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PERFORMANCE TECHNOLOGIES INC \DE\ - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
[March 07, 2013]

PERFORMANCE TECHNOLOGIES INC \DE\ - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) PT's annual operating performance is subject to various risks and uncertainties.

The following discussion should be read in conjunction with the Consolidated Financial Statements and related notes, included elsewhere herein, as well as the risk factors described in Item 1A of Part I of this Form 10-K. PT's future operating results may be affected by various trends and factors, which are beyond PT's control. These risks and uncertainties include, among other factors, business and economic conditions, rapid technological changes accompanied by frequent new product introductions, competitive pressures, dependence on key customers, inability to gauge order flows from customers, fluctuations in quarterly and annual results, the reliance on a limited number of third party suppliers, limitations of the Company's manufacturing capacity and arrangements, the protection of the Company's proprietary technology, errors or defects in our products, the effects of pending or threatened litigation, the dependence on key personnel, changes in critical accounting estimates, potential impairments related to investments, foreign regulations, possible loss or significant curtailment of significant government contracts or subcontracts and potential material weaknesses in internal control over financial reporting. In addition, during weak or uncertain economic periods, customers' visibility deteriorates causing delays in the placement of their orders. These factors often result in a substantial portion of the Company's revenue being derived from orders placed within a quarter and shipped in the final month of the same quarter.

16 Table of Contents Matters discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations, and elsewhere in this Form 10-K, include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. PT's actual results could differ materially from those discussed in the forward-looking statements.

Critical Accounting Estimates and Assumptions In preparing the financial statements in accordance with the accounting principles generally accepted in the United States (GAAP), estimates and assumptions are required to be made that have an impact on the assets, liabilities, revenue and expense amounts reported. These estimates can also affect supplemental information disclosures, including information about contingencies, risk and financial condition. The Company believes that given the current facts and circumstances, these estimates and assumptions are reasonable, adhere to GAAP, and are consistently applied. Inherent in the nature of an estimate or assumption is the fact that actual results may differ from estimates, and estimates may vary as new facts and circumstances arise.

Management's judgment in making these estimates and relying on these assumptions may materially impact amounts reported for any period.

The critical accounting policies, judgments and estimates that we believe have the most significant effect on our financial statements are set forth below: • Revenue Recognition • Software Development Costs • Valuation of Inventories • Income Taxes • Product Warranty • Stock-Based Compensation • Restructuring Costs • Carrying Value of Long-Lived Assets Revenue Recognition: Revenue is recognized from product sales in accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition." Product sales represent the majority of our revenue and include both hardware products and hardware products with embedded software. Revenue is recognized from these product sales when persuasive evidence of an arrangement exists, delivery has occurred or services have been provided, the sale price is fixed or determinable, and collectibility is reasonably assured. Additionally, products are sold on terms which transfer title and risk of loss at a specified location, typically the shipping point. Accordingly, revenue recognition from product sales occurs when all factors are met, including transfer of title and risk of loss, which typically occurs upon shipment. If these conditions are not met, revenue recognition is deferred until such time as these conditions have been satisfied.

17 Table of Contents For arrangements with multiple deliverables, the arrangement consideration is allocated at the inception of an arrangement to all deliverables using the relative selling price method. A selling price hierarchy is employed for determining the selling price of a deliverable, which includes: (1) vendor-specific objective evidence ("VSOE") if available; (2) third-party evidence ("TPE") if vendor-specific objective evidence is not available; and (3) best estimated selling price ("BESP") if neither vendor-specific nor third-party evidence is available. For PT's multiple deliverable arrangements, our products and services qualify as separate units of accounting. The Company's multiple deliverable arrangements generally include a combination of telecommunications hardware and software products, services including installation and training, and support services. These arrangements typically have both software and non-software components that function together to deliver the product's essential functionality. These arrangements generally do not include any provisions for cancellation, termination, or refunds that would significantly impact recognized revenue. Because the Company rarely sells its proprietary hardware and software products on a stand-alone basis or without support, PT isn't able to establish VSOE for these products. Additionally, PT generally expects that it will not be able to establish TPE due to the proprietary nature of PT's products and the markets in which we compete.

Accordingly, PT expects the selling price of its products to be based on its BESP. PT has established VSOE for its support and services and, therefore, it utilizes VSOE for these elements.

Since the adoption of this guidance on January 1, 2011, we have primarily used the same information used to set pricing strategy to determine BESP. The Company has corroborated the BESP with our historical sales prices, the anticipated margin on the deliverable, the selling price and profit margin for similar deliverables and the characteristics of the geographical markets in which the deliverables are sold. PT plans to analyze the selling prices used in our allocation of arrangement consideration at least semi-annually. Selling prices will be analyzed more frequently if a significant change in our business necessitates a more timely analysis.

For substantially all multiple deliverable arrangements, PT defers support and services revenue, and recognizes revenue for delivered products in an arrangement when persuasive evidence of an arrangement exists and delivery of the last product has occurred, provided the fee is fixed or determinable, and collection is deemed probable. In instances where final acceptance of the product is based on customer specific criteria, revenue is deferred until the earlier of the receipt of customer acceptance or the expiration of acceptance period. Support revenue is recognized ratably over the term of the support period. Services revenue is typically recognized upon completion of the services for fixed-fee service arrangements, as these services are relatively short-term in nature (typically several weeks, or in limited cases, several months). For service arrangements that are billed on a time and material basis, we recognize revenue as the services are performed.

For multiple deliverable arrangements entered into prior to January 1, 2011 and not materially modified after that date, PT recognized revenue based on the then-existing software revenue recognition guidance, which required the entire fee from the arrangement to be allocated to each respective element based on its relative selling price using VSOE. For such arrangements, when the Company was unable to establish VSOE for the delivered telecommunications products, PT utilized the residual method to allocate revenue to each of the elements of an arrangement. Under this method, PT allocated the total fee in an arrangement first to the undelivered elements (typically support and services) based on VSOE of those elements, and the remaining, or "residual" portion of the fee to the delivered elements (typically the product or products).

18 Table of Contents Revenue from software requiring significant production, modification, or customization is recognized using the percentage of completion method of accounting. Anticipated losses on contracts, if any, are charged to operations as soon as such losses are determined. If all conditions of revenue recognition are not met, the Company defers revenue recognition and will recognize revenue when the Company has fulfilled its obligations under the arrangement. Revenue from software maintenance contracts is recognized ratably over the contractual period.

Revenue from consulting and other services is recognized at the time the services are rendered. The Company also sells certain products through distributors who are granted limited rights of return. Potential returns are accounted for at the time of sale.

The accounting estimate related to revenue recognition is considered a "critical accounting estimate" because terms of sale can vary, and judgment is exercised in determining whether to defer revenue recognition. Such judgments may materially affect net sales for any period. Judgment is exercised within the parameters of GAAP in determining when contractual obligations are met, title and risk of loss are transferred, sales price is fixed or determinable and collectibility is reasonably assured.

Software Development Costs: All software development costs incurred in establishing the technological feasibility of computer software products to be sold are charged to expense as research and development costs. Software development costs incurred subsequent to the establishment of technological feasibility of a computer software product to be sold and prior to general release of that product are capitalized. Amounts capitalized are amortized commencing after general release of that product over the estimated remaining economic life of that product, generally three years, using the straight-line method or using the ratio of current revenues to current and anticipated revenues from such product, whichever provides greater amortization. If the technological feasibility for a particular project is judged not to have been met or recoverability of amounts capitalized is in doubt, project costs are expensed as research and development or charged to cost of goods sold, as applicable. The accounting estimate related to software development costs is considered a "critical accounting estimate" because judgment is exercised in determining whether project costs are expensed as research and development or capitalized as an asset. Such judgments may materially affect expense amounts for any period. Judgment is exercised within the parameters of GAAP in determining when technological feasibility has been met and recoverability of software development costs is reasonably assured.

Valuation of Inventories: Inventories are stated at the lower of cost or market, using the first-in, first-out method. Inventory includes purchased parts and components, work in process and finished goods. Provisions for excess, obsolete or slow moving inventory are recorded after periodic evaluation of historical sales, current economic trends, forecasted sales, estimated product life cycles and estimated inventory levels. Purchasing practices, electronic component obsolescence, accuracy of sales and production forecasts, introduction of new products, product life cycles, product support and foreign regulations governing hazardous materials are the factors that contribute to inventory valuation risks. Exposure to inventory valuation risks is managed by maintaining safety stocks, minimum purchase lots, managing product end-of-life issues brought on by aging components or new product introductions, and by utilizing certain inventory minimization strategies such as vendor-managed inventories. The accounting estimate related to valuation of inventories is considered a "critical accounting estimate" because it is susceptible to changes from period-to-period due to the requirement for management to make estimates relative to each of the underlying factors, including purchasing, sales, production, and after-sale support. If actual demand, market conditions or product life cycles differ from estimates, inventory adjustments to lower market values would result in a reduction to the carrying value of inventory, an increase in inventory write-offs and a decrease to gross margins.

19 Table of Contents Income Taxes: PT provides deferred income tax assets and liabilities based on the estimated future tax effects of differences between the financial and tax bases of assets and liabilities based on currently enacted tax laws. A valuation allowance is established for deferred tax assets in amounts for which realization is not considered more likely than not to occur. The accounting estimate related to income taxes is considered a "critical accounting estimate" because judgment is exercised in estimating future taxable income, including prudent and feasible tax planning strategies, and in assessing the need for any valuation allowance. If it should be determined that all or part of a net deferred tax asset is not able to be realized in the future, an adjustment to the valuation allowance would be charged to income in the period such determination was made. Likewise, in the event that it should be determined that all or part of a deferred tax asset in the future is in excess of the net recorded amount, an adjustment to the valuation allowance would increase income to be recognized in the period such determination was made.

PT operates within multiple taxing jurisdictions worldwide and is subject to audit in these jurisdictions. These audits can involve complex issues, which may require an extended period of time for resolution. Although management believes that adequate provision has been made for such issues, there is the possibility that the ultimate resolution of such issues could have an adverse effect on the earnings of PT. Conversely, if these issues are resolved favorably in the future, the related provisions would be reduced, thus having a positive impact on earnings.

In addition, the calculation of PT's tax liabilities involves dealing with uncertainties in the application of complex tax regulations. PT recognizes liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires PT to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as this requires PT to determine the probability of various possible outcomes. PT re-evaluates these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period. At December 31, 2012, there are no tax uncertainties that PT has determined are required to be recognized.

Finally, the value of PT's deferred tax assets is dependent upon PT's ability to generate future taxable income in the jurisdictions in which PT operates. These assets consist of research credit carry-forwards, capital and net operating loss carry-forwards, and the future tax effect of temporary differences between balances recorded for financial statement purposes and for tax return purposes.

It will require future pre-tax earnings in excess of $23 million in order to fully realize the value of the Company's deferred tax assets. Due to the uncertainty of PT's ability to realize its deferred tax assets, a valuation allowance has been recorded against substantially the full value of its deferred tax assets.

Product Warranty: Warranty obligations are generally incurred in connection with the sale of PT's products. The warranty period for these products is generally one year. The costs incurred to provide for these warranty obligations are estimated and recorded as an accrued liability at the time of sale. Future warranty costs are estimated based on historical performance rates and related costs to repair given products. The accounting estimate related to product warranty is considered a "critical accounting estimate" because judgment is exercised in determining future estimated warranty costs. Should actual performance rates or repair costs differ from estimates, revisions to the estimated warranty liability would be required.

20 Table of Contents Stock-Based Compensation: PT's board of directors approves grants of stock options to employees to purchase our common stock. Stock compensation expense is recorded based upon the estimated fair value of the stock option at the date of grant. The accounting estimate related to stock-based compensation is considered a "critical accounting estimate" because estimates are made in calculating compensation expense including expected option lives, forfeiture rates and expected volatility. Expected option lives are estimated using vesting terms and contractual lives. Expected forfeiture rates and volatility are calculated using historical information. Actual option lives and forfeiture rates may be different from estimates and may result in potential future adjustments which would impact the amount of stock-based compensation expense recorded in a particular period.

Restructuring Costs: Restructuring costs generally consist of employee-related severance costs, lease termination costs and other facility-related closing expenses. Employee-related severance benefits are recorded either at the time an employee is notified, or if there are extended service periods, is estimated and recorded pro-rata over the period of each planned restructuring activity. Lease termination costs are calculated based upon fair value considering the remaining lease obligation amounts and estimates for sublease receipts. The accounting estimate related to restructuring costs is considered a "critical accounting estimate" because estimates are made in calculating the amount of employee-related severance benefits that will ultimately be paid and the amount of sublease receipts that will ultimately be received in future periods. Actual amounts paid for employee-related severance benefits can vary from these estimates depending upon the number of employees actually receiving severance payments. Actual sublease receipts received may also vary from estimates.

Carrying Value of Long-Lived Assets: PT periodically reviews the carrying values of its long-lived assets, other than capitalized software development costs and purchased intangible assets with indefinite useful lives, for impairment whenever events or changes in circumstances indicate that the carrying values may not be recoverable. PT assesses the recoverability of the carrying values of long-lived assets by first grouping its long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (the asset group) and, secondly, by estimating the undiscounted future cash flows that are directly associated with and that are expected to arise from the use of and eventual disposition of such asset group. PT estimates the undiscounted cash flows over the remaining useful life of the primary asset within the asset group. If the carrying value of the asset group exceeds the estimated undiscounted cash flows, PT records an impairment charge to the extent the carrying value of the long-lived asset exceeds its fair value. PT determines fair value through quoted market prices in active markets or, if quoted market prices are unavailable, through the performance of internal analyses of discounted cash flows. The accounting estimate related to impairment of long-lived assets is considered a "critical accounting estimate" because PT's impairment tests include estimates of future cash flows that are dependent upon subjective assumptions regarding future operating results including revenue growth rates, expense levels, discount rates, capital requirements and other factors that impact estimated future cash flows and the estimated fair value of long-lived assets.

