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 June 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


YesxNo ̈





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 August 7, 2009.





PART
I.- FINANCIAL INFORMATION


Item
1- Financial
Statements


PORTA
SYSTEMS CORP. AND SUBSIDIARIES


Consolidated
Balance Sheets


(In
thousands, except shares and par value)


Unaudited
                      June 30, 2009
                    
                    
                    December 31,
                      2008AssetsCurrent
      assets:Cash
      and cash equivalents
                    
                    $
                    375
                    
                    
                    $
                    292Accounts
      receivable - trade, less allowance for doubtful accounts of $20 in 2009
      and $30 in 2008
                    
                    
                    2,897
                    
                    
                    
                    4,554Inventories
                    
                    
                    5,287
                    
                    
                    
                    6,110Prepaid
      expenses and other current assets
                    
                    
                    320
                    
                    
                    
                    202Total
      current assets
                    
                    
                    8,879
                    
                    
                    
                    11,158Property,
      plant and equipment, net
                    
                    
                    1,541
                    
                    
                    
                    1,564Goodwill
                    
                    
                    2,961
                    
                    
                    
                    2,961Other
      assets
                    
                    
                    78
                    
                    
                    
                    78Total
      assets
                    
                    $
                    13,459
                    
                    
                    $
                    15,761Liabilities and Stockholders’
      DeficitCurrent
      liabilities:Senior
      debt including interest
                    
                    $
                    1,658
                    
                    
                    $
                    1,500Subordinated
      notes including interest
                    
                    
                    191
                    
                    
                    
                    1916%
      subordinated debentures, principal
                    
                    
                    385
                    
                    
                    
                    385Accounts
      payable
                    
                    
                    4,409
                    
                    
                    
                    5,529Accrued
      expenses and other
                    
                    
                    1,946
                    
                    
                    
                    2,390Other
      accrued interest payable
                    
                    
                    731
                    
                    
                    
                    336Total
      current liabilities
                    
                    
                    9,320
                    
                    
                    
                    10,331Long
      term liabilities:Senior
      Debt including interest
                    
                    
                    17,583
                    
                    
                    
                    18,056Subordinated
      notes including interest
                    
                    
                    2,672
                    
                    
                    
                    2,767Deferred
      compensation and other long term liabilities
                    
                    
                    634
                    
                    
                    
                    651Total
      long term liabilities
                    
                    
                    20,889
                    
                    
                    
                    21,474Total  liabilities
                    
                    
                    30,209
                    
                    
                    
                    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
      June 30, 2009 and December 31, 2008
                    
                    
                    100
                    
                    
                    
                    100Additional
      paid-in capital
                    
                    
                    76,244
                    
                    
                    
                    76,244Accumulated
      deficit
                    
                    
                    (85,702
                    )
                    
                    
                    (85,307
                    )Accumulated
      other comprehensive loss:Foreign
      currency translation adjustment
                    
                    
                    (5,454
                    )
                    
                    
                    (5,143
                    )(14,812
                    )
                    
                    
                    (14,106
                    )Treasury
      stock, at cost, 2,785 shares
                    
                    
                    (1,938
                    )
                    
                    
                    (1,938
                    )Total
      stockholders’ deficit
                    
                    
                    (16,750
                    )
                    
                    
                    (16,044
                    )Total
      liabilities and stockholders’ deficit
                    
                    $
                    13,459
                    
                    
                    $
                    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


(In
thousands, except per share amounts)


Six months endedJune 30,
                
                
                June 30,2009
                
                
                2008Sales
                
                $
                14,075
                
                
                $
                13,222Cost
      of sales
                
                
                10,574
                
                
                
                9,539Gross
      profit
                
                
                3,501
                
                
                
                3,683Selling,
      general and administrative expenses
                
                
                2,632
                
                
                
                2,626Research
      and development expenses
                
                
                666
                
                
                
                794Total
      expenses
                
                
                3,298
                
                
                
                3,420Operating
      income
                
                
                203
                
                
                
                263Interest
      expense, net
                
                
                (464
                )
                
                
                (1,180
                )Other
      income, net
                
                
                14
                
                
                
                7Loss
      before income taxes
                
                
                (247
                )
                
                
                (910
                )Income
      tax expense
                
                
                (148
                )
                
                
                (36
                )Net
      loss
                
                $
                (395
                )
                
                $
                (946
                )Other
      comprehensive loss:Foreign
      currency translation adjustments
                
                
                (311
                )
                
                
                (122
                )Comprehensive
      loss
                
                $
                (706
                )
                
                $
                (1,068
                )Basic
      and diluted loss per share of common stock
                
                $
                (0.04
                )
                
                $
                (1.05
                )Weighted
      average shares outstanding
                
                
                9,955
                
                
                
                905





See
accompanying notes to unaudited consolidated financial
statements.


