales for the same period in 2008, and 58% for the
quarters ended September 30, 2009 and 2008.  The following table sets
forth information as to sales to each customer or customer group that accounted
for 10% or more of the Company’s sales for the nine and three months ended
September 30, 2009 and 2008 (dollars in thousands):


Nine Months Ended September 30,
                              
                              
                              Three Months Ended September 30,2009
                              
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008Customer
                              
                              Dollars
                              
                              
                              %
                              
                              
                              Dollars
                              
                              
                              %
                              
                              
                              Dollars
                              
                              
                              %
                              
                              
                              Dollars
                              
                              
                              %British
      Telecommunications
                              
                              $
                              7,047
                              
                              
                              
                              33
                              %
                              
                              $
                              7,005
                              
                              
                              
                              36
                              %
                              
                              $
                              2,713
                              
                              
                              
                              38
                              %
                              
                              $
                              2,125
                              
                              
                              
                              34
                              %British
      Telecommunications and its Systems Integrators*
                              
                              
                              7,516
                              
                              
                              
                              36
                              %
                              
                              
                              7,962
                              
                              
                              
                              41
                              %
                              
                              
                              2,732
                              
                              
                              
                              39
                              %
                              
                              
                              2,194
                              
                              
                              
                              35
                              %Teléfonos
      de México S.A. de C.V. (Telmex)
                              
                              
                              4,956
                              
                              
                              
                              23
                              %
                              
                              
                              2,881
                              
                              
                              
                              15
                              %
                              
                              
                              1,355
                              
                              
                              
                              19
                              %
                              
                              
                              1,436
                              
                              
                              
                              23
                              %




*
Sales to British Telecommunications are included in the sales and percentages
figures on the line “British Telecommunications and its Systems
Integrators”.





Note
7:  Reverse split





The
Company’s board of directors and the holder of 70% of its common stock approved
a one-for-500 reverse split of the common stock.  As part of the
reverse split, the Company will pay cash for fractional shares.  The
reverse split will become effective at least 20 days after the Company mails its
information statement describing the reverse split to its stockholders and a
certificate of amendment to the Company’s certificate of incorporation is filed
with the Secretary of State of the State of Delaware.  The information
statement has not been mailed to the stockholders as of the filing of this form
10-Q.





Note
8: Subsequent
events




Effective
November 1, 2009, the working capital senior note was replaced with a new
working capital note in the amount of $1,365,056. The new note provides for
monthly payments of $93,750 on November 30, 2009 and December 31, 2009, and
monthly payments of $62,500 commencing on January 31, 2010, with a final payment
of the remaining principal and interest on December 31,
2010.  Payments are applied first to accrued interest and any
remainder to principal.  This modification is treated as a troubled
debt restructuring.   Since the modification does not reduce the
future cash payments below the carrying amount of the liability at the
modification date, under SFAS 15 (FASB ASC 470-60 and 310-40), the additional
interest resulting from the revised payment schedule is accounted for under the
interest method and amortized to effectuate a consistent yield over the
remaining term of the working capital note. The new working capital note is
collateralized by all of the assets of the Company which also secures the
existing senior debt.




Page 9 of
22





Item
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results ofOperations





Forward Looking
Statements





Statements
contained in this Form 10-Q include forward-looking statements that are subject
to risks and uncertainties.  In particular, statements in this Form
10-Q that state our intentions, beliefs, expectations, strategies, predictions
or any other statements relating to our future activities or other future events
or conditions are “forward-looking statements.” Forward-looking statements are
subject to risks, uncertainties and other factors, including, but not limited
to, those identified under “Risk Factors,” in our Form 10-K for the year ended
December 31, 2008 and those described in “Management's Discussion and Analysis
of Financial Conditions and Results of Operations” in our Form 10-K and this
Form 10-Q, and those described in any other filings by us with the Securities
and Exchange Commission, as well as general economic conditions and economic
conditions affecting the telecommunications industry, any one or more of which
could cause actual results to differ materially from those stated in such
statements.  Such statements could be affected by risks and
uncertainties related to our financial condition, our relationship with the
holder of our senior and subordinated debt, including the willingness or
unwillingness of the holder of the senior debt to extend the maturity date of
the senior debt and the amount and timing of any payments which the holder of
the senior debt may require, our ability to sell any or all of our divisions or
effect a restructure of our business and our debt and equity structure on terms
acceptable to the holder of the senior debt, our relationship with British
Telecommunications and Telmex including their continued requirements for our
products, factors which affect the telecommunications industry, market and
customer acceptance, our access to current technology, competition, domestic and
foreign 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-Q.