Overview PT, a Delaware corporation founded in 1981, is a global supplier of advanced, high availability network communications solutions.

PT's product portfolio includes its SEGway™ Diameter and SS7 Signaling Systems, which provide tightly integrated signaling and advanced routing capabilities and applications that uniquely span the mission critical demands of both existing and next-generation 4G LTE and IMS telecommunications networks. The Company's IPnexus Multi-Protocol Gateways and Servers enable a broad range of IP-interworking in data acquisition, sensor, radar, and control applications for aviation, weather and other infrastructure networks.

21 Table of Contents PT's business addresses one industry segment - Communications, and globally targets two primary vertical markets for its network communications products: telecommunications, and government aerospace/defense.

PT is headquartered in Rochester, New York and maintains direct sales and marketing offices in the U.S. in Raleigh, North Carolina and Chicago, Illinois and international offices in London, England and Shanghai, China, and has centers of engineering excellence in San Diego, California, and Kanata, Ontario, Canada, in addition to Rochester, New York.

Please refer to Part 1, Item 1, under the caption "Business," for further discussion of the industry, markets and economic environment.

Strategy On January 10, 2013, the Company announced the sharpening of its strategic focus and refinement of its business strategy. This multi-faceted initiative involves concentrating on two product families, transitioning away from other product portfolio elements, and operational expense reductions.

The Company's strategy is to focus on its high value-add network communications solutions - leveraging its core competencies. In the telecommunications space, PT is building upon its seventeen years of signaling systems experience and its installed customer base for its SEGway SS7 Signaling Systems. The mobile telecommunications industry is in the early stages of building out much higher bandwidth 4G/ LTE-based network architectures. As part of this network evolution, service providers' signaling infrastructure is migrating from SS7 signaling to Diameter signaling. During 2012, PT introduced the SEGway Universal Diameter Router - its premier Diameter Signaling solution set for next-generation 4G LTE networks. The Company expects to be a key player in this growth market by providing high value proposition "best-of-breed" solutions and by taking those solutions to the global market through a combination of strong channel partners and focused direct sales activities.

In the government network infrastructure arena, PT is focused on maximizing the sales of its IPnexus Multi-Protocol IP-interworking solutions. These PT systems have enabled extremely reliable and highly available radar and sensor communications services over IP networks - gathering and delivering vital data such as weather, flight tracking, and ground surveillance. PT's presence in air traffic control and defense-related communications is approaching 4,000 systems deployed in over 30 different countries. Looking ahead, the Company expects to expand its IPnexus Multi-Protocol Gateways and Servers into new aerospace/defense applications as well as potentially enter new emerging markets such as Energy and Smart-Grid.

As part of its strategic realignment, PT began transitioning out of the general OEM platform business during the fourth quarter 2012. Notices were sent to selected customers informing them of a last-time buy program related to the Company's OEM platform products. This last-time buy and build program will run through 2014 for major customers. PT will continue to utilize its own open standards platforms as key elements of its network communications solutions and maintain a certain number of strategic customers.

The Company discontinued its own direct sales and development activity on its Xpress SIP applications product line and in December 2012 entered into an agreement with an independent value-added reseller for subsequent Xpress-related sales and support.

22 Table of Contents The Company reduced its personnel by ten employees, or 8% of its workforce on January 10, 2013. This action reduced operating expenses by approximately $.7 million per year. When combined with the savings from the restructuring PT announced in October 2012, the Company has reduced its break-even expense level by more than $2 million a year. During the first half of 2013, we expect to increase our sales and marketing investments in our Diameter signaling product to accelerate its penetration in this growing market.

In summary, given this concentrated product focus, the substantial steps we have taken to reduce our operating expense levels and our strong and unleveraged balance sheet, management believes PT is now well positioned for a positive future trajectory as economic conditions improve.

There are identifiable risks associated with PT's strategy in the current economic climate. While management believes that its network communications market focus offers opportunities for growth in the long term, network infrastructure investments by carriers have recently been very sluggish; the total available market for traditional SS7-based signaling products is declining and the market for next-generation 4G network products is currently in an early-stage of growth. Despite the present economic climate, which may involve new risks not currently identified, management believes the outlook for the Company's profitability is improving because expenses have been aligned with projected revenues and our new channel partners are engaged in selling our products.

Please refer to Part 1, Item 1, under the caption "Business," for further information regarding the Company's "Strategy." Key Performance Indicator PT believes that a key indicator for its business is the trend for the volume of orders received from customers. The telecommunications market, historically our largest vertical market, is fundamentally driven by investments in network infrastructure by carriers and service providers, and the mobile telecommunications industry is in the early stages of building out much higher bandwidth 4G/LTE-based network architectures. Revenues from our telecommunications customers declined by $8.0 million, or 29%, in 2012, from 2011. Much of this decrease in revenue was due to a much steeper and more rapid decline in sales to the Company's traditionally largest customer than was anticipated. Sales to this U.K.-domiciled customer declined by $5.5 million year-over-year. In addition, the Company experienced a $1.7 million year over year decline in sales to one signaling systems customer. The economy appears to be recovering unevenly around the world and current business conditions continue to remain quite challenging in the telecommunications equipment market.

Sales into the government aerospace/defense market are typically to prime contractors and system integrators that reflect investment levels by various government agencies and defense agencies in specific programs and projects requiring enhanced communications capabilities. Revenues from the government aerospace/defense market customers declined by $4.9 million, or 57%, in 2012, compared to 2011. This decrease in revenue was partially attributable to the non-recurrence in 2012 of a $2.0 million sale to the Federal Government's Federal Aviation Administration in 2011.

During 2012, the challenging global economic climate continued to cause customers to limit and/or delay investments in their network infrastructure.

Sales to customers amounted to $23.3 million in 2012, compared to $36.2 million in 2011. During weak economic periods, customers' ability to forecast their requirements deteriorates causing delays in the placement of orders.

Forward-looking visibility on customer orders continues to be very challenging.

23 Table of Contents Financial Overview Revenue: Revenue for 2012 amounted to $23.3 million, compared to $36.2 million in 2011.

With continued weakness in the global economy and lower demand for the Company's products, PT experienced a 36% decrease in sales in 2012, compared to 2011.

While the Company had anticipated that sales to the Company's traditionally largest customer would decline as that customer completed its transition away from using PT's platform products in some of their products, this process occurred earlier and much more rapidly than was anticipated. Shipments to the Company's traditionally largest customer declined by $5.5 million in 2012, compared to 2011. In addition, the Company experienced a $1.7 million year-over-year decline in sales to one signaling systems customer who did not have such equipment requirements in 2012.

Shipments to customers outside of the United States represented 46% of sales in both 2012 and 2011. Shipments to customers in the United States decreased by $7.0 million in 2012, compared to 2011. Shipments to the United Kingdom represented 8% and 20% of PT's total sales in 2012 and 2011, respectively.

Shipments to various government aerospace/defense customers amounted to $3.7 million, representing a 57% decrease, compared to 2011. This decrease in revenue was partially attributable to the non-recurrence in 2012 of a $2.0 million sale to the Federal Government's Federal Aviation Administration in 2011. In addition, we believe that during the second half of 2012, aerospace and defense budgets for radar and sensor communications projects were dramatically reduced.

Earnings: PT incurred a net loss in 2012 amounting to ($7.1 million), or ($.64) per basic share, based on 11.1 million shares outstanding. This loss included: º Charges for the impairment of software development costs, purchased intangible assets and other assets totaling $.14 per share; º OEM excess inventory charges of $.12 per share; º Restructuring charges of $.04 per share; º Stock-based compensation expense of $.02 per share; º A discrete income tax charge of $.01 per share; and º Amortization of purchased intangible assets of $.10 per share.

PT incurred a net loss in 2011 amounting to ($1.2 million), or ($.10) per basic share, based on 11.1 million shares outstanding. This loss included: º Restructuring charges of $.02 per share; º Stock-based compensation expense of $.03 per share; º An impairment charge against vendor software of $.04 per share; º Write-offs of software development costs of $.02 per share; º Amortization of purchased intangible assets of $.10 per share; and º Litigation expenses of $.04 per share.

24 Table of Contents Cash: Cash, cash equivalents and investments amounted to $14.3 million and $15.8 million at December 31, 2012 and 2011, respectively, and the Company had no long-term debt at either date. The decrease in cash in 2012 was due primarily to the final $1.0 million payment relating to the 2011 purchase of GENBAND assets and the loss for the year, net of non-cash items, and offset partially by cash flow generated by the Company's decrease in accounts receivable and inventories.

Cash flows from operating activities totaled $2.5 million in 2012, a $.9 million decline from 2011, when operations provided $3.4 million in cash flows. The 2012 amount included the net loss of ($7.1 million), non-cash revenue of $.3 million, and net bad debt recoveries of $.2 million, offset by non-cash charges including depreciation, amortization, asset write-offs and impairments totaling $5.3 million, an inventory obsolescence charge of $1.4 million, and stock-based compensation expense of $.2 million. In addition, accounts receivable, inventories and prepaid expenses decreased by $2.0 million, $.5 million and $.2 million, respectively, and accounts payable and accrued expenses and deferred revenue each increased by $.2 million. This was partially offset by a $.1 million increase in prepaid income taxes. The increase in accounts receivable was principally due to lower fourth quarter sales in 2012, compared to 2011. The decrease in inventory is primarily attributable to the Company's ongoing efforts to manage inventory levels relative to revenue expectations.

Cash flows used in investing activities totaled $4.6 million, including the final $1.0 million payment to GENBAND, $.5 million of equipment purchases and $2.3 million of capitalized software costs, offset partially by $.7 millionof net investment purchases.

Restructuring Activities: PT completed one restructuring action during 2012 and announced another subsequent to December 31, 2012.

In October 2012, the Company announced a program to restructure its operations, reduce its workforce, rationalize its product lines, and refocus its resources on initiatives that are more closely aligned with the Company's near-term objectives and market potential. The program included the elimination of fourteen positions, which represented 10% of the Company's workforce, for which the Company recorded a fourth quarter charge for severance costs in the amount of $.4 million. Substantially all of this charge resulted in an outlay of cash in the fourth quarter 2012.

In January 2013, the Company announced its decision to sharpen its strategic business focus, concentrate on its high value-add communications product families, transition away from other product portfolio elements, and implement operational expense reductions. In conjunction with this decision, the Company reduced its personnel by ten employees, or 8% of its workforce as of January 10, 2013. As a result of this action, the Company expects to incur first quarter 2013 pre-tax restructuring charges of approximately $.3 million, representing employee-related costs which will result in cash expenditures.

In December 2010, the Company announced its plan to implement a reduction of its existing workforce in response to the continuing challenges of the global economic environment. This program, which was completed in the fourth quarter 2011, was projected to reduce operating expenses by approximately $4.0 million to $4.5 million on an annualized run rate basis. It included closing the San Luis Obispo, California engineering facility and the elimination of 22 sales, marketing and engineering positions, which represented approximately 12% of the Company's workforce. The Company recorded a pre-tax charge of $0.9 million in the fourth quarter of 2010 and a pre-tax charge of $.2 million in 2011 for severance and other costs related to this program. This program required an outlay of cash totaling $1.1 in 2011.

25 Table of Contents Results of Operations The following table sets forth, for the years indicated, certain consolidated financial data expressed as a percentage of sales, which has been included as an aid to understanding PT's results and should be read in conjunction with the Selected Financial Data and Consolidated Financial Statements (including the notes thereto) appearing elsewhere in this report.

Year Ended December 31, 2012 2011 2010 Sales 100.0 % 100.0 % 100.0 % Cost of goods sold 53.2 % 51.4 % 55.7 % Software capitalization and purchased intangible asset write-offs 6.9 % 0.5 % 2.1 % OEM excess inventory charge 5.8 % Gross profit 34.1 % 48.1 % 42.2 % Operating expenses: Selling and marketing 21.2 % 17.7 % 29.7 % Research and development 23.9 % 19.7 % 28.0 % General and administrative 17.1 % 12.6 % 20.9 % Restructuring charges 1.9 % .7 % 4.2 % Impairment charges - vendor software 1.1 % Total operating expenses 64.1 % 51.8 % 82.8 % Loss from operations (30.0 %) (3.7 %) (40.6 %) Other income, net 0.2 % 0.4 % 1.2 % Loss before income taxes (29.8 %) (3.3 %) (39.4 %)Income tax provision (benefit) 0.8 % (0.1 %) 0.6 % Net loss (30.6 %) (3.2 %) (40.0 %) Year Ended December 31, 2012 compared with the Year Ended December 31, 2011Sales. Total revenue for 2012 amounted to $23.3 million, compared to $36.2 million for 2011. PT's products have been grouped into two primary vertical markets within one segment, communications. Revenue from each product category is expressed as a percentage of sales for the periods indicated: 2012 2011 Telecommunications 84 % 76 % Military, aerospace and government systems 16 % 24 % Total 100 % 100 % Telecommunications products: Revenue from telecommunications products amounted to $19.6 million and $27.6 million in 2012 and 2011, respectively. This decrease in revenue of $8.0 million, or 29%, was primarily due to a much steeper and more rapid decline in sales to the Company's traditionally largest customer than was anticipated.