Page 2 of
22





PORTA
SYSTEMS CORP. AND SUBSIDIARIES


Unaudited
Consolidated Statements of Operations and Comprehensive Loss


(In
thousands, except per share amounts)





Three Months EndedJune 30,
                
                
                June 30,2009
                
                
                2008Sales
                
                $
                6,422
                
                
                $
                6,677Cost
      of sales
                
                
                4,856
                
                
                
                4,831Gross
      profit
                
                
                1,566
                
                
                
                1,846Selling,
      general and administrative expenses
                
                
                1,327
                
                
                
                1,284Research
      and development expenses
                
                
                330
                
                
                
                370Total
      expenses
                
                
                1,657
                
                
                
                1,654Operating
      (loss) income
                
                
                (91
                )
                
                
                192Interest
      expense, net
                
                
                (432
                )
                
                
                (589
                )Other
      income, net
                
                
                5
                
                
                
                1Loss
      before income taxes
                
                
                (518
                )
                
                
                (396
                )Income
      tax expense
                
                
                (53
                )
                
                
                (12
                )Net
      loss
                
                $
                (571
                )
                
                $
                (408
                )Other
      comprehensive loss:Foreign
      currency translation adjustments
                
                
                (160
                )
                
                
                (38
                )Comprehensive
      loss
                
                $
                (731
                )
                
                $
                (446
                )Basic
      and diluted loss per share of common stock
                
                $
                (0.06
                )
                
                $
                (0.45
                )Weighted
      average shares outstanding
                
                
                9,955
                
                
                
                905





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)





Six months endedJune 30,
                
                
                June 30,2009
                
                
                2008Cash
      flows from operating activities:Net
      loss
                
                $
                (395
                )
                
                $
                (946
                )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                
                
                150
                
                
                
                186Inventory
      reserve
                
                
                (110
                )
                
                
                (376
                )Allowance
      for doubtful accounts
                
                
                (10
                )
                
                
                (30
                )Changes
      in operating assets and liabilities:Accounts
      receivable
                
                
                1,895
                
                
                
                (884
                )Inventories
                
                
                991
                
                
                
                401Prepaid
      expenses and other current assets
                
                
                (74
                )
                
                
                (393
                )Other
      assets
                
                
                (2
                )
                
                
                (6
                )Accounts
      payable, accrued expenses and other liabilities
                
                
                (1,221
                )
                
                
                1,543Net
      cash provided by (used in) operating activities
                
                
                1,224
                
                
                
                (505
                )Cash
      flows from investing activities:Capital
      expenditures, net
                
                
                (132
                )
                
                
                (76
                )Net
      cash used in investing activities
                
                
                (132
                )
                
                
                (76
                )Cash
      flows from financing activities:(Repayments)
      borrowings of senior debt
                
                
                (410
                )
                
                
                600Net
      cash (used in) provided by financing activities
                
                
                (410
                )
                
                
                600Effect
      of exchange rate changes on cash
                
                
                (599
                )
                
                
                (142
                )Increase
      (decrease) in cash and cash equivalents
                
                
                83
                
                
                
                (123
                )Cash
      and cash equivalents - beginning of the year
                
                
                292
                
                
                
                494Cash
      and cash equivalents - end of the period
                
                $
                375
                
                
                $
                371Supplemental
      cash flow disclosure:Cash
      paid for interest expense
                
                $
                27
                
                
                $
                5Cash
      paid for income taxes
                
                $
                148
                
                
                $
                4





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
second quarter or the first six 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 June 30, 2009, subsequent events were evaluated by the Company as of
August 13, 2009, the date on which the Form 10-Q, which included the
unaudited consolidated financial statements at and for the quarter ended June
30, 2009, were 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 $1,769,000 for 2009 and $1,575,000 for 2008):





June 30, 2009
                  
                  
                  June 30, 2008Parts
      and components
                  
                  $
                  3,467,000
                  
                  
                  $
                  4,424,000Work-in-process
                  
                  
                  903,000
                  
                  
                  
                  716,000Finished
      goods
                  
                  
                  917,000
                  
                  
                  
                  1,247,000$
                  5,287,000
                  
                  
                  $
                  6,387,000


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, “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 and June 1,
2009, the payment terms for the floating rate working capital senior note were
revised.  The three 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, under SFAS 15, 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.  The total interest that should
have been recorded during the quarter ended March 31, 2009 was approximately
$186,000.  During the quarter ended March 31, 2009, the Company
recorded interest expense of approximately $7,500.  In order to
properly record the year to date interest expense, the Company recorded an
additional $178,500 of interest expense in the second quarter of
2009.