Overview




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




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




Page 10
of 22




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




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




Our
Connection/protection segment generated income from operations, prior to
allocation of corporate expenses, of $1,216,000 for the nine months ended
September 30, 2009 (the “September 2009 Period”) compared to $637,000 for the
nine months ended September 30, 2008 (the “September 2008 Period”). We sustained
a net loss from operations after allocation of corporate expenses on our
Connection/protection segment of $227,000 for the September 2009 Period compared
to $669,000 in the September 2008 Period. Our sales from this segment increased
by $732,000 from the September 2008 Period to the September 2009 Period due to
increased sales to Telmex which were offset in part by decreased sales to
British Telecommunications system integrators and a decline in sales to another
customer, that was less than a 10% customer in the September 2009 and 2008
Periods.  Additionally, our gross margin improved slightly as a result
of cost saving initiatives in the procurement of raw material and reduction of
shipping costs, which was offset by the strength of the US dollar versus the
British pound on our sales to British Telecommunications and its system
integrators.




Our
Signal segment generated net income from operations, prior to allocation of
corporate expenses, of $1,350,000 in the September 2009 Period compared to
$724,000 in the September 2008 Period, and this segment had net income from
operations after allocation of corporate expense of $965,000 in the September
2009 Period compared to $435,000 in September 2008 Period, reflecting our
increased sales of $904,000 in this segment, offset in part by reduced
margins.  We recognize revenue from Connection/protection and Signal
products when the product is shipped.




Our
Connection/protection segment generated income from operations, prior to
allocation of corporate expenses, of $700,000 for the three months ended
September 30, 2009 (the “September 2009 Quarter”) compared to a loss from
operations, prior to allocation of corporate expenses of $260,000 for the three
months ended September 30, 2008 (the “September 2008 Quarter”). We had a net
income from operations after allocation of corporate expenses on our
Connection/protection segment of $240,000 for the September 2009 Quarter
compared to a net loss from operations after allocation of corporate expenses of
$633,000 for the September 2008 Quarter. Our sales from this segment increased
by $470,000 from the September 2008 Quarter to the September 2009 Quarter due to
increased sales to British Telecommunications offset in part by decreased sales
to Telmex, which directly relates to the increase in operating income prior to
allocation of corporate expense.  Additionally, our gross margin
increased in part due to the operating efficiencies resulting from increased
sales and change in product mix to higher margin products, and as a result of
cost saving initiatives in the procurement of raw material and reduction of
shipping costs, offset by the strength of the US dollar versus the British pound
on our sales to British Telecommunications and its system
integrators.




Page 11
of 22




Our
Signal segment generated net income from operations, prior to allocation of
corporate expenses, of $416,000 in the third quarter of 2009 compared to
$220,000 in the comparable period in 2008, and had income from operations after
allocation of corporate expense of $295,000 in the September 2009 Quarter
compared to $136,000 in September 2008 Quarter, due to increased sales volume
and increased margins resulting in part from cost cutting initiatives primarily
in purchasing of raw materials and increased production in our Mexico
facility.  We recognize revenue from Connection/protection and Signal
products when the product is shipped.




In
February 2009, we entered into a supplier finance agreement with Lloyds TSB
Commercial Finance Limited to factor British Telecommunications accounts
receivable on a non-recourse basis.  We pay fees to Lloyds TSB
Commercial Financing at a rate equal to LIBOR plus 0.7%, based on the number of
days to maturity of each invoice that is factored.  These fees, which
are included in general and administrative expense, were approximately $8,000 in
the September 2009 Quarter and $32,000 for the September 2009
Period.





Dependence on British
Telecommunications





During
the past three years, sales to British Telecommunications, consisting of both
direct sales and sales to systems integrators for British Telecommunications
represented a substantial percentage of our total sales. References to British
Telecommunications include British Telecommunications and its systems
integrators, unless the context indicates otherwise.  These sales were
of copper connection and protection products. Our sales to British
Telecommunications have declined significantly, from $20,313,000 in 2006 to
$12,504,000 in 2007 to $10,296,000 in 2008.   Sales for the
September 2009 Period were $7,516,000.  We were not able to offset
completely this decline in sales.  Sales to customers in Great Britain
are made in the local currency. As a result, while our costs are incurred in
dollars, the dollar value of our collections from these customers, primarily
British Telecommunications, has decreased. The exchange rate change along with
reduced sales volume and change in product mix sold to British
Telecommunications, had an impact on overall gross margin, which declined from
33% for 2006 to 29% for 2007 to 21% for 2008.  In the September 2009
Period, our gross margin increased to 26% due to cost saving initiatives in the
procurement of raw material and reduction of shipping costs offset in part by
the exchange rate
change.                                            .