Sales to this customer declined by $5.5 million year-over-year. In addition, the Company experienced a $1.7 million year-over-year decline in sales to one signaling systems customer.

26 Table of Contents As part of its strategic realignment, PT began transitioning out of the general OEM platform business during the fourth quarter 2012. Notices were sent to selected customers informing them of a last-time buy program related to the Company's OEM platform products. This last-time buy and build program will run through 2014 for major customers. PT will continue to utilize its own open standards platforms as key elements of its network communications solutions and maintain a certain number of strategic customers.

The Company discontinued its own direct sales and development activity on its Xpress SIP applications product line and in December 2012 entered into an agreement with an independent value-added reseller for subsequent Xpress-related sales and support.

Looking ahead, PT's telecommunications product portfolio includes its SEGway Diameter and SS7 Signaling Systems, which provide tightly integrated signaling and advanced routing capabilities and applications that uniquely span the mission critical demands of both existing and next-generation 4G LTE and IMS telecommunications networks.

Government aerospace/defense products: The Company's IPnexus Multi-Protocol Gateways and Servers enable a broad range of IP-interworking in data acquisition, sensor, radar, and control applications for aviation, weather and other infrastructure networks. We continue to work with numerous prime contractors to incorporate these products into specific programs and projects requiring enhanced communications capabilities. Revenue from government aerospace/defense products amounted to $3.7 million and $8.6 million in 2012 and 2011, respectively. This decrease of $4.9 million, or 57%, was principally due to the non-recurrence of a $2.0 million sale in 2011 to support the Federal Aviation Administration, plus sales decreases totaling $1.9 million to two Federal government prime contractors.

Gross profit. Gross profit consists of sales, less cost of goods sold including material costs, manufacturing expenses, depreciation, amortization of software development costs, and expenses associated with engineering contracts and the technical support function. Gross profit totaled $8.0 million and $17.4 million in 2012 and 2011, respectively, a decrease of $9.4 million, or 54%. The decline in gross margin was primarily caused by the decrease in sales, the impairment of software development costs, purchased intangible assets and other assets, and an OEM excess inventory charge. Gross margin was 34.1% and 48.1% of sales for 2012 and 2011, respectively. An impairment charge of $1.6 million was recorded in 2012 to write off the recorded value of software development costs and purchased intangible assets relating to the Company's Xpress product family. In addition, an inventory obsolescence charge totaling $1.4 million was recorded in 2012 to reflect the Company's decision to transition away from its general OEM platform products. These two charges represent 6.9% and 5.8% of sales, respectively.

Without including these charges, cost of goods sold as a percentage of sales increased from 51% in 2011 to 53% in 2012, primarily due to reduced utilization of relatively fixed manufacturing labor and overhead costs due to the Company's significantly lower sales, offset partially by an improved sales mix toward higher-margin, higher software content products. Included in cost of goods sold is the amortization of software development costs and purchased intangible assets, which totaled $2.8 million and $3.0 million in 2012 and 2011, respectively, excluding the charges for the impairment of capitalized software development projects and purchased intangible assets discussed above.

27 Table of Contents Total Operating Expenses. Total operating expenses in 2012 amounted to $14.9 million including restructuring expenses of $.4 million, and stock compensation expense of $.2 million. Total operating expenses in 2011 amounted to $18.8 million including restructuring charges of $.3 million, an impairment charge-vendor software of $.4 million and stock compensation expense of $.3 million. Total operating expenses decreased $3.8 million from 2011 to 2012,as discussed below.

Selling and marketing expensesamounted to $4.9 million and $6.4 million in 2012 and 2011, respectively. This decrease of $1.5 million, or 23%, was principally the result of reduced numbers of sales and marketing personnel primarily due to the Company's December 2010 restructuring program, lower sales commissions,and lower trade show expenses.

Research and development expenses amounted to $5.6 million and $7.1 million in 2012 and 2011. The Company capitalizes certain software development costs, which reduces the amount charged to research and development expenses. Amounts capitalized were $2.0 million in both 2012 and 2011. Gross research and development expenditures were $7.6 million and $9.1 million in 2012 and 2011, respectively. The decrease in gross research and development expenditures totaled $1.5 million, or 16%, and was primarily due to the effect of the Company's decision to close its engineering center in San Luis Obispo, California, as well as the reduction in personnel that occurred in 2012, plus lower new product prototype costs.

General and administrative expenses totaled $4.0 million and $4.6 million for 2012 and 2011, respectively. General and administrative expenses in 2011 were unusually high due to the costs associated with the Company's defense of intellectual property litigation instituted by one of the Company's competitors.

This litigation was dismissed in May 2011. These litigation-related expenses totaled $.4 million in 2011.

During 2011, PT recorded a $.4 million charge to impair certain assets in conjunction with the Company's termination of a value-added reseller agreement.

In addition, a $.1 million out-of-period charge was recorded in 2011 to reduce the recorded balance of software development costs.

Restructuring charges amounted to $.4 million and $.3 million in 2012 and 2011, respectively. In 2012, the Company announced its decision torestructure its operations, reduce its workforce, rationalize its product lines, and refocus its resources on initiatives that are more closely aligned with the Company's near-term objectives and market potential. The program included the elimination of fourteen positions, which represented 10% of the Company's workforce, for which the Company recorded a fourth quarter charge for severance costs in the amount of $.4 million.

In December 2010, the Company announced a reduction in force, which was completed during 2011. A restructuring charge of $.3 million was recorded in 2011 in connection with this action.

28 Table of Contents A summary with respect to the 2012 and 2011 restructuring activities is as follows (amounts in millions): Severance Lease commit- Number of employees Reserve ments and other TotalBalance at January 1, 2011 23 $ .9 $ - $ .9 2011 restructuring charges 2 .1 .1 .2 2011 utilization (25 ) (1.0 ) (.1 ) (1.1 ) Balance at December 31, 2011 - - - - 2012 restructuring charges 14 .4 - .4 2012 utilization (14 ) (.4 ) - (.4 )Balance at December 31, 2012 - $ - $ - $ - All utilization amounts except $.1 million in 2011 represent cash payments.

Other Income, net. Other income consists primarily of interest income and totaled $.1 million in 2012 as compared to $.2 million in 2011. This decrease was due to continued depressed yields the Company is earning on its investments and lower average cash and investment balances in 2012, compared to 2011, plus the effect of a $.06 million out-of-period charge to adjust the recorded balance of accumulated other comprehensive income. As of December 31, 2012, the Company's funds are primarily invested in high-quality corporate bonds of short duration, government-backed money market funds, and municipal bonds.

Income taxes. The effective income tax rate is a combination of federal, state and foreign tax rates and is generally lower than statutory rates because it includes benefits derived from tax credits related to research and development activities in the United States and Canada, and tax-exempt interest income. The Company carries a full valuation allowance against its net deferred incometax assets.

For 2012, the income tax provision amounted to $.2 million and includes a tax provision relating to the possible repatriation of foreign subsidiaries' earnings and the recording of a full valuation allowance against the Company's foreign subsidiaries' deferred tax assets. Unlike 2011, the 2012 tax provision excludes the effect of expected foreign investment and research credits, which are now presented as a reduction of research and development expenses. For 2011, the income tax benefit amounted to $.02 million and includes the effect of refundable foreign investment and research tax credits.

Stock compensation expense. Cost of goods sold and operating expenses include stock compensation expense, which totaled $.2 million and $.3 million in 2012 and 2011, respectively.

Year Ended December 31, 2011 compared with the Year Ended December 31, 2010 The following discussion references a number of products which, as detailed in this annual report, the Company has discontinued. Those products were sold in 2011 and 2010 and are therefore included in this discussion.

29 Table of Contents Sales. Total revenue for 2011 amounted to $36.2 million, compared to $27.9 million for 2010. PT's products have been grouped into two primary vertical markets within one segment, communications. Revenue from each product category is expressed as a percentage of sales for the periods indicated: 2011 2010 Telecommunications 76 % 81 % Military, aerospace and government systems 24 % 19 % Total 100 % 100 % Telecommunications products: Telecommunications products are comprised of Application-Ready Platforms, SEGway signaling systems and Xpress products. PT's Application-Ready Platforms are designed for high availability, scalability, and long life cycle deployments and are sold to telecommunication equipment manufacturers. The Company's SEGway signaling products, which are built on our Application-Ready Platforms, provide a full suite of signaling solutions that seamlessly bridge between circuit-switched networks and growing "IP-based" networks. PT's Xpress products are a portfolio of SIP-based applications and enabling infrastructure for next-generation network (NGN) architectures.

Revenue from telecommunications products amounted to $27.6 million and $22.6 million in 2011 and 2010, respectively. This increase in revenue of $5.0 million, or 22%, primarily reflects the impact of PT's significant new channel partner relationships which totaled $3.4 million in 2011, plus a $1.6 million increase in sales to a customer in Africa. Sales to the Company's largest customer increased $.2 million, from $6.7 million to $6.9 million.

Military, aerospace and government products: Our Government Systems group continues to work with numerous prime contractors to incorporate PT's Multi-Protocol Gateways and Servers into specific programs and projects requiring enhanced communications capabilities. Revenue from military, aerospace and government system products was $8.6 million and $5.3 million in 2011 and 2010, respectively. This increase of $3.3 million, or 61%, included increased shipments to two customers amounting to $1.5 million and$.7 million, respectively.

Gross profit. Gross profit consists of sales, less cost of goods sold including material costs, manufacturing expenses, depreciation, amortization of software development costs, and expenses associated with engineering contracts and the technical support function. Gross profit totaled $17.4 million and $11.8 million in 2011 and 2010, respectively, an increase of $5.6 million, or 47%. Gross margin was 48.1% and 42.2% of sales for 2011 and 2010, respectively. Of the increase in margin, $.4 million resulted from a decrease in charges to write off or write down to estimated net realizable value software development costs. Such charges totaled $.2 million and $.6 million in 2011 and 2010, respectively. The most significant factors impacting the improved gross margin were the increase in revenue; an improvement in product mix toward higher-margin, more software-content products, especially our signaling products; and better utilization of the Company's fixed manufacturing labor and overhead due to the increase in sales. Included in cost of goods sold is the amortization of software development costs and purchased intangible assets, which totaled $3.0 million and $2.1 million in 2011 and 2010, respectively, excluding the charges for the write down of capitalized software development projects discussed above.

The amount of amortization recorded in 2011 increased by $.9 million, as compared to 2010, due to the amortization associated with the purchase of signaling technology from GENBAND in January 2011. This technology is being amortized over a five-year estimated life.

30 Table of Contents Total Operating Expenses. Total operating expenses in 2011 amounted to $18.8 million including restructuring expenses of $.3 million, an impairment charge-vendor software of $.4 million and stock compensation expense of $.3 million. Total operating expenses in 2010 amounted to $23.1 million including restructuring charges of $1.2 million and stock compensation expense of $.4 million. Total operating expenses decreased $4.3 million from 2010 to 2011,as discussed below.

Selling and marketing expensesamounted to $6.4 million and $8.3 million in 2011 and 2010, respectively. This decrease of $1.9 million, or 23%, was principally the result of reduced numbers of sales and marketing personnel primarily due to the Company's December 2010 restructuring program, lower trade show spending, and lower expenses due to an improved foreign currency exchange rate between the U.S. dollar and the British pound, offset partially by higher commissions.

Research and development expenses amounted to $7.1 million and $7.8 million in 2011 and 2010. The Company capitalizes certain software development costs, which reduces the amount charged to research and development expenses. Amounts capitalized were $2.0 million and $2.3 million in 2011 and 2010, respectively.

Gross research and development expenditures were $9.1 million and 10.1 million in 2011 and 2010, respectively. The decrease in gross research and development expenditures totaled $1.0 million, or 10%, and was primarily due to the Company's decision to close its engineering center in San Luis Obispo, California, reducing engineering by seventeen positions.

General and administrative expenses totaled $4.6 million and $5.8 million for 2011 and 2010, respectively. General and administrative expenses in 2010 and early in 2011 were unusually high due to the costs associated with the Company's defense of intellectual property litigation instituted by one of the Company's competitors. This litigation was dismissed in May 2011. Litigation-related expenses declined by $.8 million from 2010 to 2011.

During 2011, PT recorded a $.4 million charge to impair certain assets in conjunction with the Company's termination of a value-added resellers agreement.

$.4 million of the decrease in total operating expenses from 2010 to 2011 was due to a change in the Company's paid-time-off policy. In addition, a $.1 million out-of-period charge was recorded in 2011 to reduce the recorded balance of software development costs.

Restructuring charges amounted to $.3 million and $1.2 million in 2011 and 2010, respectively. In 2010, the Company recorded restructuring charges related to two programs. In December 2009, the Company announced its decision to outsource its printed circuit board assembly operation to a contract manufacturer. This action resulted in the elimination of fourteen positions during 2010, for which a restructuring charge of $.3 million was recorded. In December 2010, the Company announced a reduction in force, which was completed during the fourth quarter of 2011. A restructuring charge of $.2 million and $.9 million was recorded in 2011 and 2010, respectively, in connection with this action.