The
Company has evaluated the effect of recording the additional interest expense on
the financial statements taken as a whole, and to its shareholders, and has
determined that a restatement of the Company’s financial statements for the
quarter ended March 31, 2009 is not warranted because of the
following:





·
            the
      non-cash nature of the interest
charge;




·
            the
      adjustment had no impact on income from
  operations;




·
            the
      fact that the results of operations for the six months ended June 30, 2009
      reflect the accrual of interest resulting from the troubled debt
      restructuring in accordance with SFAS 15;
and




·
            due
      to the various debt restructurings and the amount of accreted interest
      recorded on the balance sheet, the interest expense recorded in relation
      to the debt is not considered to be
meaningful.




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





June 30, 2009
                  
                  
                  December 31, 200812.5%
      senior note payable in installments through September 30, 2016, including
      interest of $6,165,000 at June 30, 2009 and December 31, 2008
      (1)(2)
                  
                  $
                  17,766,000
                  
                  
                  $
                  17,766,000Floating
      rate working capital senior note, including interest of $0 at June 30,
      2009 and $54,000 at December 31, 2008 (1)(3)
                  
                  
                  1,475,000
                  
                  
                  
                  1,790,00010%
      Subordinated notes due in installments through January 31, 2016, including
      interest of $1,125,000 at June 30, 2009 and $1,256,000 at December 31,
      2008 (4)
                  
                  
                  2,863,000
                  
                  
                  
                  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 was
      revised.  At June 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 (See Note 8- Subsequent Event).  Payments are applied first
      to accrued interest and any remainder to
  principal.


Page 6 of
22


(3)
            These
      notes bear interest at the six-month LIBOR rate plus 10% per annum, which
      was 11.1% per annum at June 30, 2009 and 11.7% at December 31,
      2008.  On June 1, 2009, the terms of this note were modified to
      provide for monthly payments of $125,000, with a final payment of the
      remaining principal and interest on July 30, 2010.  Payments are
      applied first to accrued interest and any remainder to
      principal.  During the second quarter of 2009 and for the six
      months ended June 30, 2009, the Company made payments of $125,000, and
      $375,000, of which $16,000 and $76,000 was interest and $109,000 and
      $299,000 was principal,
respectively.




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




(5)
            At
      June 30, 2009 and December 31, 2008, accrued interest on these notes was
      $344,000 and $326,000, respectively, and the interest is included in other
      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 June 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





On May
11, 2009, the Company’s board of directors approved the 2009 Long-Term Incentive
Plan, which covers 1,000,000 shares of common stock.  The plan
provides for the grant of incentive and non-qualified options, stock grants,
stock appreciation rights and other equity-based incentives to employees,
including officers, and consultants. The plan provides for the automatic grant
of options to independent directors as follows:  On the date that the
plan was adopted, each independent director received the grant of an option to
purchase 5,000 shares of common stock at an exercise price of $0.022 per share,
which was the average of the last reported price for the common stock for the
ten trading days immediately preceding the date of grant.  On May 1 of
each year, commencing May 1, 2010, each independent director will receive an
option to purchase 5,000 shares at an exercise price equal to the average of the
last reported price for the common stock for the ten trading days immediately
preceding the date of grant.  Each newly elected independent director
will receive an option to purchase 10,000 shares at an exercise price equal to
the average of the last ten trading days immediately preceding the date of
becoming a director.  Independent directors are not eligible for
options or other rights under the plan except for the options granted pursuant
to the automatic grant provision.  The plan was approved subject to
stockholder approval.  The Company’s principal stockholder, which
holds 70% of the outstanding stock, has advised the Company that it approved the
plan.




For the
six months ended June 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.


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 others, 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).





Six Months ended
                
                
                Three Months EndedJune 30,
                
                
                June 30,
                
                
                June 30,
                
                
                June 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Sales:Line
                
                $
                11,109
                
                
                $
                10,847
                
                
                $
                4,889
                
                
                $
                5,455Signal
                
                
                2,966
                
                
                
                2,375
                
                
                
                1,533
                
                
                
                1,222Total
                
                $
                14,075
                
                
                $
                13,222
                
                
                $
                6,422
                
                
                $
                6,677Segment
      profit:Line
                
                $
                515
                
                
                $
                897
                
                
                $
                45
                
                
                $
                450Signal
                
                
                935
                
                
                
                503
                
                
                
                464
                
                
                
                262Total
                
                $
                1,450
                
                
                $
                1,400
                
                
                $
                509
                
                
                $
                712




Page 8 of
22




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





Six Months ended
                  
                  
                  Three Months EndedJune 30,
                  
                  
                  June 30,
                  
                  
                  June 30,
                  
                  
                  June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Operating
      income:Total
      segment income for reportable segments
                  
                  $
                  1,450
                  
                  
                  $
                  1,400
                  
                  
                  $
                  509
                  
                  
                  $
                  712Corporate
      and unallocated
                  
                  
                  (1,247
                  )
                  
                  
                  (1,137
                  )
                  
                  
                  (600
                  )
                  
                  
                  (520
                  )Consolidated
      total operating income (loss)
                  
                  $
                  203
                  
                  
                  $
                  263
                  
                  
                  $
                  (91
                  )
                  
                  $
                  192




Note  6:
New Accounting
Standards




The terms
“SFAS” and “FASB” used in these notes refer to Statements of Financial
Accounting Standards issued by the United States Financial Accounting Standards
Board.