The
following table sets forth information as to sales to each customer or customer
group that accounted for 10% or more of the Company’s sales for the three and
nine months ended September 30, 2009 and 2008 (dollars in
thousands):




Nine Months Ended September 30,
                                  
                                  
                                  Three Months Ended September 30,2009
                                  
                                  
                                  2008
                                  
                                  
                                  2009
                                  
                                  
                                  2008Customer
                                  
                                  Dollars
                                  
                                  
                                  %
                                  
                                  
                                  Dollars
                                  
                                  
                                  %
                                  
                                  
                                  Dollars
                                  
                                  
                                  %
                                  
                                  
                                  Dollars
                                  
                                  
                                  %British
      Telecommunications
                                  
                                  $
                                  7,047
                                  
                                  
                                  
                                  33
                                  %
                                  
                                  $
                                  7,005
                                  
                                  
                                  
                                  36
                                  %
                                  
                                  $
                                  2,713
                                  
                                  
                                  
                                  38
                                  %
                                  
                                  $
                                  2,125
                                  
                                  
                                  
                                  34
                                  %British
      Telecommunications and its Systems Integrators*
                                  
                                  
                                  7,516
                                  
                                  
                                  
                                  36
                                  %
                                  
                                  
                                  7,962
                                  
                                  
                                  
                                  41
                                  %
                                  
                                  
                                  2,732
                                  
                                  
                                  
                                  39
                                  %
                                  
                                  
                                  2,194
                                  
                                  
                                  
                                  35
                                  %Teléfonos
      de México S.A. de C.V. (Telmex)
                                  
                                  
                                  4,956
                                  
                                  
                                  
                                  23
                                  %
                                  
                                  
                                  2,881
                                  
                                  
                                  
                                  15
                                  %
                                  
                                  
                                  1,355
                                  
                                  
                                  
                                  19
                                  %
                                  
                                  
                                  1,436
                                  
                                  
                                  
                                  23
                                  %




* Sales
to British Telecommunications are included in the sales and percentages figures
on the line “British Telecommunications and its Systems
Integrators.”





To the
extent that British Telecommunications reduces its purchases from, or purchases
products at a price which results in a reduced gross margin, our ability to
operate profitably will be impaired.  We may not be able to replace
this business from other customers and we cannot give any assurance that British
Telecommunications will increase or continue its purchases from us in the future
or that we will be able to improve our margins on these sales.




Page 12
of 22




Reverse Split and Debt
Restructuring





On July
31, 2008, we effected a one-for-11.11 reverse split pursuant to which each share
of common stock became converted into 0.0900090009 shares of common
stock.   All share and per share information reflects this
reverse split.




On July
31, 2008, we implemented a trouble debt restructuring plan (as defined under
SFAS 15 (FASB ASC 470-60 and 310-40)) which resulted in a restructuring and
reduction of our senior and subordinated debt.  As part of the debt
restructuring, we issued to Cheyne Special Situations Fund, L.P., as the holder
of the senior debt, 7,038,236 shares of common stock, which represents 70% of
the outstanding common stock.   As a result, pursuant to Section
482 of the Internal Revenue Code, our ability to use net operating loss
carryforwards which were generated prior to the debt restructuring was
significantly reduced.





Critical Accounting
Policies





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. Because of
our stockholders’ deficit of $16,044,000 at December 31, 2008, a net loss from
continuing operations before extraordinary gain and discontinued operations of
$2,352,000 for the year ended December 31, 2008, and our working capital
constraints, our accounting firm included in its report on our financial
statements for the year ended December 31, 2008, an explanatory paragraph about
our ability to continue as a going concern.  We have generated net
income of $239,000 for the September 2009 Quarter; however, have continued to
generate net losses in 2009 of $157,000 for the September 2009 Period. Our
stockholders’ deficit at September 30, 2009 was $16,730,000, and we continue to
be subject to working capital constraints.





Use of
Estimates





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





Allowance for Doubtful
Accounts Receivable





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




Page 13
of 22




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.





Interest




In the
third quarter of 2008, we effected a restructuring of our senior and
subordinated debt under SFAS 15, (FASB ASC 470-60 and 310-40) “Accounting by
Debtors and Creditors for Troubled Debt Restructuring.”  Accordingly,
the interest accrued through maturity was included in the amount of the note
reflected on the September 30, 2008 balance sheet. On January 1, 2009, the
payment terms for the senior notes were revised and extended, and on May 1,
2009,  June 1, 1009, July 1, 2009 and September 1, 2009 the payment
terms for the floating rate working capital senior note were revised and
extended.  The modifications in 2009 were treated as troubled debt
restructurings.  Since these modifications did not reduce the future
cash payments below the carrying amount of the liability on the balance sheet as
of the date of the modification, as required by the Troubled Debt Restructuring
by Debtors topic of FASB ASC 470-60 and 310-40, the additional interest
resulting from the revised payment schedule is to be accounted for prospectively
under the interest method and amortized to effectuate a consistent yield over
the remaining term of the senior note.  See Note 3 of Notes to the
Consolidated Financial Statements.




The
convertible debentures were not changed as a result of the troubled debt
restructuring, and we continue to accrue interest on these
debentures.