Restructuring charges amounted to $.6 million in 2009 and relate to two reductions in force that management initiated during the year. In January 2009, twenty positions were eliminated in an involuntary reduction in force, while in August 2009, eight positions were eliminated in a voluntary reduction in force.

Both of these actions were completed in 2009.

31 Table of Contents A summary of the activity with respect to the 2011 and 2010 restructuring activity is as follows (amounts in millions): Severance Lease commitments and Number of employees Reserve other Total Balance at January 1, 2010 - $ - $ - $ - 2010 restructuring charges 36 1.1 .1 1.2 2010 utilization (13 ) (.2 ) (.1 ) (.3 ) Balance at December 31, 2010 23 .9 - .9 2011 restructuring charges 2 .1 .1 .2 2011 utilization (25 ) (1.0 ) (.1 ) (1.1 ) Balance at December 31, 2011 - $ - $ - $ - All utilization amounts except $.1 million in each of 2011 and 2010 represent cash payments.

Other Income, net. Other income consists primarily of interest income and totaled $.2 million in 2011, compared to $.3 million in 2010. This decrease was due to continued depressed yields the Company is earning on its investments and lower average cash and investment balances in 2011 than in 2010. As of December 31, 2011, the Company's funds are primarily invested in high-quality corporate bonds of short duration, government-backed money market funds, municipal bonds and bank guaranteed interest contracts.

Income taxes. The effective income tax rate is a combination of federal, state and foreign tax rates and is generally lower than statutory rates because it includes benefits derived from tax credits related to research and development activities in the United States and Canada, and tax-exempt interest income.

For 2011, the income tax benefit amounted to $.02 million and includes the effect of expected foreign investment and research credits. For 2010, the income tax provision amounted to $.2 million and includes the effect of a discrete foreign deferred tax provision of $.1 million resulting from the Company revising its assertion that the earnings in its Canadian subsidiary will be indefinitely reinvested. The 2010 provision also includes a discrete income tax provision of $.1 million which was recorded due to the income tax benefit which resulted from the decrease in unrealized gain on foreign currency hedge contracts during 2010, and state and foreign taxes, offset by refundable U.S.

federal and Province of Ontario credits.

Stock compensation expense. Cost of goods sold and operating expenses include stock compensation expense which totaled $.3 million and $.4 million in 2011 and 2010, respectively.

Liquidityand Capital Resources At December 31, 2012, our primary sources of liquidity are cash, cash equivalents and investments. The Company does not currently have a revolving credit facility. Together, cash, cash equivalents and investments totaled $14.3 million and $15.8 million at December 31, 2012 and 2011, respectively. The decrease in cash, cash equivalents and investments amounted to $1.5 million and is primarily the result of the Company's final $1.0 million payment relating to the 2011 purchase of GENBAND assets and the loss for the year, net of non-cash items, and offset partially by cash flow generated by the Company's decrease in accounts receivable and inventories. The Company had working capital of $15.5 million and $18.7 million at December 31, 2012 and 2011, respectively. The decrease in working capital amounted to $3.2 million and can be largely attributed to the final GENBAND payment, capital expenditures totaling $.5 million, and $.7 million of net purchases of investments. In 2012, the Company also used cash to fund capitalized software development costs of $2.3 million.

32 Table of Contents Cash flows from operating activities totaled $2.5 million in 2012, a $.9 million decline from 2011, when operations provided $3.4 million in cash flows. The 2012 amount included the net loss of ($7.1 million), non-cash revenue of $.3 million, and net bad debt recoveries of $.2 million, offset by non-cash charges including depreciation, amortization, asset write-offs and impairments totaling $5.3 million, an inventory obsolescence charge of $1.4 million, and stock-based compensation expense of $.2 million. In addition, accounts receivable, inventories and prepaid expenses decreased by $2.0 million, $.5 million and $.2 million, respectively, and accounts payable and accrued expenses, and deferred revenue each increased by $.2 million. This was partially offset by a $.1 million increase in prepaid income taxes. The increase in accounts receivable was principally due to lower fourth quarter sales in 2012, compared to 2011. The decrease in inventory is primarily attributable to obsolescence charges.

While cash flow from operations was positive for 2012, the Company is prepared to take measures and consider alternatives to further reduce its costs should significant negative cash flow from operations occur.

Cash used by investing activities during 2012 amounted to $4.6 million, compared to cash used by investing activities during 2011, which amounted to $6.5 million. Cash used by investing activities resulted primarily from the Company's final $1.0 million payment for the purchase of software, equipment, inventory and intellectual property from GENBAND in early 2012 and payments to acquire property, equipment and improvements of $.5 million. In addition, the Company capitalized $2.3 million of software development costs and had a net increase in investments totaling $.7 million. Cash used by investing activities during 2011 amounted to $6.5 million resulting primarily from payments to acquire software, equipment, inventory and intellectual property from GENBAND which totaled $4.4 million, purchases of property, equipment and improvements of $.3 million, and capitalized software development costs of $2.0 million, offset partially by net sales of investments, which amounted to $.2 million.

In 2012, management continued to take measures to align expenses with projected revenue levels and in January 2013, the Company reduced its personnel by ten employees, or 8% of its workforce. Management believes that the Company's current cash, cash equivalents and investments will be sufficient to meet our anticipated cash requirements, including working capital and capital expenditure requirements, for at least the next twelve months. However, if revenue levels are not sustained, expenses may need to be reduced further. Furthermore, management is continuing to evaluate strategic acquisitions to accelerate the Company's growth and market penetration efforts. These strategic acquisition efforts could have an impact on our working capital, liquidity or capital resources.

Off-Balance Sheet Arrangements: The Company had no off-balance sheet arrangements during 2012.

Contractual Obligations: The Company leases facilities under operating leases. PT's corporate headquarters is located in 32,000 square feet of leased office and manufacturing space in Rochester, New York, for which the Company pays rent of approximately $30,000 per month. This lease expires in June 2017, and the Company may, at its option, reduce its rented space by approximately 11,000 square feet in February 2015. Corporate headquarters includes executive offices, along with sales, marketing, engineering and manufacturing operations.

During 2011, the Company exercised its option to early terminate its lease for its former facility in San Luis Obispo, California, effective April 30, 2011.

33 Table of Contents The Company leases office space in Kanata, Ontario, Canada under a lease which was extended in 2011. This lease terminates in October 2013. Rent payments under this lease, including payments of minimum operating costs, amount to $435,000CDN annually (approximately $435,000USD at December 31, 2012), with annual inflationary adjustments.

PT also leases engineering office space in San Diego, California under a lease which expires in November 2013. Rent payments under this lease will amountto $80,000 in 2013.

The Company leases office space near London, England under a contract which expires in March 2013.

For the lease agreements described above, the Company is also required to pay the pro rata share of the real property taxes and assessments, expenses and other charges associated with these facilities.

The Company enters into purchase commitments during the normal course of its operations. Certain of these purchase commitments are non-cancelable.

The Company is not a party to any other significant contractual obligations.

Due to uncertainties regarding whether, and when, the Company's tax returns may be examined by the applicable taxing authorities, and the uncertain possible outcomes of such examinations, if any, an estimate of the timing of payments related to uncertain tax positions and related interest cannot be made. See Note L, "Income Taxes," in the Notes to Consolidated Financial Statements for additional information regarding the Company's uncertain tax positions.

RECENT ACCOUNTING PRONOUNCEMENTS Comprehensive Income: In June 2011, the FASB issued authoritative guidance on the presentation of comprehensive income that eliminates the option to present the components of other comprehensive income as part of the statement of equity and requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance was effective retrospectively for fiscal years (and interim periods within those years) beginning after December 15, 2011 (an effective date of January 1, 2012 for the Company). The guidance required changes in financial statement presentation only and has had no impact on the Company's financial position or results of operations.

In January 2013, the FASB issued authoritative guidance on the presentation of amounts reclassified out of accumulated other comprehensive income. This guidance requires an entity to provide information about the amounts reclassified from accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the income statement or in the notes, significant amounts reclassified from accumulated other comprehensive income by the net income line item. The Company does not expect the adoption of this standard, which is required for reporting periods beginning in 2013, to have an impact on its consolidated financial positionor results of operations.

34 Table of Contents Fair Value Measurement and Disclosures: In May 2011, the FASB issued authoritative guidance that amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. This guidance was effective for the Company for reporting periods beginning in 2012. The adoption of this guidance did not have a significant impact on the Company's consolidated financial statements.

35 Table of Contents ITEM 8 - Financial Statements and Supplementary Data Index to Financial Statements: Page Report of Independent Registered Public Accounting Firm 37 Consolidated Balance Sheets at December 31, 2012 and 2011 38 Consolidated Statements of Operations for the Years Ended December 31, 2012, 2011 and 2010 39 Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2012, 2011 and 2010 40 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2012, 2011 and 2010 41 Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010 42 Notes to Consolidated Financial Statements 43 36 Table of Contents Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Performance Technologies, Incorporated: In our opinion, the consolidated financial statements listed in the accompanying indexpresent fairly, in all material respects, the financial position of Performance Technologies, Incorporated and its subsidiaries at December 31, 2012 and 2011, and the results of theiroperations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).

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

/s/ PricewaterhouseCoopers LLP Rochester, New York March 6, 2013 37 Table of Contents PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 2012 2011 ASSETS Current assets: Cash and cash equivalents $ 7,546,000 $ 9,641,000 Investments (Note D) 4,794,000 2,798,000 Accounts receivable, net (Note E) 3,775,000 5,622,000 Inventories (Note F) 3,615,000 5,421,000 Prepaid expenses and other assets 932,000 1,155,000 Prepaid income taxes (Note L) 206,000 67,000 Deferred income taxes (Note L) 445,000 368,000 Total current assets 21,313,000 25,072,000 Investments (Note D) 1,969,000 3,362,000Property, equipment and improvements, net (Note G) 1,683,000 1,891,000 Software development costs, net (Note M) 3,716,000 3,932,000 Purchased intangible assets, net (Notes B and C) 2,835,000 4,390,000 Deferred income taxes (Note L) 102,000 Total assets $ 31,516,000 $ 38,749,000 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,134,000 $ 1,015,000 Accrued expenses (Note H) 1,664,000 1,547,000 Deferred revenue 3,002,000 2,808,000 Fair value of foreign currency hedge contracts (Note O) 46,000 Other payable (Note B) 999,000 Total current liabilities 5,800,000 6,415,000 Deferred income taxes (Note L) 696,000 553,000 Total liabilities 6,496,000 6,968,000 Commitments and contingencies (Notes I and P) Stockholders' equity: Preferred stock - $.01 par value: 1,000,000 shares authorized; none issued Common stock - $.01 par value: 50,000,000 shares authorized; 13,304,596 shares issued; 11,116,397 shares outstanding 133,000 133,000 Additional paid-in capital 17,591,000 17,347,000 Retained earnings 17,099,000 24,237,000 Accumulated other comprehensive income (loss) 15,000 (118,000 ) Treasury stock - at cost; 2,188,199 shares held (9,818,000 ) (9,818,000 ) Total stockholders' equity 25,020,000 31,781,000 Total liabilities and stockholders' equity $ 31,516,000 $ 38,749,000 The accompanying notes are an integral part of these consolidated financial statements.

38 Table of Contents PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, 2012 2011 2010 Product sales $ 18,440,000 $ 32,103,000 $ 24,920,000 Support and service revenue 4,880,000 4,073,000 3,026,000 Total revenue 23,320,000 36,176,000 27,946,000 Cost of goods sold 12,416,000 18,585,000 15,558,000 Impairments of software development costs, purchased intangible assets and other assets (Notes C and M) 1,600,000 175,000 604,000 OEM excess inventory charge (Notes C and F) 1,351,000 Gross profit 7,953,000 17,416,000 11,784,000 Operating expenses: Selling and marketing 4,935,000 6,410,000 8,301,000 Research and development 5,583,000 7,124,000 7,823,000 General and administrative 3,997,000 4,568,000 5,824,000 Restructuring charges (Note Q) 434,000 253,000 1,176,000 Impairment charge - vendor software (Note G) 400,000 Total operating expenses 14,949,000 18,755,000 23,124,000 Loss from operations (6,996,000 ) (1,339,000 ) (11,340,000 ) Other income, net 52,000 154,000 329,000 Loss before income taxes (6,944,000 ) (1,185,000 ) (11,011,000 ) Income tax provision (benefit) 194,000 (22,000 ) 166,000 Net loss $ (7,138,000 ) $ (1,163,000 ) $ (11,177,000 ) Basic loss per share $ (.64 ) $ (.10 ) $ (1.01 ) Weighted average number of common shares used in basic loss per share 11,116,397 11,116,397 11,116,397 The accompanying notes are an integral part of these consolidated financial statements.

39 Table of Contents PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS Year Ended December 31, 2012 2011 2010 Net loss $ (7,138,000 ) $ (1,163,000 ) $ (11,177,000 ) Change in unrealized gain (loss) on foreign currency hedge contracts 46,000 (57,000 ) (117,000 ) Change in unrealized gain (loss) on available-for-sale investments 87,000 (72,000 ) Other comprehensive income (loss) 133,000 (129,000 ) (117,000 ) Comprehensive loss $ (7,005,000 ) $ (1,292,000 ) $ (11,294,000 ) The accompanying notes are an integral part of these consolidated financial statements.