In May
2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS 165).
SFAS 165 establishes general standards for accounting for and disclosure of
events that occur after the balance sheet date but before financial statements
are available to be issued (subsequent events). More specifically, SFAS 165
sets forth the period after the balance sheet date during which management of a
reporting entity should evaluate events or transactions that may occur for
potential recognition in the financial statements, identifies the circumstances
under which an entity should recognize events or transactions occurring after
the balance sheet date in its financial statements and the disclosures that
should be made about events or transactions that occur after the balance sheet
date. SFAS 165 provides largely the same guidance on subsequent events
which previously existed only in auditing literature. The statement was adopted
by the Company in its second quarter and did not have an impact on its
Consolidated Financial Statements.




In June
2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162 (SFAS 168). SFAS 168
establishes the FASB Standards Accounting Codification (Codification) as the
source of authoritative U.S. generally accepted accounting principles
(GAAP) recognized by the FASB to be applied to nongovernmental entities and
rules and interpretive releases of the SEC as authoritative GAAP for SEC
registrants. The Codification will supersede all the existing non-SEC accounting
and reporting standards upon its effective date and subsequently, the FASB will
not issue new standards in the form of Statements, FASB Staff Positions or
Emerging Issues Task Force Abstracts. SFAS 168 also replaces FASB Statement
No. 162, The Hierarchy of Generally Accepted Accounting Principles, given
that once in effect, the Codification will carry the same level of authority.
SFAS 168 will be effective for financial statements issued for reporting periods
that end after September 15, 2009.




In April
2009, the FASB issued Staff Position No. FAS 107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments (FSP FAS 107-1 and APB
28-1), which requires publicly traded companies to include in their interim
financial reports certain disclosures about the carrying value and fair value of
financial instruments previously required only in annual financial statements
and to disclose changes in significant assumptions used to calculate the fair
value of financial instruments. FSP FAS 107-1 and APB 28-1 is effective for all
interim reporting periods ending after June 15, 2009, with early adoption
permitted for interim reporting periods ending after March 15, 2009. The
Company adopted FSP FAS 107-1 and APB 28-1 in the second quarter of 2009. The
adoption did not have a material impact on the Company’s consolidated financial
statements.


Page 9 of
22




Note
7: Significant
Customers




Sales to
British Telecommunications and its systems integrators and Teléfonos de Mexico
S.A. de C.V. (Telmex) accounted for approximately 60% of sales in the six months
of 2009, and 55% of sales for the same period in 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 three months ended June
30, 2009 and 2008 (dollars in thousands):




Six Months Ended June 30,
                          
                          
                          Three Months Ended June 30,2009
                          
                          
                          2008
                          
                          
                          2009
                          
                          
                          2008Customer
                          
                          Dollars
                          
                          
                          %
                          
                          
                          Dollars
                          
                          
                          %
                          
                          
                          Dollars
                          
                          
                          %
                          
                          
                          Dollars
                          
                          
                          %British
      Telecommunications
                          
                          $
                          4,334
                          
                          
                          
                          31%
                          
                          
                          $
                          4,880
                          
                          
                          
                          37%
                          
                          
                          $
                          1,377
                          
                          
                          
                          21%
                          
                          
                          $
                          2,542
                          
                          
                          
                          38%British
      Telecommunications and its Systems Integrators*
                          
                          
                          4,784
                          
                          
                          
                          34%
                          
                          
                          
                          5,769
                          
                          
                          
                          44%
                          
                          
                          
                          1,433
                          
                          
                          
                          22%
                          
                          
                          
                          2,843
                          
                          
                          
                          43%Teléfonos
      de México S.A. de C.V. (Telmex)
                          
                          
                          3,601
                          
                          
                          
                          26%
                          
                          
                          
                          1,464
                          
                          
                          
                          11%
                          
                          
                          
                          1,926
                          
                          
                          
                          30%
                          
                          
                          
                          1,206
                          
                          
                          
                          18%


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





Note
8: Subsequent
events





Effective
August 1, 2009, the working capital senior note was replaced with a new working
capital note in the amount of $1,452,447.  The new note provides for
monthly payments of $125,000 commencing August 31, 2009, with a final payment of
the remaining principal and interest on July 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, 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.





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





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 conditions, 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 including its 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.


Page 10
of 22





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.