Goodwill





Goodwill
represents the difference between the purchase price and the fair market value
of net assets acquired in business combinations. With respect to the testing of
our goodwill for impairment, we determine the estimated fair value of the
reporting unit by considering the projected cash flows generated and a market
approach analysis to which the goodwill relates.  The market approach is
based on the comparable transaction method, which considers the sale and
acquisition activities in our industry.  We test the goodwill for
impairment on an annual basis, or more frequently if certain events or changes
in circumstances indicate that the carrying value may not be
recoverable.    As of September 30, 2009 and December 31, 2008,
all of our goodwill related to our signal processing division. We cannot give
assurances that write-downs in the future will not be necessary, although
management believes that no goodwill impairment charges are necessary at this
time and that there was no impairment of goodwill for the nine months ended
September 30, 2009.




Fair Values of Financial Instruments
  Cash
equivalents, accounts receivable, accounts payable and accrued expenses 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 market pricing of such instruments.
Due to the Company's financial position and the July 31, 2008 restructuring of
the senior and subordinated debt, excluding accreted interest, the carrying
value of these instruments approximates the fair values.




Page 14
of 22







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. An effect of our debt restructuring was the issuance of
more than 50% of our common stock to new stockholders.  As a result, our
ability to use our remaining net operating loss carryforwards will be severely
curtailed in accordance with Section 382 of the Internal Revenue Code. Due to
our current losses as well as 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.





Other
Matters





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





Results of
Operations





The
Company’s consolidated statements of operations for the periods indicated below
are shown in dollars and as a percentage of sales:





Nine Months Ended September 30,
                  
                  
                  Three Months Ended September 30,(Dollars in thousands)2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Dollars
                  
                  
                  %
                  
                  
                  Dollars
                  
                  
                  %
                  
                  
                  Dollars
                  
                  
                  %
                  
                  
                  Dollars
                  
                  
                  %Sales
                  
                  $
                  21,163
                  
                  
                  
                  100
                  %
                  
                  $
                  19,527
                  
                  
                  
                  100
                  %
                  
                  $
                  7,088
                  
                  
                  
                  100
                  %
                  
                  $
                  6,305
                  
                  
                  
                  100
                  %Cost
      of sales
                  
                  
                  15,485
                  
                  
                  
                  73
                  %
                  
                  
                  14,779
                  
                  
                  
                  76
                  %
                  
                  
                  4,911
                  
                  
                  
                  69
                  %
                  
                  
                  5,239
                  
                  
                  
                  83
                  %Gross
      profit
                  
                  
                  5,678
                  
                  
                  
                  27
                  %
                  
                  
                  4,748
                  
                  
                  
                  24
                  %
                  
                  
                  2,177
                  
                  
                  
                  31
                  %
                  
                  
                  1,066
                  
                  
                  
                  17
                  %Selling,
      general and administrative expenses
                  
                  
                  3,927
                  
                  
                  
                  19
                  %
                  
                  
                  3,847
                  
                  
                  
                  19
                  %
                  
                  
                  1,294
                  
                  
                  
                  18
                  %
                  
                  
                  1,222
                  
                  
                  
                  19
                  %Research
      and development expenses
                  
                  
                  1,014
                  
                  
                  
                  5
                  %
                  
                  
                  1,136
                  
                  
                  
                  6
                  %
                  
                  
                  348
                  
                  
                  
                  5
                  %
                  
                  
                  341
                  
                  
                  
                  6
                  %Operating
      income (loss)
                  
                  
                  737
                  
                  
                  
                  3
                  %
                  
                  
                  (235
                  )
                  
                  
                  -1
                  %
                  
                  
                  535
                  
                  
                  
                  8
                  %
                  
                  
                  (497
                  )
                  
                  
                  (8
                  )%Interest
      expense  and other income (net)
                  
                  
                  (686
                  )
                  
                  
                  (3
                  )%
                  
                  
                  (1,366
                  )
                  
                  
                  (7
                  )%
                  
                  
                  (236
                  )
                  
                  
                  (4
                  )%
                  
                  
                  (196
                  )
                  
                  
                  (3
                  )%Income/(loss)
      before income taxes
                  
                  
                  51
                  
                  
                  
                  -
                  %
                  
                  
                  (1,602
                  )
                  
                  
                  -8
                  %
                  
                  
                  299
                  
                  
                  
                  4
                  %
                  
                  
                  (693
                  )
                  
                  
                  (11
                  )%Income
      tax expense
                  
                  
                  (208
                  )
                  
                  
                  (1
                  )%
                  
                  
                  (53
                  )
                  
                  
                  -
                  %
                  
                  
                  (60
                  )
                  
                  
                  (1
                  )%
                  
                  
                  (16
                  )
                  
                  
                  -
                  %Extraordinary
      gain on Debt Restructure
                  
                  
                  -
                  
                  
                  
                  -
                  %
                  
                  
                  17,645
                  
                  
                  
                  90
                  %
                  
                  
                  -
                  
                  
                  
                  -
                  %
                  
                  
                  17,645
                  
                  
                  
                  280Net
      income (loss)
                  
                  
                  (157
                  )
                  
                  
                  (1
                  )%
                  
                  $
                  15,990
                  
                  
                  
                  82
                  %
                  
                  $
                  239
                  
                  
                  
                  3
                  %
                  
                  $
                  16,936
                  
                  
                  
                  269
                  %


Page 15
of 22


Our sales
by product line for the three and nine month periods ended September 30, 2009
and 2008 are as follows (dollars in thousands).