40 Table of Contents PERFORMANCETECHNOLOGIES, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010 Accumulated Common Common Additional Other Stock Stock Paid-in Retained Treasury Comprehensive Shares Amount Capital Earnings Stock Income (Loss) Total Balance - January 1, 2010 13,304,596 $ 133,000 $ 16,596,000 $ 36,577,000 $ (9,818,000 ) $ 128,000 $ 43,616,000 Comprehensive loss (11,177,000 ) (117,000 ) (11,294,000 ) Stock compensation expense 446,000 446,000 Balance - December 31, 2010 13,304,596 133,000 17,042,000 25,400,000 (9,818,000 ) 11,000 32,768,000 Comprehensive loss (1,163,000 ) (129,000 ) (1,292,000 ) Stock compensation expense 305,000 305,000 Balance - December 31, 2011 13,304,596 133,000 17,347,000 24,237,000 (9,818,000 ) (118,000 ) 31,781,000 Comprehensive (loss) income (7,138,000 ) 133,000 (7,005,000 ) Stock compensation expense 244,000 244,000 Balance - December 31, 2012 13,304,596 $ 133,000 $ 17,591,000 $ 17,099,000 $ (9,818,000 ) $ 15,000 $ 25,020,000 The accompanying notes are an integral part of these consolidated financial statements.

41 Table of Contents PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, 2012 2011 2010Cash flows from operating activities: Net loss $ (7,138,000 ) $ (1,163,000 ) $ (11,177,000 ) Non-cash adjustments: Depreciation and amortization 3,743,000 3,767,000 2,959,000 Stock-based compensation expense 244,000 305,000 446,000 Impairment of long-lived assets 1,600,000 575,000 666,000 OEM excess inventory charge 1,351,000 (Recovery) provision for bad debts (161,000 ) 75,000 91,000 Revenue from non-monetary exchange (257,000 ) Loss (gain) on disposal of assets 9,000 32,000 (75,000 ) Non-cash interest and other 1,000 26,000 Deferred income taxes 168,000 38,000 191,000 Realized loss on maturity of investments 17,000 Changes in operating assets and liabilities: Accounts receivable 2,008,000 (219,000 ) 973,000 Inventories 455,000 2,433,000 (3,328,000 ) Prepaid expenses and other assets 164,000 (215,000 ) (120,000 ) Accounts payable and accrued expenses 236,000 (3,122,000 ) 2,787,000 Deferred revenue 194,000 862,000 (374,000 ) Income taxes payable and prepaid income taxes (139,000 ) (36,000 ) 423,000 Net cash provided (used) by operating activities 2,478,000 3,375,000 (6,538,000 ) Cash flows from investing activities: Purchase of equipment, inventory and intangible assets (1,000,000 ) (4,378,000 ) Purchases of property, equipment and improvements (530,000 ) (300,000 ) (1,341,000 ) Capitalized software development costs (2,295,000 ) (2,037,000 ) (2,261,000 ) Purchases of investments (3,501,000 ) (4,782,000 ) (5,344,000 ) Proceeds from sales and maturities of investments 2,753,000 4,963,000 10,605,000 Proceeds from sale of equipment 4,000 112,000 Net cash (used) provided by investing activities (4,573,000 ) (6,530,000 ) 1,771,000 Net decrease in cash and cash equivalents (2,095,000 ) (3,155,000 ) (4,767,000 ) Cash and cash equivalents at beginning of year 9,641,000 12,796,000 17,563,000 Cash and cash equivalents at end of year $ 7,546,000 $ 9,641,000 $ 12,796,000 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Net income taxes refunded $ 64,000 $ 26,000 $ 475,000 Purchased intangible assets acquired in non-monetary exchange $ 257,000 Non-cash investing activity: Other payable incurred for the purchase of assets $ 973,000 The accompanying notes are an integral part of these consolidated financial statements.

42 Table of Contents PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note A - Nature of Business and Summary of Significant Accounting Policies The Company: Performance Technologies, Incorporated ("the Company", "PT") was formed in 1981 under the laws of the State of Delaware and maintains its corporate offices in Rochester, New York. The Company is a global supplier of advanced high-availability communications solutions.

Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company transactions have been eliminated.

Foreign Currency Translation: The U.S. dollar is the functional currency of the Company's foreign subsidiaries. Monetary assets and liabilities are re-measured at year-end exchange rates. Non-monetary assets and liabilities are re-measured at historical rates. Revenues, expenses, gains and losses are re-measured using the rates on which those elements were recognized during the period.

Use of Estimates: The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at year-end and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Reclassifications and Adjustments: An out-of-period charge amounting to $63,000 was made to other income during 2012 to adjust the recorded balance of unrealized gain (loss) on available-for-sale securities, and a $94,000 out-of-period charge was recorded in 2011 to reduce the recorded balance of software development costs. These adjustments did not have a material impact on our consolidated financial statements.

Prior year amounts for current and non-current deferred taxes have been corrected to conform with the current year presentation to reflect the pro-rata allocation of the Company's full valuation allowance against its netdeferred tax assets. The correction resulted in an increase of $368,000 in current deferred tax assets, an increase of $102,000 in non-current deferred tax assets, and an increase of $470,000 of non-current deferred tax liabilities. This adjustment did not have any impact on the 2011 results of operations.

Concentration of Credit Risk: Financial instruments that potentially expose the Company to significant concentrations of credit risk consist principally of bank deposits, investments, and accounts receivable. Investments consist of high quality, interest bearing financial instruments. Included in cash and cash equivalents at December 31, 2012 are $1.3 million of AAA-rated money market funds and $4.9 million of deposits with one AA- rated Canadian bank.

The Company performs ongoing credit evaluations of its customers' financial condition and maintains an allowance for uncollectible accounts receivable based upon the expected collectibility of all accounts receivable. As of December 31, 2012, two customers represented 21% and 15% of net accounts receivable, respectively. As of December 31, 2011, three customers represented 25%, 14% and 11% of net accounts receivable, respectively.

Fair Value of Financial Instruments:The carrying amounts of the Company's accounts receivable and accounts payable approximate fair values at December 31, 2012 and 2011, as the maturity of these instruments are short term. The fair value of investments is discussed in Note D - Investments.

Cash Equivalents: The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

43 Table of Contents Investments: The Company may classify its investments as available-for-sale, held-to-maturity, or trading. Available-for-sale investments are carried at fair value, with unrealized gains and losses, if any, reported in accumulated other comprehensive income, a component of stockholders' equity. Losses that are judged to be other-than-temporary, if any, are recorded in net income (loss).

Amortization of purchase premiums or discounts is included in other income, net.

Inventories: Inventories are valued at the lower of cost or market. Cost is determined using the first-in, first-out method. The Company records provisions for excess, obsolete or slow moving inventory based on changes in customer demand, technology developments or other economic factors.

Revenue Recognition: The Company recognizes revenue from product sales in accordance with the SEC Staff Accounting Bulletin No. 104, "Revenue Recognition." Product sales represent the majority of the Company's revenue and include hardware products and hardware products with embedded software. The Company recognizes revenue from these product sales when persuasive evidence of an arrangement exists, delivery has occurred or services have been provided, the sale price is fixed or determinable, and collectibility is reasonably assured.

Additionally, the Company sells its products on terms which transfer title and risk of loss at a specified location, typically shipping point. Accordingly, revenue recognition from product sales occurs when all factors are met, including transfer of title and risk of loss, which typically occurs upon shipment by the Company. If these conditions are not met, the Company will defer revenue recognition until such time as these conditions have been satisfied. The Company collects and remits sales taxes in certain jurisdictions and reports revenue net of any associated sales taxes.

Revenue Recognition for Arrangements with Multiple Deliverables - For arrangements with multiple deliverables, the arrangement consideration is allocated at the inception of an arrangement to all deliverables using the relative selling price method. A selling price hierarchy is employed for determining the selling price of a deliverable, which includes: (1) vendor-specific objective evidence ("VSOE") if available; (2) third-party evidence ("TPE") if vendor-specific objective evidence is not available; and (3) best estimated selling price ("BESP") if neither vendor-specific nor third-party evidence is available. For PT's multiple deliverable arrangements, our products and services qualify as separate units of accounting. The Company's multiple deliverable arrangements generally include a combination of telecommunications hardware and software products, services including installation and training, and support services. These arrangements typically have both software and non-software components that function together to deliver the product's essential functionality. These arrangements generally do not include any provisions for cancellation, termination, or refunds that would significantly impact recognized revenue. Because the Company rarely sells such products on a stand-alone basis or without support, PT isn't able to establish VSOE for these products. Additionally, PT generally expects that it will not be able to establish TPE due to the proprietary nature of PT's products and the markets in which we compete. Accordingly, PT expects the selling price of its proprietary hardware and software products to be based on its BESP. PT has established VSOE for its support and services and, therefore, it utilizes VSOE for these elements.

Since the adoption of this guidance on January 1, 2011, we have primarily used the same information used to set pricing strategy to determine BESP. The Company has corroborated the BESP with our historical sales prices, the anticipated margin on the deliverable, the selling price and profit margin for similar deliverables and the characteristics of the geographical markets in which the deliverables are sold. PT plans to analyze the selling prices used in our allocation of arrangement consideration at least semi-annually. Selling prices will be analyzed more frequently if a significant change in our business necessitates a more timely analysis.

44 Table of Contents For substantially all multiple deliverable arrangements, PT defers support and services revenue, and recognizes revenue for delivered products in an arrangement when persuasive evidence of an arrangement exists and delivery of the last product has occurred, provided the fee is fixed or determinable, and collection is deemed probable. In instances where final acceptance of the product is based on customer specific criteria, revenue is deferred until the earlier of the receipt of customer acceptance or the expiration of acceptance period. Support revenue is recognized ratably over the term of the support period. Services revenue is typically recognized upon completion of the services for fixed-fee service arrangements, as these services are relatively short-term in nature (typically several weeks, or in limited cases, several months). For service arrangements that are billed on a time and material basis, we recognize revenue as the services are performed.

For multiple deliverable arrangements entered into prior to January 1, 2011 and not materially modified after that date, PT recognized revenue based on the then-existing software revenue recognition guidance, which required the entire fee from the arrangement to be allocated to each respective element based on its relative selling price using VSOE. For such arrangements, when the Company was unable to establish VSOE for the delivered telecommunications products, PT utilized the residual method to allocate revenue to each of the elements of an arrangement. Under this method, PT allocated the total fee in an arrangement first to the undelivered elements (typically support and services) based on VSOE of those elements, and the remaining, or "residual" portion of the fee to the delivered elements (typically the product or products).

Revenue from software requiring significant production, modification, or customization is recognized using the percentage of completion method of accounting. Anticipated losses on contracts, if any, are charged to operations as soon as such losses are determined. If all conditions of revenue recognition are not met, the Company defers revenue recognition and will recognize revenue when the Company has fulfilled its obligations under the arrangement. Revenue from software maintenance contracts is recognized ratably over the contractual period.

Revenue from consulting and other services is recognized at the time the services are rendered. The Company also sells certain products through distributors who are granted limited rights of return. Potential returns are accounted for at the time of sale.

Property, Equipment and Improvements: Property, equipment and improvements are stated at cost. Depreciation of equipment and improvements is provided for using the straight-line method over the following estimated useful lives: Engineering equipment and software 3 - 5 years Manufacturing equipment and tooling 3 - 5 years Furniture and equipment 3 - 5 years Leasehold improvements the lesser of 10 years or the leaseterm Repairs and maintenance costs are expensed as incurred. Asset betterments are capitalized.

45 Table of Contents Long-Lived Assets: The Company reviews the carrying values of its long-lived assets (other than goodwill, capitalized software development costs and purchased intangible assets with indefinite useful lives) for impairment whenever events or changes in circumstances indicate that the carrying values may not be recoverable. The Company assesses the recoverability of the carrying values of long-lived assets by first grouping its long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (the asset group) and, secondly, by estimating the undiscounted future cash flows that are directly associated with, and that are expected to arise from, the use of and eventual disposition of such asset group. The Company estimates the undiscounted cash flows over the remaining useful life of the primary asset within the asset group. If the carrying value of the asset group exceeds the estimated undiscounted cash flows, the Company records an impairment charge to the extent the carrying value of the long-lived asset exceeds its fair value. The Company determines fair value through quoted market prices in active markets or, if quoted market prices are unavailable, through the performance of internal analyses of discounted cash flows. If this review indicates that the remaining useful life of the long-lived asset has changed significantly, the Company adjusts the depreciation on that asset to facilitate full cost recovery over its revised estimated remaining useful life.

Derivative Financial Instruments:The Company may use derivative financial instruments from time to time as foreign currency hedges of a portion of the costs of its Canadian and United Kingdom operations. The fair value of these derivative instruments is estimated in accordance with the framework for measuring fair value contained in GAAP and is recorded as either an asset or liability in the balance sheet based on changes in the current spot rate, as compared to the exchange rates specified in the contracts. For these instruments, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and is reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. The fair value measurement of the Company's derivative instruments is estimated using Level 2 inputs, which are inputs other than quoted prices that are directly or indirectly observable for the asset or liability (See Note O).

Research and Development: Research and development costs, excluding amounts capitalized as software development costs, are expensed as incurred and include employee related costs, occupancy expenses and new product prototyping costs.

Shipping and Handling Costs and Sales Taxes: Amounts charged to customers and costs incurred by the Company related to shipping and handling are included in net sales and cost of goods sold, respectively. Revenue is presented net of any sales taxes collected and remitted by the Company.