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
allocations of corporate expenses, of $515,000 for the six months ended June 30,
2009 (the “June 2009 Period”) compared to $897,000 for the six months ended June
30, 2008 (the “June 2008 Period”). We had a net loss from operations after
allocations of corporate expenses on our Connection/protection segment of
$467,000 for the June 2009 Period compared to $36,000 in the June 2008 Period.
Our sales from this segment decreased by $262,000 from the June 2008 Period to
the June 2009 Period due to decreased sales to British Telecommunications, which
were offset in part by increased sales to Telmex.  Additionally our
gross margin decreased, primarily due to 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 $935,000 in the June 2009 Period compared to $503,000 in
the June 2008 Period, and this segment had net income from operations after
allocations of corporate expense of $670,000 in the June 2009 Period compared to
$299,000 in June 2008 Period, reflecting our increased sales in this
segment.  We recognize revenue from Connection/protection and Signal
products when the product is shipped.




Our
Connection/protection segment generated income from operations, prior to
allocations of corporate expenses, of $45,000 for the three months ended June
30, 2009 (the “June 2009 Quarter”) compared to $450,000 for the three months
ended June 30, 2008 (the “June 2008 Quarter”). We had a net loss from operations
after allocations of corporate expenses on our Connection/protection segment of
$412,000 for the June 2009 Quarter compared to a net income from operations
after allocation of corporate expenses of $25,000 for the June 2008 Quarter. Our
sales from this segment decreased by $566,000 from the June 2008 Quarter to the
June 2009 Quarter due to decreased sales to British Telecommunications offset in
part by increased sales to Telmex, which directly relates to the decrease in
operating income prior to allocations of corporate
expense.  Additionally our gross margin decreased, in part due to the
strength of the US dollar versus the British pound on our sales to British
Telecommunications and its system integrators and in part due to the operating
inefficiencies resulting from lower sales and a change in the product mix to
lower margin products.  Our Signal segment generated net income from
operations, prior to allocation of corporate expenses, of $464,000 in the second
quarter of 2009 compared to $262,000 in the comparable period in 2008, and had
income from operations after allocations of corporate expense of $321,000 in the
June 2009 Quarter compared to $167,000 in June 2008 Quarter, due to increased
sales volume.  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
receivables 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 expenses, were approximately $8,000
in the June 2009 Quarter and $24,000 for the June 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 June
2009 Period were $4,784,000.  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 and was 25% for the June 2009 Period.


Page 12
of 22




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
six months ended June 30, 2009 and 2008 (dollars in thousands):




Six Months Ended June 30,
                          
                          
                          Three Months Ended June 30,2009
                          
                          
                          2008
                          
                          
                          2009
                          
                          
                          2008Customer
                          
                          Dollars
                          
                          
                          %
                          
                          
                          Dollars
                          
                          
                          %
                          
                          
                          Dollars
                          
                          
                          %
                          
                          
                          Dollars
                          
                          
                          %British
      Telecommunications
                          
                          $
                          4,334
                          
                          
                          
                          31%
                          
                          
                          $
                          4,880
                          
                          
                          
                          37%
                          
                          
                          $
                          1,377
                          
                          
                          
                          21%
                          
                          
                          $
                          2,542
                          
                          
                          
                          38%British
      Telecommunications and its Systems Integrators*
                          
                          
                          4,784
                          
                          
                          
                          34%
                          
                          
                          
                          5,769
                          
                          
                          
                          44%
                          
                          
                          
                          1,433
                          
                          
                          
                          22%
                          
                          
                          
                          2,843
                          
                          
                          
                          43%Teléfonos
      de México S.A. de C.V. (Telmex)
                          
                          
                          3,601
                          
                          
                          
                          26%
                          
                          
                          
                          1,464
                          
                          
                          
                          11%
                          
                          
                          
                          1,926
                          
                          
                          
                          30%
                          
                          
                          
                          1,206
                          
                          
                          
                          18%





* 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.





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.




On July
31, 2008, we implemented a trouble debt restructuring plan (as defined under
SFAS 15). As a result of the debt restructuring, our senior and subordinated
debt was restructured and reduced. 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 continued to generate net
losses in 2009 of $571,000 for the June 2009 Quarter and $395,000 for the June
2009 Period, our stockholders’ deficit at June 30, 2009 was $16,750,000, 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.


Page 13
of 22


Allowance for Doubtful
Accounts Receivable





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





Inventory
Reserves





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





Interest




In the
third quarter of 2008, we effected a restructure of our senior and subordinated
debt under SFAS 15, “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 Mary 1, 2009 and June 1, 1009, 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, under
SFAS 15, 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 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 June 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 six months
ended June 30, 2009.


Page 14
of 22


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.
However, management believes, because of the Company’s financial position and
the restructuring of the senior and subordinated debt on July 31, 2008, that the
carrying value of these instruments approximates their fair values.





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.