Nine months ended September 30,2009
                  
                  
                  2008Line
                  
                  $
                  16,724
                  
                  
                  
                  79
                  %
                  
                  $
                  15,992
                  
                  
                  
                  82
                  %Signal
                  
                  
                  4,439
                  
                  
                  
                  21
                  %
                  
                  
                  3,535
                  
                  
                  
                  18
                  %$
                  21,163
                  
                  
                  
                  100
                  %
                  
                  $
                  19,527
                  
                  
                  
                  100
                  %





Three Months Ended September 30,2009
                  
                  
                  2008Line
                  
                  $
                  5,615
                  
                  
                  
                  79
                  %
                  
                  $
                  5,145
                  
                  
                  
                  82
                  %Signal
                  
                  
                  1,473
                  
                  
                  
                  21
                  %
                  
                  
                  1,160
                  
                  
                  
                  18
                  %$
                  7,088
                  
                  
                  
                  100
                  %
                  
                  $
                  6,305
                  
                  
                  
                  100
                  %





Line
equipment sales for the September 2009 Period, compared to the September 2008
Period, increased by $732,000 (5%).  The increase in sales was primarily a
result of increased sales to Telmex of approximately $2,075,000 offset by
decreased sales to British Telecommunications and its systems integrators of
approximately $447,000 and a decline in sales of $761,000 to another customer
that was less than a 10% customer in the September 2008 Period.





Line
equipment sales for the September 2009 Quarter increased by $470,000 (9%),
compared to the September 2008 Quarter.  This increase in sales for the
three months is the result of an increase in sales of connector products to
British Telecommunications and its systems integrators of approximately $539,000
partially offset by the decrease of sales to Telmex of $81,000.  As stated
under “Overview,” British Telecommunications and its installers represented our
largest customer in each of the September 2009 and 2008 Periods and the
September 2009 and 2008 Quarters. Any significant reduction in the level of
business from British Telecommunications and its installers or Telmex could have
a material adverse effect upon both our revenue and net income.





Signal
sales for the September 2009 Period were $4,439,000, compared to $3,535,000 in
the September 2008 Period, an increase of $904,000 (26%).  Sales for the
September 2009 Quarter increased by $313,000 (27%) from $1,160,000 in the
September 2008 Quarter to $1,473,000.  The increase in Signal revenue for
the nine months was primarily due to increases in orders from the military
sector.





Our gross
margin for the September 2009 Period was 27% compared to 24% for the September
2008 Period.  Gross margin for the September 2009 Quarter was 31% compared
to 17% for the September 2008 Quarter. Gross margin for connection/protection
was 26% and 21% for the three months and nine months ended September 30, 2009,
respectively, as compared to 11% and 20% for the three and nine month period
ended September 30, 2008.  The increase is related to operating
efficiencies resulting from increased sales and a change in the product mix to
higher margin products, as well as from cost saving initiatives in the
procurement of raw material and reduction of shipping costs which were partially
offset by the strength of the US dollar versus the British pound on our sales to
British Telecommunications and its system integrators.  We do not engage in
hedging as a method of seeking to reduce the impact of currency
fluctuations.  Gross margin for Signal was 48% and 50% for the three and
nine months ended September 30, 2009, respectively, compared to 43% and 45% for
the same periods in 2008, primarily due to cost cutting initiatives primarily in
the procurement of raw materials and increased productivity in our Mexico
facility.





Selling,
general and administrative expenses were generally constant, increasing from
$3,847,000 for the September 2008 Period to $3,927,000 for September 2009
Period.  For the September 2009 Quarter, selling, general and
administrative expenses increased by $72,000 from $1,222,000 in September 2008
Quarter to $1,294,000. Selling expenses decreased due to a reduction in
advertising. Administrative expenses increased primarily as a result of
increased professional fees offset by expense reductions.


Page 16
of 22





Research
and development expenses decreased by $122,000 (11%) in the September 2009
Period compared to the September 2008 Period, from $1,136,000 to
$1,014,000.  In the September 2009 Quarter, research and development
expenses increased by $7,000 (2%) to $348,000 from $341,000 in the September
2008 Quarter. The decrease in the nine months resulted primarily from a
reduction of personnel.