Advertising: Advertising costs are expensed as incurred and recorded in "Selling and marketing" in the Consolidated Statements of Operations. Advertising expense, including web-based marketing expenses, amounted to $44,000, $108,000, and $93,000 for 2012, 2011, and 2010, respectively.

Software Development Costs: On a product-by-product basis, software development costs incurred subsequent to the establishment of technological feasibility and prior to general release of the product are capitalized and amortized commencing after general release over its estimated remaining economic life, generally three years, using the straight-line method or using the ratio of current revenues to current and anticipated revenues from such software, whichever provides greater amortization.

Income Taxes: The Company provides deferred income tax assets and liabilities based on the estimated future tax effects of differences between the financial and tax basis of assets and liabilities based on currently enacted tax laws. A valuation allowance is established for deferred tax assets in amounts for which realization is not considered more likely than not to occur.

46 Table of Contents Prior to the fourth quarter 2010, the Company had not provided for federal and state income taxes on the accumulated earnings of its Canadian subsidiary as it was the Company's intent to indefinitely reinvest such earnings in the operations of the subsidiary. As of December 2010, the Company now believed that it is reasonably possible that a portion of such accumulated earnings may be repatriated in the foreseeable future. As such, during 2012, 2011 and 2010, the Company recorded a deferred tax provision amounting to $65,000, $48,000 and $138,000, respectively, calculated based on the amount of earnings of the Canadian subsidiary that the Company may repatriate, recorded at the federal and state marginal tax rates, less the amount of net operating losses and tax credit carry-forwards that can be used to offset the federal and state tax.

The Company recognizes and measures uncertain tax positions using a two-step approach. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained upon examination, including resolution of related appeals or litigation processes, if any. In making this assessment, the Company must assume that the taxing authority will examine the income tax position and have full knowledge of all relevant information. The second step is to measure the tax benefit as the largest amount which is more than 50% likely to be realized upon ultimate settlement. The Company considers many factors when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments and which may or may not accurately forecast actual outcomes.

The Company reports interest and penalties accrued relating to uncertain income tax positions as a component of income tax provision.

Earnings Per Share: Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Due to the net losses in 2012, 2011 and 2010, diluted earnings per share are equal to basic earnings per share. Diluted earnings per share calculations reflect the assumed exercise and conversion of dilutive employee stock options and unvested restricted stock, if any, applying the treasury stock method. Diluted earnings per share calculations exclude the effect of approximately 1,654,000, 1,688,000 and 1,663,000 options in 2012, 2011 and 2010, respectively, since such options have an exercise price in excess of the average market price of the Company's common stock.

Stock Options and Stock-Based Employee Compensation: In 2003, the stockholders approved the 2003 Omnibus Incentive Plan pursuant to which 1,500,000 shares of common stock were reserved for future grants. Awards under the 2003 Omnibus Incentive Plan may include stock options, stock appreciation rights, restricted stock and other stock performance awards as determined by the Board of Directors. During 2012, the stockholders approved the 2012 Omnibus Incentive Plan pursuant to which 1,500,000 shares of common stock were reserved for future grants. At December 31, 2012, 394,000 shares were available for future grant under the 2003 Plan and 1,500,000 shares were available for grant under the2012 Plan.

Stock options may be granted to any officer or employee at not less than the fair market value at the date of grant (not less than 110% of the fair market value in the case of holders of more than 10% of the Company's common stock).

Options granted under the plans generally expire between five and ten years from the date of grant and vest in periods ranging from one year to five years.

The Company recognizes compensation expense in the financial statements for share-based awards based on the grant date fair value of those awards.

Stock-based compensation expense includes an estimate for pre-vesting forfeitures and is recognized over the requisite service periods of the awards on a straight-line or graded vesting basis, which is generally commensuratewith the vesting term.

47 Table of Contents The Company may either issue shares or utilize treasury stock shares upon employees' stock option exercises. In 2012, 2011 and 2010 there were no exercises of stock options.

Segment Data, Geographic Information and Significant Customers and Vendors: The Company is not organized by market and is managed and operated as one business.

A single management team that reports to the chief operating decision maker comprehensively manages the entire business. The Company does not operate any material separate lines of business or separate business entities. Accordingly, the Company does not accumulate discrete financial information, other than product revenue and material costs, with respect to separate product lines and does not have separately reportable segments.

Shipments to customers outside of the United States represented 46%, 46% and 58% of sales in 2012, 2011 and 2010, respectively. In 2012, 2011 and 2010, export shipments to the United Kingdom represented 8%, 20% and 26% of sales, respectively. The Company maintains significant amounts of long-lived assets in the United States and Canada.

For 2012, 2011, and 2010, four customers accounted for approximately 32%, 38% and 39% of sales respectively. In 2012, one customer accounted for 14% of sales.

In 2011, one customer accounted for 19% of sales. In 2010, one customer accounted for 24% of sales.

As of December 31, 2012, all of the Company's printed circuit board assembly operations are conducted by one vendor and platform chassis are manufactured by two contract manufacturers.

Fair Value Measurements: GAAP establishes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs are inputs other than quoted prices included in Level 1 that are directly or indirectly observable for the asset or liability.

Such inputs include quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs derived principally from or corroborated by observable market data by correlation or other means. Level 3 inputs are unobservable inputs for the asset or liability. Such inputs are used to measure fair value when observable inputs are not available.

The Company's assets measured at fair value on a recurring basis at December 31, 2012 were as follows: Level 1 Level 2 Level 3 Assets: Investments $ 5,262,000 $ 1,501,000 $ - Total assets measured at fair value $ 5,262,000 $ 1,501,000 $ - There were no liabilities measured at fair value on a recurring basis at December 31, 2012.

48 Table of Contents The Company's assets and liabilities measured at fair value on a recurring basis at December 31, 2011 were as follows: Level 1 Level 2 Level 3 Assets: Investments $ 4,260,000 $ 1,900,000 $ - Total assets measured at fair value $ 4,260,000 $ 1,900,000 $ - Liabilities: Foreign currency hedge contracts $ - $ 46,000 $ - Total liabilities measured at fair value $ - $ 46,000 $ - Foreign currency hedge contracts are valued based on observable market spot and forward rates as of our reporting date and are included in Level 2 inputs. We use these derivative instruments to mitigate the effect of changing foreign currency exchange rates on our expense levels in our Canadian operations. All contracts are recorded at fair value and marked to market at the end of each reporting period and realized and unrealized gains and losses are includedin net income for that period.

Contingencies and Related Legal Costs: An accrual of losses related to contingencies is made when, in the opinion of management and legal counsel, if applicable, the likelihood of loss is deemed probable and the amount of loss is reasonably estimable. Related legal costs are expensed as incurred. (See Note P).

Recent Accounting Pronouncements: From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our financial position or results of operations upon adoption.

Comprehensive Income: In June 2011, the FASB issued authoritative guidance on the presentation of comprehensive income that eliminates the option to present the components of other comprehensive income as part of the statement of equity and requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance was effective retrospectively for fiscal years (and interim periods within those years) beginning after December 15, 2011 (an effective date of January 1, 2012 for the Company). The guidance required changes in financial statement presentation only and has had no impact on the Company's financial position or results of operations.

In January 2013, the FASB issued authoritative guidance on the presentation of amounts reclassified out of accumulated other comprehensive income. This guidance requires an entity to provide information about the amounts reclassified from accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the income statement or in the notes, significant amounts reclassified from accumulated other comprehensive income by the net income line item. The Company does not expect the adoption of this standard, which is required for reporting periods beginning in 2013, to have an impact on its consolidated financial positionor results of operations.

49 Table of Contents Fair Value Measurement and Disclosures: In May 2011, the FASB issued authoritative guidance that amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. This guidance was effective for the Company for reporting periods beginning in 2012. The adoption of this guidance did not have a significant impact on the Company's consolidated financial statements.

Note B - Asset Purchase In January 2011, the Company entered into an asset purchase agreement with GENBAND to acquire GENBAND's Universal Signaling Platform ("USP") and SP2000 signaling technology which GENBAND acquired in its May 2010 acquisition of Nortel's Carrier VoIP and Application Solutions business. In connection with this transaction, the Company acquired software, equipment, inventories, and intellectual property including a signaling-related patent, a license under GENBAND's signaling patent portfolio and an assignment of certain signaling technology conveyed to GENBAND under license from Nortel. Certain of these licensed property rights are not transferable without GENBAND's consent.

Furthermore, under certain circumstances, GENBAND has the right to terminate this licensing agreement. In addition to the acquisition of assets, the Company agreed to provide GENBAND with ongoing development, support and maintenance of signaling solutions, and solutions for stand-alone signaling applications as well as integrated signaling capabilities.

The total consideration for these assets amounted to $5,378,000, of which $4,000,000 was paid at closing in January 2011, $378,000 was paid for transaction-related costs, and $1,000,000 was due in January 2012. This payable, discounted at 3%, had a present value of $973,000 at the date of closing and $999,000 at December 31, 2011. The full balance of $1,000,000 was paid in January 2012.

Approximately $613,000 of the total consideration for the GENBAND assets was allocated to property, plant and equipment, $67,000 to inventory, and the remainder was allocated to purchased intangible assets, including the estimated value of the support contract, which amounted to $420,000, and purchased developed technologies, which amounted to $4,260,000.

Note C - Purchased Intangible Assets and Asset Impairments In addition to the software technologies acquired from GENBAND, purchased intangible assets include the technologies acquired in 2009 from Pactolus with a cost of $835,000. Purchased intangible assets are being amortized over estimated useful lives of three to five years.

In the fourth quarter 2012, the Company made the decision to transition out of its general OEM platform and Xpress product lines and to focus on its Signaling and Multi-Protocol IP-internetworking product families. As a result of this business decision, the Company recorded a fourth quarter 2012 impairment charge against purchased intangible assets, capitalized software development costs and other assets associated with these product lines. This impairment charge totaled $1,600,000, of which $656,000 reduced the recorded value of purchased intangible assets, $885,000 reduced the recorded value of capitalized software development costs (see Note M), and $59,000 reduced the recorded value of other assets. In addition, in conjunction with this decision, the Company recorded a charge to increase its reserve for excess and obsolete inventories amounting to $1,351,000 (see Note F) which reduces its carrying value of the inventories for its OEM Platform product line.

50 Table of Contents Purchased intangible assets consist of the following: At December 31, 2012 2011 Purchased developed technologies $ 5,352,000 $ 5,095,000 Support contracts 420,000 420,000 Total 5,772,000 5,515,000 Less: impairment charge (656,000 ) Less: accumulated amortization (2,281,000 ) (1,125,000 ) Purchased intangible assets, net $ 2,835,000 $ 4,390,000 Amortization of purchased intangible assets totaled $1,812,000, $1,094,000 and $31,000 in 2012, 2011 and 2010, respectively, including the impairment charge of $656,000 in 2012. Amortization of purchased intangible assets will total approximately $936,000, $936,000, $936,000, and $27,000 in 2013, 2014, 2015and 2016, respectively.

Note D - Investments Investments consisted of the following: At December 31, 2012 2011 Amortized cost Fair value Amortized cost Fair value Corporate bonds $ 5,247,000 $ 5,262,000 $ 4,328,000 $ 4,260,000 Municipal bonds 1,501,000 1,501,000 504,000 500,000 Guaranteed investment certificates - - 1,400,000 1,400,000 Total investments 6,748,000 6,763,000 6,232,000 6,160,000 Less-current investments (4,786,000 ) (4,794,000) (2,849,000 ) (2,798,000 ) Non-current investments $ 1,962,000 $ 1,969,000 $ 3,383,000 $ 3,362,000 All income generated from the Company's investments is recorded net of bond premium amortization in other income, net, and totaled $22,000, $169,000 and $198,000 in 2012, 2011 and 2010, respectively.

The Company's bond investments have a cumulative par value of $6,678,000 at December 31, 2012. Nine of these bonds with a cumulative par value of $4,748,000 mature in 2013 and are classified as current assets, while four bonds with a cumulative par value of $1,930,000 mature in 2014 and are classified as non-current assets.

Note E - Accounts Receivable, net Accounts receivable consisted of the following: At December 31, 2012 2011 Accounts receivable $ 3,905,000 $ 5,942,000Less: allowance for doubtful accounts (130,000 ) (320,000 ) Net $ 3,775,000 $ 5,622,000 The (recovery of) provision for doubtful accounts is included in selling and marketing expenses and amounted to $(161,000), $75,000 and $91,000 in 2012,2011 and 2010, respectively.

51 Table of Contents Note F - Inventories Inventories consisted of the following: At December 31, 2012 2011 Purchased parts and components $ 1,245,000 $ 2,036,000 Work in process and purchased assemblies 1,631,000 2,015,000 Finished goods 739,000 1,370,000 Net $ 3,615,000 $ 5,421,000 In conjunction with the Company's decision in the fourth quarter 2012 to transition away from its OEM platform products, a charge amounting to $1,351,000 was recorded to increase its reserve for excess and obsolete inventories (see Note C).

Note G - Property, Equipment and Improvements, net Property, equipment and improvements consisted of the following: At December 31, 2012 2011 Land $ 407,000 $ 407,000 Engineering equipment and software 6,618,000 6,698,000 Manufacturing equipment 1,196,000 1,141,000 Furniture and equipment 1,621,000 1,608,000 Leasehold improvements 289,000 412,000 10,131,000 10,266,000 Less: accumulated depreciation and amortization (8,448,000 ) (8,375,000 ) Net $ 1,683,000 $ 1,891,000 Total depreciation and amortization expense for equipment and improvements for 2012, 2011 and 2010 was $719,000, $748,000 and $766,000, respectively.