Page 15
of 22


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:





Six Months Ended June 30,
                    
                    
                    Three Months Ended June 30,(Dollars
      in thousands)2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Dollars
                    
                    
                    %
                    
                    
                    Dollars
                    
                    
                    %
                    
                    
                    Dollars
                    
                    
                    %
                    
                    
                    Dollars
                    
                    
                    %Sales
                    
                    $
                    14,075
                    
                    
                    
                    100%
                    
                    
                    $
                    13,222
                    
                    
                    
                    100%
                    
                    
                    $
                    6,422
                    
                    
                    
                    100%
                    
                    
                    $
                    6,677
                    
                    
                    
                    100%Cost
      of sales
                    
                    
                    10,574
                    
                    
                    
                    75%
                    
                    
                    
                    9,539
                    
                    
                    
                    72%
                    
                    
                    
                    4,856
                    
                    
                    
                    76%
                    
                    
                    
                    4,831
                    
                    
                    
                    72%Gross
      profit
                    
                    
                    3,501
                    
                    
                    
                    25%
                    
                    
                    
                    3,683
                    
                    
                    
                    28%
                    
                    
                    
                    1,566
                    
                    
                    
                    24%
                    
                    
                    
                    1,846
                    
                    
                    
                    28%Selling,
      general and administrative expenses
                    
                    
                    2,632
                    
                    
                    
                    19%
                    
                    
                    
                    2,626
                    
                    
                    
                    20%
                    
                    
                    
                    1,327
                    
                    
                    
                    20%
                    
                    
                    
                    1,284
                    
                    
                    
                    19%Research
      and development expenses
                    
                    
                    666
                    
                    
                    
                    5%
                    
                    
                    
                    794
                    
                    
                    
                    6%
                    
                    
                    
                    330
                    
                    
                    
                    5%
                    
                    
                    
                    370
                    
                    
                    
                    6%Operating
      income (loss)
                    
                    
                    203
                    
                    
                    
                    1%
                    
                    
                    
                    263
                    
                    
                    
                    2%
                    
                    
                    
                    (91
                    )
                    
                    
                    (1)%
                    
                    
                    
                    192
                    
                    
                    
                    3%Interest
      expense and other income (net)
                    
                    
                    (450
                    )
                    
                    
                    (3)%
                    
                    
                    
                    (1,173
                    )
                    
                    
                    (9)%
                    
                    
                    
                    (427
                    )
                    
                    
                    (7)%
                    
                    
                    
                    (588
                    )
                    
                    
                    (9)%Loss
      before income taxes
                    
                    
                    (247
                    )
                    
                    
                    (2)%
                    
                    
                    
                    (910
                    )
                    
                    
                    (7)%
                    
                    
                    
                    (518
                    )
                    
                    
                    (8)%
                    
                    
                    
                    (396
                    )
                    
                    
                    (6)%Income
      tax expense
                    
                    
                    (148
                    )
                    
                    
                    (1)%
                    
                    
                    
                    (36
                    )
                    
                    
                    -%
                    
                    
                    
                    (53
                    )
                    
                    
                    (1)%
                    
                    
                    
                    (12
                    )
                    
                    
                    -%Net
      loss
                    
                    $
                    (395
                    )
                    
                    
                    (3)%
                    
                    
                    $
                    (946
                    )
                    
                    
                    (7)%
                    
                    
                    $
                    (571
                    )
                    
                    
                    (9)%
                    
                    
                    $
                    (408
                    )
                    
                    
                    (6)%




The
Company’s sales, from continuing operations, by product line for the three and
six month periods ended June 30, 2009 and 2008 are as follows (dollars in
thousands).


Six
      months ended June 30,2009
                                  
                                  
                                  2008Line
                                  
                                  $
                                  11,109
                                  
                                  
                                  
                                  79
                                  %
                                  
                                  $
                                  10,847
                                  
                                  
                                  
                                  82
                                  %Signal
                                  
                                  
                                  2,966
                                  
                                  
                                  
                                  21
                                  %
                                  
                                  
                                  2,375
                                  
                                  
                                  
                                  18
                                  %$
                                  14,075
                                  
                                  
                                  
                                  100
                                  %
                                  
                                  $
                                  13,222
                                  
                                  
                                  
                                  100
                                  %
 
 Three
      Months Ended June 30,2009
                              
                              
                              2008Line
                              
                              $
                              4,889
                              
                              
                              
                              76
                              %
                              
                              $
                              5,455
                              
                              
                              
                              82
                              %Signal
                              
                              
                              1,533
                              
                              
                              
                              24
                              %
                              
                              
                              1,222
                              
                              
                              
                              18
                              %$
                              6,422
                              
                              
                              
                              100
                              %
                              
                              $
                              6,677
                              
                              
                              
                              100
                              %


Line
equipment sales for the June 2009 Period, compared to the June 2008 Period,
increased by $262,000 (2%). The increase in sales was primarily a result of
increased sales to Telmex of approximately $2,137,000 offset by decreased sales
to British Telecommunications and its systems integrators of approximately
$985,000 and a decline in sales of $761,000 to another customer, that was less
than a 10% customer in the June 2008 Period.