As a
result of the foregoing, we had operating income of $737,000 for the September
2009 Period, compared with an operating loss of $235,000 in the September 2008
Period. We had operating income of $535,000 for the September 2009 Quarter as
compared with an operating loss of $497,000 in the September 2008
Quarter.





Interest
expense, net, for the September 2009 Period was $705,000, compared with
$1,393,000 for the September 2008 Period, a decrease of $688,000. 
 Interest expense, net, for the September 2009 Quarter was $240,000,
compared with $213,000 for the September 2008 Quarter, an increase of
$27,000.  The decrease in the nine month period resulted from the
restructuring of our senior and subordinated debt during the third quarter of
2008. The debt restructuring was treated as a troubled debt restructuring, all
of the interest through the stated maturity dates of the notes was accrued on
July 31, 2008, the date of the debt restructuring, and added to the principal of
the notes.  As a result, the interest on the restructured subordinated debt
which was issued on July 31, 2008 is not treated as a current period cost. 
On January 1, 2009, the payment terms for the senior notes were revised and
extended, and on May 1, 2009, June 1, 2009, July 1, 2009, September 1, 2009 and
November 1, 2009 the payment terms for the floating rate working capital senior
note were revised and extended.  These modifications were treated as
troubled debt restructurings.   Since these modifications did not
reduce the future cash payments below the carrying amount of the liability on
the balance sheet as of the date of the modification, under the Troubled Debt
Restructuring by Debtors topic of FASB ASC 40-60 and310-40, the additional
interest resulting from the revised payment schedule is to be accounted for
prospectively under the interest method and amortized to effectuate a consistent
yield over the remaining term of the senior note, resulting in increased
interest expense for the September 2009 Quarter as compared to the same quarter
of 2008.  Interest expense at the stated interest rates on the restructured
debt would have been $1,345,000 and $445,000 for the nine months and quarter
ended September 30, 2009, respectively, if the debt had not been treated as a
troubled debt restructuring.





In
addition to the interest on our 12.5% senior debt, interest which we accrued
during the September 2009 Period and September 2009 Quarter represents interest
on a floating rate working capital loan in the amount of $1,353,000 made to us
by our senior lender in 2008, as modified, at a rate of LIBOR plus 10%, which
was approximately 11.2% per annum for the September 2009 Period and 10.8% per
annum for the September 2009 Quarter, and interest on our subordinated
debentures at 8.26%.  Since the subordinated debentures have not been
restructured, the interest on those debentures continues to be recorded as a
period cost.





Income
tax expense for the quarter and nine months ended September 30, 2009 and 2008
relates to state and foreign taxes.  No federal income tax expense has been
provided due to losses incurred during the three and nine month
periods.





As a
result of the foregoing, we generated a net loss before extraordinary gain of
$157,000, or ($0.02) per share (basic and diluted), for the September 2009
Period, compared with net loss before extraordinary gain on troubled debt
restructuring of $1,655,000, or ($0.57), basic, and ($0.54) per share, diluted,
in the September 2008 Period.  The net income before extraordinary gain for
the September 2009 Quarter was $239,000, or $0.02 per share (basic and diluted),
compared with net loss before extraordinary gain of $709,000, or ($0.10) per
share (basic and diluted) in the September 2008 Quarter.





We had no
extraordinary item during the September 2009 Period and Quarter, and our net
loss per share was $0.02 (basic and diluted) for the September 2009 Period and
Quarter.  During the September 2008 Period and Quarter, we recognized
extraordinary income of $17,645,000, or $6.05 per share (basic) and $5.79
(diluted) for the September 2008 Period and $2.54 (basic) and $2.53 (diluted)
for the September 2009 Quarter.  Our net income per share was $5.48 (basic)
and $5.25 (diluted) for the September 2008 Period and $2.44 (basic) and $2.43
(diluted) for the September 2008 Quarter.


Page 17
of 22





Liquidity and Capital
Resources





At
September 30, 2009, we had cash and cash equivalents of $222,000 compared with
$292,000 at December 31, 2008, and we had a working capital deficit of $299,000,
as compared with working capital of $827,000 at December 31, 2008.  The
following table sets forth information as to the principal changes in the
components of our working capital (dollars in thousands):





Category
                                          
                                          September
                                          
                                          
                                          December
                                          
                                          
                                          December 31, 2008 to September 30, 200930,
                                          
                                          
                                          31,2009
                                          
                                          
                                          2008
                                          
                                          
                                          Dollar Change
                                          
                                          
                                          Percent ChangeCurrent
      AssetsCash
      and cash equivalents
                                          
                                          $
                                          222
                                          
                                          
                                          $
                                          292
                                          
                                          
                                          $
                                          (70
                                          )
                                          
                                          
                                          (24
                                          )%Accounts
      receivable – trade, net
                                          
                                          
                                          3,095
                                          
                                          
                                          
                                          4,554
                                          
                                          
                                          
                                          (1,459
                                          )
                                          