The net book value of property, equipment and improvements located in the United States was $987,000 and $951,000 at December 31, 2012 and 2011, respectively.

Substantially all of the Company's property, equipment and improvements outside the United States are located in Canada.

During 2010, the Company paid one-time license fees totaling $580,000 to acquire certain software technologies, which the Company planned to use in synergistic combination with its captive technologies to develop new end-market products.

These amounts were recorded in property, equipment and improvements. During 2011, the Company terminated a value-added reseller agreement with the licensor of certain of these software technologies and recorded an impairment totaling $400,000 against this asset.

During 2012, the Company disposed of assets with a cost basis of $663,000 and accumulated depreciation of $654,000. The loss on disposal was $9,000. During 2011, the Company disposed of assets with a cost basis of $1,352,000 (including the $400,000 impairment of vendor software technologies) and accumulated depreciation of $916,000. The loss on disposal totaled $32,000. During 2010, the Company disposed of assets with a cost basis of $994,000 and accumulated depreciation of $957,000 and recorded a gain on disposal of $75,000.

52 Table of Contents During 2009, the Company made the decision to outsource manufacturing of the printed circuit board assembly for the hardware elements of the Company's products. This action was completed during 2010 and certain long-lived manufacturing assets were identified for sale, which was completed during 2010.

As of December 31, 2010, the carrying values of the remaining assets relating to the printed circuit board assembly operation were reviewed for recoverability and the Company recorded a non-cash impairment against the recorded value of property, equipment and improvements in the amount of $61,000.

Note H - Accrued Expenses Accrued expenses consisted of the following: At December 31, 2012 2011 Accrued compensation and related costs $ 680,000 $776,000 Accrued vacation 27,000 33,000 Accrued professional services 132,000 221,000 Accrued warranty obligations 68,000 92,000 Accrued restructuring 2,000 3,000 Accrued OEM inventory commitments (Note I) 317,000 Other accrued expenses 438,000 422,000 Total $ 1,664,000 $1,547,000 The Company has warranty obligations in connection with the sale of certain of its products. The warranty period for its products is generally one year. The costs incurred to provide for these warranty obligations are estimated and recorded as an accrued liability at the time of sale. The Company estimates its future warranty costs based on product-based historical performance rates and related costs to repair. The changes in the Company's accrued warranty obligations for 2012, 2011 and 2010 were as follows: Accrued warranty obligations at January 1, 2010 $ 78,000 Actual warranty experience (106,000 ) Net warranty provisions 184,000 Accrued warranty obligations at December 31, 2010 156,000 Actual warranty experience (101,000 ) Net warranty provisions 37,000 Accrued warranty obligations at December 31, 2011 92,000 Actual warranty experience (58,000 ) Net warranty provisions 34,000 Accrued warranty obligations at December 31, 2012 $ 68,000 Note I - Commitments The Company leases facilities under operating leases. During 2012, the Company entered into a lease for new, more appropriately-sized office and manufacturing space in Rochester, New York. Under the terms of this lease, the Company pays rent of approximately $30,000 per month, with an annual escalation of approximately 1.3%. The lease expires in February 2015 for approximately 1/3 of the space and in June 2017 for the remainder of the space. The Company has an option to renew the lease for periods of up to five years.

53 Table of Contents The lease for office space in San Diego, California requires a monthly payment of approximately $7,000, and expires in November 2013.

The Company also leases office space in Kanata, Ontario, Canada. This lease, which requires a monthly rental and operating expense totaling approximately $36,000CDN (approximately $36,000USD based on the December 31, 2012 exchange rate) expires in October 2013.

Finally, the Company leases office space near London, England. This lease requires a quarterly rental of approximately £1,500 (approximately $2,000 based on the December 31, 2012 exchange rate) expires in June 2013.

As of December 31, 2010, the Company exercised its option to terminate its San Luis Obispo, California lease as of April 30, 2011, and the hardware research and development activities that were conducted at that facility were transitioned to the Company's Rochester, New York facility.

For the lease agreements described above, the Company is required to pay the pro rata share of the real property taxes and assessments, expenses and other charges associated with these facilities.

Future minimum payments for all operating leases at December 31, 2012 are as follows (based on current foreign currency exchange rates): 2013 $ 877,000 2014 737,000 2015 266,000 2016 249,000 2017 126,000 Total $2,255,000 Rent expense amounted to $866,000, $1,344,000 and $1,386,000 for 2012, 2011 and 2010, respectively.

The Company is committed to repurchase excess inventory at vendors totaling $317,000 under its contracts with contract manufacturers as of December 31, 2012. The expense relating to this commitment has been recorded as part of the OEM excess inventory charge (see Note F).

Note J - Stock-based Compensation Expense The table below summarizes the impact of outstanding stock options on the results of operations for the years ended December 31, 2012, 2011 and 2010: 2012 2011 2010 Stock-based compensation expense - Stock options $ 244,000 $ 305,000 $ 446,000Decrease in earnings per share: Basic $ .02 $ .03 $ .04 The Black-Scholes-Merton option pricing model was used to estimate the fair value of share-based awards. This model incorporates various and highly subjective assumptions, including expected term and expected volatility. For valuation purposes, stock option awards were categorized into two groups, stock option grants to employees and stock option grants to members of the Boardof Directors.

54 Table of Contents Based on employee exercise history, the term of options granted for 2010 through 2012 is estimated as the average of the vesting term of the options granted. The expected volatility at the grant date is estimated using historical stock prices based upon the expected term of the options granted. The risk-free interest rate assumption is determined using the rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued.

Cash dividends have never been paid and are not anticipated to be paid in the foreseeable future. Therefore, the assumed expected dividend yield is zero.

Pre-vesting option forfeitures at the time of grant are required to be estimated and periodically revised in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation expense is recorded only for those awards expected to vest using an estimated forfeiture rate based on historical pre-vesting forfeiture data.

The following table shows the detailed assumptions used to compute the fair value of stock options granted during 2012, 2011 and 2010: 2012 2011 2010 Expected term (years) 3.33 to 4 3.28 to 4 3.28 to 4 Volatility 36% to 40% 32% to 33% 33% Risk free interest rate 0.2% to 0.5% 0.8% to 1.6% 1.3% to 1.9% The weighted average grant date fair value of options granted during 2012 and 2011 was $.55 and $.60 per option, respectively. Unrecognized stock-based compensation expense was approximately $232,000 as of December 31, 2012, relating to a total of 800,000 unvested stock options under the Company's stock option plans. This stock-based compensation expense is expected to be recognized over a weighted average period of approximately 1.7 years.

The following table summarizes stock option activity for the three years ended December 31, 2012: Weighted Average Exercise Exercise Number of Shares Price Price RangeOutstanding at January 1, 2010 1,444,983 $4.99 $2.59 - $7.08 Granted 421,150 $2.93 $2.60 - $2.97 Exercised - Expired (203,200) $5.40 $2.97 - $6.78Outstanding at December 31, 2010 1,662,933 $4.42 $2.59 - $7.08 Granted 391,000 $2.17 $1.71 - $2.22 Exercised - Expired (365,550) $5.10 $2.59 - $7.08Outstanding at December 31, 2011 1,688,383 $3.75 $1.71 - $6.64 Granted 386,000 $1.88 $1.87 - $1.96 Exercised - Expired (419,783) $4.63 $1.87 - $6.64Outstanding at December 31, 2012 1,654,600 $3.08 $1.71 - $6.64 55 Table of Contents The following table summarizes stock option information at December 31, 2012: Options outstanding Options exercisable Weighted Weighted Weighted Weighted Range of Average average average average exercise Remaining exercise remaining exercise price Shares life (yrs) price Shares life (yrs) price $1.71 - $2.40 745,600 3.73 $2.03 107,800 3.37 $2.13 $2.41 - $2.97 546,500 1.75 $2.80 402,575 1.64 $2.74 $2.98 - $5.00 - - - - - - $5.01 - $6.64 362,500 1.35 $5.72 362,500 1.35 $5.72 1,654,600 2.55 $3.08 872,875 1.73 $3.90 The total intrinsic value of all outstanding options at December 31, 2012 whose exercise price was less than the Company's closing stock price on that date was $0. No options were exercised in 2012, 2011 or 2010. The total grant-date fair value of options that vested during 2012, 2011 and 2010 was $155,000, $428,000 and $722,000, respectively.

Subsequent to December 31, 2012, options to purchase 692,000 shares of common stock were granted to the Company's executive officers and other key employees with an exercise price of $.90, which was the market price on the date the options were granted. These options vest over a three-year period and expire after five years. These options have a value of approximately $.31 per share.

Note K - Stockholder Rights Plan On October 27, 2000, the Company's Board of Directors adopted a Stockholder Rights Plan. Under this plan, one preferred stock Purchase Right was distributed as a dividend for each share of common stock held by the stockholders of record as of the close of business on November 8, 2000. Until the occurrence of certain events, the Rights are traded as a unit with the common stock. Each Right will separate and entitle stockholders to buy stock upon the occurrence of certain events generally related to the change of control of the Company as defined in the Plan. The Rights become exercisable ten days after either (1) an "Acquiring Person" acquires or commences a tender offer to acquire 15% or more of the Company's common stock, or (2) an "Adverse Person" has acquired 10% or more of the Company's common stock and the Board determines this person is likely to cause pressure on the Company to enter into a transaction that is not in the Company's best long-term interest. All Rights not held by an Acquiring Person or an Adverse Person become rights to purchase from the Company one one-thousandth of one share of preferred stock at an initial exercise price of $110 per Right.

Each Right entitles the holder of that Right to purchase the equivalent of $220 worth of the Company's common stock for $110. If after such an event the Company merges, consolidates or engages in a similar transaction in which it does not survive, each holder has a "flip over" right to buy discounted stock in the surviving entity. The Company may redeem the Rights for $.001 each.

The Rights Plan was scheduled to expire on November 1, 2012 and was extended by the Board of Directors through November 1, 2015. The Plan can be modified or terminated, at the option of the Board of Directors.

56 Table of Contents Note L - Income Taxes Pre-tax earnings consisted of the following for the years ended December 31, 2012, 2011 and 2010: 2012 2011 2010 Pre-tax (loss) earnings: United States $ (7,402,000 ) $ (1,448,000 ) $ (11,547,000 ) Outside United States 458,000 263,000 536,000 Total pre-tax (loss) earnings $ (6,944,000 ) $ (1,185,000 ) $ (11,011,000 ) For the same periods, the provision (benefit) for income taxes was as follows: 2012 2011 2010Current income tax provision (benefit): Federal $ 14,000 $ 53,000 State $ 14,000 13,000 5,000 Foreign 12,000 (81,000 ) (83,000 ) Net change in liability for unrecognized tax benefits (6,000 ) 26,000 (54,000 ) (31,000 ) Deferred provision 168,000 32,000 197,000 Total provision (benefit) $ 194,000 $ (22,000 ) $ 166,000 Prior to December 31, 2010, the Company had not provided for federal and state income taxes on the accumulated earnings of its Canadian subsidiary as it was the Company's intent to indefinitely reinvest such earnings in the operations of the subsidiary. At December 31, 2010, the Company believed that it was reasonably possible that a portion of such accumulated earnings may be repatriated in the foreseeable future. The 2010 deferred provision included a discrete tax provision of $138,000 related to the impact on earnings of this change in assumption, recorded at the federal and state marginal tax rates, less the amount of net operating losses and tax credit carry-forwards that can be used to offset the federal and state tax. Because at December 31, 2012 the Company believes it remains reasonably possible that a portion of accumulated earnings may be repatriated in the foreseeable future, a discrete tax provision of $65,000 and $48,000 was recorded in 2012 and 2011, respectively, relatedto this potential impact.

In 2012, the Company recorded a discrete income tax charge of $102,000 to record a full valuation allowance against the Company's foreign subsidiaries' net deferred tax assets.

During 2010, the Company received a refund amounting to $387,000 relating to a 2009 United States tax law change that allowed the Company to carry back net operating losses five years rather than two years.

57 Table of Contents A reconciliation of the statutory U.S. federal income tax rate to the effective rates is as follows: 2012 2011 2010 Federal income tax at statutory rate 34.0 % 34.0 % 34.0 % Foreign taxes (2.5 ) 1.4 .8 State tax provision 2.0 30.2 2.7 Meals and Entertainment (.2 ) (4.3 ) (0.7 ) Stock compensation expense (.1 ) (2.6 ) (0.5 ) Tax exempt interest .1 .3 Canadian tax credits 9.5 46.0 4.4 Repatriation of foreign earnings (7.7 ) (30.0 ) (10.3 ) Research and development credits .2 23.1 3.0 Resolution of prior year tax uncertainties .1 Valuation allowance (39.0 ) (97.3 ) (35.4 ) Other 1.0 1.3 .1 Effective tax rate (2.8 )% 1.9 % (1.5 )% Research and development tax credits and Canadian tax credits are generated primarily from research and development efforts in the United States and Canada.

The tax exempt interest relates to the Company's investment portfolio. The tax uncertainties were released based upon the lapsing of the statute of limitations related to these uncertainties. The Company receives certain foreign research tax credits which are refundable regardless of the reported income in the jurisdiction; those credits are reported as a reduction of research and development expense.