Sales for
the June 2009 Quarter decreased by $566,000 (10%), compared to the June 2008
Quarter. The decrease in sales for the three months is the result of a decrease
in sales of connector products to British Telecommunications and its systems
integrators of approximately $1,410,000 partially offset by the increase of
sales to Telmex of $720,000. As stated under “Overview,” British
Telecommunications and its installers represented our largest customer in each
of the June 2009 and 2008 Periods and the June 2009 and 2008 Quarters. Any
continuation of the significant reduction in the level of business from British
Telecommunications and its installers could continue to have a material adverse
effect upon both our revenue and net loss.




Page 16
of 22




Signal
sales for the June 2009 Period were $2,966,000, compared to $2,375,000 in the
June 2008 Period, an increase of $591,000 (25%). Sales for the June 2009 Quarter
increased by $311,000 (25%) from $1,222,000 in the June 2008 Quarter to
$1,533,000. The increase in Signal revenue for the six months was primarily due
to increases in orders from the military sector.




Our gross
margin for the June 2009 Period was 25% compared to 28% for the June 2008
Period. Gross margin for the June 2009 Quarter was 24% compared to 28% for the
June 2008 Quarter. Gross margin for connection/protection was 17% and 18% for
the three months and six months ended June 30, 2009, respectively, as compared
to 24% for the three and six month period ended June 30, 2008. The decrease is
related to changes in product mix in the connection/protection division and the
effects of the stronger dollar against the British pound. We do not engage in
hedging as a method of seeking to reduce the impact of currency fluctuations.
Gross margin for Signal was 49% and 50% for the three and six months ended June
30, 2009, respectively, compared to 44% and 46% for the same periods in
2008.




Selling,
general and administrative expenses were generally constant, increasing from
$2,626,000 for the June 2008 Period to $2,632,000 for June 2009 Period. For the
June 2009 Quarter, selling, general and administrative expenses increased by
$43,000 from $1,284,000 in June 2008 Quarter to $1,327,000. Selling expenses
decreased slightly due to a reduction in advertising. Administrative expenses
increased primarily as a result of increased professional fees offset by the
effects of our overall cost cutting initiatives.




Research
and development expenses decreased by $128,000 (16%) in the June 2009 Period
compared to the June 2008 Period, from $794,000 to $666,000. In the June 2009
Quarter, research and development expenses decreased by $40,000 (11%) to
$330,000 from $370,000 in the June 2008 Quarter. The decrease in the quarter and
six months resulted primarily from a reduction of personnel and a decrease in
prototypes which were not required in the current phase of the development of
our new products.




As a
result of the foregoing, we had operating income of $203,000 for the June 2009
Period, compared with operating income of $263,000 in the June 2008 Period. We
had an operating loss of $91,000 for the June 2009 Quarter as compared operating
income of $192,000 in the June 2008 Quarter.





Interest
expense, net, for the June 2009 Period was $464,000, compared with $1,180,000
for the June 2008 Period. The decrease of $716,000 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 and June 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 SFAS 15, 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. During the June 2009 Period, we recorded
approximately $364,000 of accrued interest on the 12.5% senior debt, which
included $178,500 which, under SFAS 15, would have been accrued in the quarter
ended March 31, 2009 (see Note 3 of Notes to Consolidated Financial Statements).
Interest expense at the stated interest rates on the restructured debt would
have been $899,000 and $447,000 for the six months and quarter ended June 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 June 2009 Quarter represents interest on a floating
rate working capital loan in the amount of $1,475,000 made to us by our senior
lender in 2008, and modified on May 1, 2009 and on June 1, 2009 (See Note 8 of
Notes to Consolidated Financial Statements), at a rate of LIBOR plus 10%, which
was approximately 11.1% for the June 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.


Page 17
of 22


Income
tax expense for the quarter and six months ended June 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 six month periods.





As a
result of the foregoing, we generated a net loss of $395,000, or $.04 per share
(basic and diluted), for the June 2009 Period, compared with net loss of
$946,000, or $1.05 per share (basic and diluted) in the June 2008 Period. The
net loss for the June 2009 Quarter was $571,000, or $0.06 per share (basic and
diluted), compared with net loss of $408,000, or $0.45 per share (basic and
diluted) in the June 2008 Quarter. The change in the net loss per share reflects
the effect of the debt restructuring which resulted in the issuance of
additional shares of common stock which, as of June 30, 2009, represents 91% of
our outstanding common stock.