                                          
                                          (32
                                          )%Inventories
                                          
                                          
                                          5,119
                                          
                                          
                                          
                                          6,110
                                          
                                          
                                          
                                          (991
                                          )
                                          
                                          
                                          (16
                                          )%Prepaid
      expenses and other current assets
                                          
                                          
                                          352
                                          
                                          
                                          
                                          202
                                          
                                          
                                          
                                          150
                                          
                                          
                                          
                                          74
                                          %Total
      current assets
                                          
                                          $
                                          8,788
                                          
                                          
                                          $
                                          11,158
                                          
                                          
                                          $
                                          (2,370
                                          )
                                          
                                          
                                          (21
                                          )%Current
      LiabilitiesSenior
      debt, including interest
                                          
                                          $
                                          1,355
                                          
                                          
                                          $
                                          1,500
                                          
                                          
                                          $
                                          (145
                                          )
                                          
                                          
                                          (10
                                          )%Subordinated
      notes, including interest
                                          
                                          
                                          191
                                          
                                          
                                          
                                          191
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          %6%
      subordinated debentures, principal
                                          
                                          
                                          385
                                          
                                          
                                          
                                          385
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          %Accounts
      payable
                                          
                                          
                                          4,208
                                          
                                          
                                          
                                          5,529
                                          
                                          
                                          
                                          (1,321
                                          )
                                          
                                          
                                          (24
                                          )%Accrued
      expenses and other
                                          
                                          
                                          2,036
                                          
                                          
                                          
                                          2,390
                                          
                                          
                                          
                                          (354
                                          )
                                          
                                          
                                          (15
                                          )%Accrued
      interest payable
                                          
                                          
                                          912
                                          
                                          
                                          
                                          336
                                          
                                          
                                          
                                          576
                                          
                                          
                                          
                                          171
                                          %Total
      current liabilities
                                          
                                          $
                                          9,087
                                          
                                          
                                          $
                                          10,331
                                          
                                          
                                          $
                                          (1,244
                                          )
                                          
                                          
                                          12
                                          %Working
      Capital
                                          
                                          $
                                          (299
                                          )
                                          
                                          $
                                          827
                                          
                                          
                                          $
                                          (1,126
                                          )
                                          
                                          
                                          (136
                                          )%





Cash flow
from operations was $1,418,000 for the September 2009 Period, as compared with
$274,000 of cash used in operations for the September 2008 Period.  In
February 2009, we entered into a supplier finance agreement with Lloyds TSB
Commercial Finance to factor British Telecommunications receivables without
recourse.  The use of this agreement has had the effect of accelerating the
cash flow on British Telecommunications’ receivables and represents a
significant portion of the $1,459,000 reduction in accounts receivable from
December 31, 2008 to September 30, 2009.  Fees are at LIBOR plus 0.7% on
the days to maturity of each invoice that is factored.





During
the September 2009 Period and the September 2008 Period, our only investing
activities were capital expenditures of $202,000 and $103,000,
respectively.





During
the September 2009 Period, we paid senior and subordinated debt of $584,000 of
which $223,000 was paid in the third quarter.  We paid fees related to our
financing arrangements with Lloyds of $32,000 during the September 2009 Period,
of which $8,000 were incurred in the third quarter.  We had no other cash
flow or expenditures from financing activities during the three and nine months
ended September 30, 2009.  In June 2008, we borrowed an additional $600,000
from our senior debt holders and paid senior and subordinated debt of
$274,000.  There were no other financing activities during the three and
nine months ended September 30, 2008.


Page 18
of 22


Because a
significant portion of our sales are foreign and denominated in currencies other
than the United States dollar, changes in exchange rates have an effect on our
cash. During the September 2009 and 2008 Periods, we sustained losses as a
result of exchange rates of $702,000  and $71,000, respectively, of which
an exchange loss of $103,000 and exchange gain of $71,000 were sustained in the
September 2009 Quarter and the September 2008 Quarter,
respectively.





As a
result of the debt restructuring, we had positive working capital at December
31, 2008; however, repayments of debt, interest accrued resulting from the
modification of debt agreements, and daily working capital requirements,
resulted in a working capital deficit as of September 30, 2009.  The debt
restructuring itself did not provide us with any additional cash for our
operations.  Our only source of funds other than normal operations is our
senior lender, Cheyne Special Situations Fund, L.P.   During the
fourth quarter of 2008, we required additional funds from Cheyne, and Cheyne
provided such funds.  Cheyne also rescheduled the payments on the senior
debt as of January 1, 2009, and rescheduled the payments on the floating rate
working capital note on May 1, 2009, June 1, 2009, August 1, 2009, September 1,
2009 and November 1, 2009. Due to our continued losses and the uncertainty of
any significant, if any, increase in business from British Telecommunications or
Telmex, together with the worldwide economic downturn and the general lack of
credit even for companies with strong balance sheets and positive operation
results, our difficulties in obtaining financings from other sources is
increasing.  These factors may continue to affect our ability to generate
business from new customers as well as our ability to make the payments that are
due to Cheyne, even under the revised payment terms.  Furthermore, Cheyne
has advised us that it would not advance new funds to the Company; therefore, we
cannot give any assurance that Cheyne will provide us with any additional
modification of our payment terms if the need arises. If we are not able to
generate sufficient revenue to enable us to meet our obligations or obtain
financing from Cheyne, we would not be able to continue in business, and it
would be likely that we would seek protection under the Bankruptcy
Code.