Deferred income tax assets and liabilities consist of the following: At December 31, 2012 2011 Assets: Current: Accrued vacation, payroll and other accrued expenses $ 230,000 $ 289,000 Inventory and inventory related items 1,786,000 1,262,000 Bad debt and note receivable reserves 47,000 115,000 Fair value of foreign currency hedge contracts 17,000 Non-current: Net operating loss carryforwards 8,767,000 6,170,000 Stock compensation expense 1,031,000 949,000 Capital loss carryforwards 68,000 Tax credit carryforwards 4,659,000 4,025,000 Depreciation 214,000 Goodwill 665,000 776,000 Other 32,000 37,000 Total deferred income tax assets 17,217,000 13,922,000 Less - valuation allowance (13,678,000 ) (11,120,000 ) Net deferred income tax assets 3,539,000 2,802,000 58 Table of Contents (continued) At December 31, 2012 2011 Liabilities: Non-current: Capitalized software development costs, net $ (1,363,000 ) $ (1,361,000 ) Depreciation (369,000 ) Unremitted earnings (2,058,000 ) (1,524,000 ) Total deferred income tax liabilities (3,790,000 ) (2,885,000 ) Net deferred income tax liabilities $ (251,000 ) $ (83,000 ) The total deferred tax assets and liabilities as presented in the accompanying Consolidated Balance Sheets are as follows: At December 31, 2012 2011 Net current deferred income tax assets $ 445,000 $ 368,000 Net non-current deferred income tax assets 102,000Net non-current deferred income tax liabilities $ (696,000 ) $ (553,000 ) The Company has recorded a full valuation allowance against its net deferred income tax assets. Deferred income tax liabilities used in this assessment are of like character, in the same jurisdiction and are scheduled to reverse in the same period as the deferred tax assets.

The total change in the valuation allowance in 2012 and 2011 was $2,558,000 and $876,000, respectively.

In 2012, 2011 and 2010, the Company generated federal and state net operating losses for income tax purposes. These federal and state net operating loss carryforwards, which total approximately $23,700,000 at December 31, 2012, begin to expire in 2026, if not utilized. Of the Company's tax credit carryforwards, $4,372,000 expire between 2019 and 2032, if not utilized, and the remainingof carryforwards do not expire.

At December 31, 2012 and 2011, the Company's balance of unrecognized tax benefits was $0. A reconciliation of the unrecognized tax benefits liability for 2010 is as follows: Balance at January 1, 2010 $ 65,000 Additions for the accrual of interest 2,000 Reductions from settlements with taxing authorities (including interest and penalties of $14,000) (67,000 ) Balance at December 31, 2010, 2011 and 2012 $ - The Company files U.S. federal, U.S. state, and foreign tax returns. For federal tax returns, the Company is no longer subject to tax examinations for years prior to 2009. For foreign and state returns, the Company is also no longer subject to tax examinations for years prior to 2008. It is reasonably possible that the liability associated with the Company's unrecognized tax benefits will increase within the next twelve months. Based upon the closing of the tax years in these various jurisdictions, the Company may adjust its liability for unrecognized tax benefits. These changes may be the result of new examinations by taxing authorities, ongoing examinations, or the expiration of statutesof limitations.

59 Table of Contents Note M - Research and Development The Company incurred research and development costs relating to the development of new products as follows: 2012 2011 2010 Gross expenditures for engineering and software development $ 7,878,000 $ 9,161,000 $ 10,084,000 Less: amounts capitalized (2,295,000 ) (2,037,000 ) (2,261,000 ) Net charged to operating expenses $ 5,583,000 $ 7,124,000 $ 7,823,000 Software development costs consisted of the following: At December 31, 2012 2011 Capitalized software development costs $ 24,450,000 $ 22,155,000 Less: accumulated amortization (20,734,000 ) (18,223,000 ) Net $ 3,716,000 $ 3,932,000 Amortization of software development costs included in cost of goods sold was $2,511,000, $1,925,000 and $2,716,000 for 2012, 2011 and 2010, respectively.

Amortization of software development costs for 2012, 2011 and 2010 included charges to write off or write down to estimated net realizable value software development costs amounting to $885,000, $175,000 and $604,000, respectively, which were capitalized for new products which either had not reached commercial general release and were discontinued, or which have been released and for which revenue is not expected to be sufficient to absorb the project's unamortized cost. (See Note C) It is estimated that amortization of software development costs capitalized at December 31, 2012 will total approximately $1,615,000, $1,213,000, $771,000, and $117,000 in 2013, 2014, 2015, and 2016, respectively.

Note N - Employee Benefit Plans For the Company's operations in the United States, the Company's Retirement Savings Plan qualifies under Section 401(k) of the Internal Revenue Code. The Company made no discretionary matching contributions in 2012, 2011 or 2010. For its operations in Canada, statutory contributions were made in 2012, 2011 and 2010 to a Registered Retirement Savings Plan (RRSP) that is administered by the Canadian government. No discretionary matching contributions were made for the Company's operations in Canada in 2012, 2011 or 2010.

Note O - Derivative Instruments - Foreign Currency Hedge Contracts The Company is exposed to the impact of fluctuations in foreign exchange rates in its Canadian and United Kingdom operations. The Company's risk management program is designed to reduce the exposure and volatility arising from thisrisk.

60 Table of Contents During 2011, the Company entered into foreign currency forward contracts with JPMorgan Chase Bank, N.A. (the "Bank") in order to fix in U.S. dollars a portion of the monthly costs of the Company's Canadian operation, which is denominated in Canadian dollars. The purpose of these contracts was to reduce the Company's exposure to variability in the exchange rates between the United States and Canada for each month. These contracts effectively fixed the exchange rate on the first $100,000CDN of 2011 monthly expenses for the months of July and August and on the first $200,000CDN of monthly expenses for the months of September through December at a rate of .98. In addition, the Company entered into contracts to fix the exchange rate on the first $200,000CDN of 2012 monthly expenses through June 2012 at approximately .983.

During 2010, the Company entered into similar foreign currency forward contracts with the Bank. These contracts effectively fixed the exchange rate on the first $100,000CDN of 2010 monthly expenses for the months of April and May at approximately .948, on the first $200,000CDN of 2010 monthly expenses for the months of June through July at approximately .941, and on the first $300,000CDN of 2010 monthly expenses for the months of August through December at approximately .943. In addition, during 2010 the Company entered into contracts to effectively fix the exchange rate on the first $100,000CDN of 2011 monthly expenses for the months of January through March at approximately .948.

All of these contracts were designated as effective cash flow hedges and any gains or losses resulting from changes in the fair value of these contracts are recorded in other comprehensive income. The Company receives, or is required to disburse, cash payments upon the expiration of each contract depending on fluctuations in the underlying exchange rates; such payments will be recorded as reductions to or increases in expense as they are determined.

The Company did not have any foreign currency forward contracts in place at December 31, 2012.

The fair value of the Company's derivative instruments was as follows: Balance Sheet Fair value at December 31, Location 2012 2011 Derivatives designated as hedging Current instruments liabilities $ - $(46,000) All of the fair value of the Company's derivative instruments at December 31, 2011 was reclassified against earnings during 2012.

The Company's derivative instruments had the following effect on the statements of operations: Amount of gain reclassified from Location of gain accumulated other comprehensive income (loss) (loss) to the statement of operations Derivatives fair value hedging recognized in Year ended December 31, relationships operations 2012 2011 2010 Foreign exchange contracts Operating $(27,000) $(8,000) $273,000 expenses 61 Table of Contents The Company's derivative instruments had the following effect on accumulated other comprehensive income: Amount of gain recognized in comprehensive income Year ended December 31, 2012 2011 2010 Accumulated other comprehensive (loss) income -derivatives, beginning $ (46,000 ) $ 11,000 $ 128,000 Amount of loss (gain) recognized in statement of operations, net of tax 27,000 5,000 (175,000 ) Net change in fair value of derivative instruments 19,000 (62,000 ) 58,000 Accumulated other comprehensive (loss) income - derivatives, ending $ - $ (46,000 ) $ 11,000 Subsequent to December 31, 2012, the Company entered into similar foreign currency forward contracts with the Bank. These contracts effectively fix the exchange rate on the first $125,000CDN of 2013 monthly expenses for the months of February through December 2013 at approximately 1.004, and fix the exchange rate on $125,000CDN of 2013 monthly expenses for the months of March through December 2013 at 1.0202. All of these contracts have been designated as effective cash flow hedges and any gains or losses resulting from changes in the fair value of these contracts will be recorded in other comprehensive income.

Note P - Litigation The Company is subject to various legal proceedings and claims that arise in the ordinary course of business.

In 2009, a complaint was filed against the Company by Tekelec, a California corporation headquartered in Morrisville, North Carolina, which alleged that certain of the Company's signaling systems products infringe certain of Tekelec's issued patents. The claim sought a determination of infringement, a preliminary and permanent injunction from further infringement and an unspecified amount of damages. In May 2011, PT and Tekelec agreed to voluntarily dismiss all of the claims and defenses against each other, without prejudice. By stipulation dated May 4, 2011, the litigation was dismissed without prejudice.

The Company issues indemnifications in the ordinary course of business with certain customers, suppliers, service providers and business partners. Further, the Company indemnifies its directors and officers who are, or were, serving at the Company's request in such capacities. The fair value of the indemnifications that the Company issued during 2012 was not material to the Company's financial position, results of operations or cash flows.

Note Q - Restructuring Charges Restructuring charges amounted to $434,000, $253,000 and $1,176,000 in 2012, 2011 and 2010, respectively.

In October 2012, the Company announced an expense reduction action. The program included the elimination of 14 positions, which represented approximately 10% of the Company's workforce. Annualized cost savings resulting from this action are estimated to be approximately $1,039,000. Restructuring charges associated with this action included employee severance and related costs and totaled $437,000 in 2012. These amounts were cash charges and this action was completed during the fourth quarter 2012.

62 Table of Contents In December 2010, the Company announced an expense reduction action which was implemented during the first and second quarters 2011. The program included the elimination of 22 positions, which represents 12% of the Company's workforce. In addition, in connection with this action, the Company's San Luis Obispo, California engineering center was closed with those hardware engineering functions assumed by the Company's engineering staff in Rochester, New York.

Restructuring charges associated with this action, which was completed in 2011, totaled $245,000 and $905,000 in 2011 and 2010, respectively. The charges resulting from this action were employee severance and related costs, rental and lease termination expenses, moving costs and write-downs of equipment. Cash expenditures incurred in relation to this action totaled $1,123,000 and $0in 2011 and 2010, respectively.

A summary of the activity with respect to restructuring charges is as follows: Lease Severance commitments and Number of employees Reserve other TotalBalance at January 1, 2010 - - - - 2010 restructuring charges 36 $ 1,114,000 $ 62,000 $ 1,176,000 2010 utilization (13 ) (190,000 ) (62,000 ) (252,000 ) Balance at December 31, 2010 23 924,000 - 924,000 2011 restructuring charges 2 141,000 112,000 253,000 2011 utilization (25 ) (1,065,000 ) (109,000 ) (1,174,000 ) Balance at December 31, 2011 - - 3,000 3,000 2012 restructuring charges 14 437,000 (3,000 ) 434,000 2012 utilization (14 ) (435,000 ) - (435,000 )Balance at December 31, 2012 - $ 2,000 $ - $ 2,000 Subsequent to December 31, 2012, the Company announced an expense reduction action which is being implemented in the first quarter 2013. This action includes the elimination of 10 positions, representing 8% of the Company's workforce, from which approximately $700,000 of annualized cost savings are expected to be achieved. Restructuring costs associated with this action total $252,000 and will be recognized in the first quarter 2013.

Note R - Product Revenue The following table represents the Company's total sales for 2012, 2011 and 2010 classified by product category: 2012 2011 2010 Telecommunications $ 19,595,000 $ 27,568,000 $ 22,599,000 Government aerospace/defense 3,725,000 8,608,000 5,347,000 Total $ 23,320,000 $ 36,176,000 $ 27,946,000 63 Table of Contents Note S - Quarterly Results (unaudited) The following is a summary of unaudited quarterly results of operations for the years ended December 31, 2012 and 2011: 2012 (in thousands, except per share data) Mar. 31 Jun. 30 Sep. 30 Dec. 31 Sales $ 8,356 $ 5,018 $ 4,671 $ 5,275 Software capitalization and intangible asset write-off 1,600 OEM excess inventory charge 1,351 Gross profit (loss) 4,559 2,074 1,801 (481 ) Restructuring charges 434 Stock compensation expense 67 58 61 58 Income (loss) from operations 298 (1,830 ) (1,635 ) (3,829 ) Net income (loss) $ 289 $ (1,754 ) $ (1,673 ) $ (4,000 ) Basic income (loss) per share $ 0.03 $ (0.16 ) $ (0.15 ) $ (.36 ) Diluted income per share $ 0.03 2011 (in thousands, except per share data) Mar. 31 Jun. 30 Sep. 30 Dec. 31 Sales $ 9,672 $ 8,453 $ 9,000 $ 9,051Software capitalization write-off 175 Gross profit 4,493 3,667 4,546 4,710 Restructuring charges 122 60 71 Stock compensation expense 89 79 66 71 Litigation expenses 347 69 12Impairment charge - vendor software 400(Loss) income from operations (1,224 ) (537 ) (84 ) 506 Net (loss) income $ (1,098 ) $ (452 ) $ (86 ) $ 473 Basic (loss) income per share $ (0.10 ) $ (0.04 ) $ (0.01 ) $ 0.04 Diluted income per share $ 0.04

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