Liquidity and Capital
Resources





At June
30, 2009, we had cash and cash equivalents of $375,000 compared with $292,000 at
December 31, 2008, and we had a working capital deficit of $441,000, 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
                            
                            June
      30,
                            
                            
                            December
      31,
                            
                            
                            December
      31, 2008 to June 30, 20092009
                            
                            
                            2008
                            
                            
                            DollarChange
                            
                            
                            Percent
      ChangeCurrent
      AssetsCash
      and cash equivalents
                            
                            $
                            375
                            
                            
                            $
                            292
                            
                            
                            $
                            83
                            
                            
                            
                            29
                            %Accounts
      receivable – trade, net
                            
                            
                            2,897
                            
                            
                            
                            4,554
                            
                            
                            
                            (1,657
                            )
                            
                            
                            (36
                            )%Inventories
                            
                            
                            5,287
                            
                            
                            
                            6,110
                            
                            
                            
                            (823
                            )
                            
                            
                            (13
                            )%Prepaid
      expenses and other current assets
                            
                            
                            320
                            
                            
                            
                            202
                            
                            
                            
                            118
                            
                            
                            
                            58
                            %Total
      current assets
                            
                            $
                            8,879
                            
                            
                            $
                            11,158
                            
                            
                            $
                            (2,279
                            )
                            
                            
                            (20
                            )%Current
      LiabilitiesSenior
      debt, including interest
                            
                            $
                            1,658
                            
                            
                            $
                            1,500
                            
                            
                            $
                            158
                            
                            
                            
                            11
                            %Subordinated
      notes, including interest
                            
                            
                            191
                            
                            
                            
                            191
                            
                            
                            
                            -
                            
                            
                            
                            -6%
      subordinated debentures, principal
                            
                            
                            385
                            
                            
                            
                            385
                            
                            
                            
                            -
                            
                            
                            
                            -Accounts
      payable
                            
                            
                            4,409
                            
                            
                            
                            5,529
                            
                            
                            
                            (1,120
                            )
                            
                            
                            (20
                            )%Accrued
      expenses and other
                            
                            
                            1,946
                            
                            
                            
                            2,390
                            
                            
                            
                            (444
                            )
                            
                            
                            (19
                            )%Other
      accrued interest payable
                            
                            
                            731
                            
                            
                            
                            336
                            
                            
                            
                            395
                            
                            
                            
                            118
                            %Total
      current liabilities
                            
                            $
                            9,320
                            
                            
                            $
                            10,331
                            
                            
                            $
                            (1,011
                            )
                            
                            
                            10
                            %Working
      Capital
                            
                            $
                            (441
                            )
                            
                            $
                            827
                            
                            
                            $
                            (1,268
                            )
                            
                            
                            (153
                            )%





Cash flow
from operations was $1,224,000 for the June 2009 Period, as compared with
$505,000 of cash used in operations for the June 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
$1,657,000 reduction in accounts receivable from December 31, 2008 to the six
months ended June 30, 2009. Fees are at LIBOR plus 0.7% on the days to maturity
of each invoice that is factored.




Page 18
of 22




During
the June 2009 Period and the June 2008 Period, our only investing activities
were capital expenditures of $132,000 and $76,000, respectively.




During
the June 2009 Period, we paid senior and subordinated debt of $410,000 of which
$124,000 was paid in the second quarter. We paid fees related to our financing
arrangements with Lloyds of $42,000 during the June 2009 Period, of which
$26,000 were incurred in the second quarter. We had no other cash flow or
expenditures from financing activities during the three and six months ended
June 30, 2009. In June 2008, we borrowed an additional $600,000 from our senior
debt holders. There were no other financing activities during the three and six
months ended June 30, 2008.




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 June 2009 and 2008 Periods, we sustained losses as a result of
exchange rates of $599,000, and $142,000, respectively, of which $471,000 and
$102,000 were sustained in the June 2009 Quarter and the June 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 June 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 and August 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 June 2009 Period, the loss from exchange rates represented approximately 4%
of sales and was 4% of sales for the June 2008 Period.


Page 19
of 22


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.




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 June 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 may 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, have concluded that, as of the June 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;




Page 20
of 22


·
            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.




PART
II – OTHER INFORMATION





Item 5. Other
Information





Modification of Working
Capital Senior Note





On May
1, 2009 and June 1, 2009, the working capital senior note was replaced with a
new working capital note. The new note, issued June 1, 2009 in the amount of
$1,475,279 (including accrued interest), provides for monthly payments of
$125,000 commencing July 31, 2009, with a final payment of the remaining
principal and interest on July 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. See Note 8 of Notes to the Consolidated Financial
Statements.





Item 6.
Exhibits





4.1
              
              Working
      capital senior note dated June 1, 2009.31.1
              
              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:
      August 14, 2009
                                  By:
                                  /s/Edward B. KornfeldEdward
      B. KornfeldChief
      Executive OfficerBy:
                                  /s/ Leslie K. BrandLeslie
      K. BrandChief
      Financial
Officer


Page 22
of 22