We have
in the past, and may in the future, consider the sale of one or more of our
divisions.  However, all of our past discussions terminated without any
agreement and we cannot give any assurance that we would be able to effect any
sale of our business or that such a sale would not be part of bankruptcy
reorganization.  Further, our senior debt is secured by a lien on
substantially all of our and our subsidiaries’ assets, and substantially all, if
not all, of the proceeds from any sale may be required to be paid to our debt
holders, principally the holder of our senior debt.





Item
3.  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
pounds. Any pound-denominated receipts are promptly converted into United States
dollars. We do not engage in any hedging or other currency transactions. During
the September 2009 Period, the loss from exchange rates represented
approximately 3% of sales and was nil% of sales for the September 2008
Period.





Item 4.  Controls and
Procedures





Evaluation
of disclosure controls and procedures




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


Page 19
of 22




We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms, and that such information is accumulated and
communicated to management, including our chief executive officer and our chief
financial officer, as appropriate to allow timely decisions regarding required
disclosure. Our management, with participation of our chief executive and
financial officers, has conducted an evaluation of the effectiveness of our
disclosure controls and procedures (as defined in the Securities Exchange Act of
1934 Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by
this quarterly report on Form 10-Q.




As
previously disclosed in our annual report on Form 10-K for the year ended
December 31, 2008, we determined that, as of the end of the fiscal year 2008,
there was a material weakness affecting our internal control over financial
reporting with respect to information technology (as described below) and, as a
result of the material weakness, our disclosure controls and procedures were not
effective. We are continuing to evaluate a change in the information system
platform for our financial and operational systems which will remediate the
material weakness.  As a result of our current cash constraints the
selection and implementation of a new system is expected to be completed over
the next few years. Consequently, based on the evaluation described above, our
management, including our chief executive officer and our chief financial
officer, have concluded that, as of the September 30, 2009, our disclosure
controls and procedures were not effective.




Internal
Control over Financial Reporting




As
previously reported in form 10-K for the year ended December 31, 2008,
management identified significant deficiencies that when aggregated give rise to
a material weakness specifically relating to  a) program change management
in the Company’s PROCOMM system, b) lack of integrated modules with the general
ledger and c) excessive manual adjustments to the inventory module are
required. Consequently, based on the evaluation described above, our
management, including our chief executive officer and our chief financial
officer, has concluded that, as of the September 30, 2009, our internal control
over financial reporting was not effective.




Management’s
Plan of Remediation


Management
plans to evaluate, select and install a new integrated enterprise resource
planning (ERP) system that will include a complete general ledger and reporting
package to eliminate the need for manual updates and significantly reduce the
need for journal entries in the financial reporting process. Specific
remediation actions used in 2009 to address our material weakness in internal
control over financial reporting with respect to information technology include
the following:




·
            In-depth
      review of all perpetual inventory
reports;




·
            Analyzing
      of production reporting with respect to ending inventory,
    and




·
            Re-computation
      of reports on a test basis.




However,
our lack of cash and our continuing losses are impairing our ability to take the
necessary steps to rectify these problems.




Changes
in Internal Control over Financial Reporting


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


Page 20
of 22





PART
II – OTHER INFORMATION





Item 5.   Other
Information





Modification of Working
Capital Senior Note





On August
1, 2009, September 1, 2009 and November 1, 2009, the working capital senior note
was replaced with a new working capital note.  The new note, issued
November 1, 2009 in the amount of $1,365,056, provides
for monthly payments of $93,750 on November 30, 2009 and December 31, 2009, and
monthly payments of $62,500 commencing on January 31, 2010, with a final payment
of the remaining principal and interest on December 31,
2010.  Payments are applied first to accrued interest and any
remainder to principal. The
new working capital note is collateralized by all of the assets of the Company
which also secure the existing senior debt.





Item 6.
Exhibits





4.1
              
              Restated
      working capital senior note dated November 1, 200931.1
              
              Certification
      of chief executive officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
              
              Certification
      of 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 21
of 22


SIGNATURES





Pursuant to the requirements 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: 
      November 12, 2009
              By:
              /s/Edward B. KornfeldEdward
      B. KornfeldChief
      Executive OfficerBy:
              /s/ Leslie K. BrandLeslie
      K. BrandChief
      Financial Officer


Page 22
of 22