Performance Technologies Inc/DE · 10-K · For 12/31/02

Filed On 3/28/03 5:20pm ET   ·   SEC File 0-27460   ·   Accession Number 1003950-3-5

Annual Report   ·   Form 10-K
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 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 -------------------

 FORM 10-K
(Mark One)                                                                      
         [X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No Fee Required)          
 For the Fiscal Year Ended December 31, 2002
OR
  [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
   For the transition period from   to
Commission File Number 0-27460

PERFORMANCE TECHNOLOGIES, INCORPORATED
(Exact name of registrant as specified in its charter)
------------------
               Delaware                             16-1158413
(State or other jurisdiction of incorporation of      (I.R.S. Employer  
                  organization)                      Identification No.)

205 Indigo Creek Drive, Rochester, New York                     14626           
(Address of principal executive offices)                    (Zip Code)        
Registrant's telephone number, including area code: (585) 256-0200
--------------------------- 
 Securities registered pursuant to section 12(b) of the Act:
NONE
------------------------
 Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK, par value $.01 per share
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes [X] No [ ].                              

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]                                                                  

Indicate  by check mark  whether  the  registrant  is an  accelerated  filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [ X ]                             

The  aggregate  market value of the voting stock held by  non-affiliates  of the
registrant  as of the  close  of  business  on June 28,  2002 was  approximately
$64,916,000.                                                                    

The number of shares  outstanding  of the  registrant's  Common Stock,  $.01 par
value, was approximately 12,230,000 as of February 28, 2003.                    

 Documents Incorporated by Reference
The  information  called  for by Item  10-13  of  Part  III is  incorporated  by
reference  to  the  definitive   Proxy  Statement  for  the  Annual  Meeting  of
Stockholders  of the  Company to be held June 3, 2003,  which will be filed with
the  Securities  and Exchange  Commission not later than 120 days after December
31, 2002.                                                                       

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Performance Technologies, Incorporated
 Index to Annual Report on Form 10-K

PART I                                                                     Page 

ITEM 1          Business                                                      1 
ITEM 2          Properties                                                   11 
ITEM 3          Legal Proceedings                                            11 
ITEM 4          Submission of Matters to a Vote of Security Holders          11 

PART II                                                                         

ITEM 5          Market for the Registrant's Common Equity and                   
                  Related Stockholder Matters                               11
ITEM 6          Selected Financial Data                                      12 
ITEM 7          Management's Discussion and Analysis of Financial               
                  Condition and Results of Operations                       13
ITEM 7A         Quantitative and Qualitative Disclosures About Market Risk   20 
ITEM 8          Financial Statements and Supplementary Data                  20 
ITEM 9          Changes in and Disagreements with Accountants on                
                  Accounting and Financial Disclosure                       34

PART III                                                                        

ITEM 10         Directors and Executive Officers of the Registrant           34 
ITEM 11         Executive Compensation                                       34 
ITEM 12         Security Ownership of Certain Beneficial Owners                 
                  and Management                                            35
ITEM 13         Certain Relationships and Related Transactions               35 
ITEM 14         Controls and Procedures                                      35 

PART IV                                                                         

ITEM 15         Exhibits, Financial Statement Schedules and Reports on          
                  Form 8-K                                                  35

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PART 1                                                                          

ITEM 1 - Business                                                               

Overview                                                                        

Performance  Technologies  (the  "Company") is a supplier of embedded  computing
products  and  system-level  solutions  that  can be used in a  broad  range  of
applications and end markets.                                                   

Since  its  founding  in  1981  as  a  Delaware  corporation,  the  Company  has
consistently  designed  innovative  embedded  products and system solutions that
focus on attributes such as reduced  time-to-market for our customers,  enhanced
performance, high availability and cost advantages for a user base that includes
communications,  military and commercial applications.  The Company has a proven
history of  successfully  adapting  its  products  and  services to a constantly
changing, technology-driven  marketplace  through the course of several business
cycles that have occurred since its founding.                                   

The  Company'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 section  appearing  in ITEM 1 of this Form 10-K under the heading
"Risk  Factors."  The  Company's  future  operating  results  may be affected by
various trends and factors which are beyond the Company's  control.  These risks
and uncertainties  include,  among other factors,  general business and economic
conditions, rapid or unexpected changes in technologies, cancellations or delays
of customer orders including those associated with "design wins," changes in the
product or customer mix of sales,  delays in new product  development,  customer
acceptance of new products and customer delays in qualification of products.    

Important Year 2002 Milestones                                                  

2002 was a  challenging  year with  continuing  erosion in the general  business
environment,  as well as the Company's target markets.  Management  responded to
these demanding market  conditions  through a series of initiatives that allowed
the  Company  to  maintain  profitability.                                      

As the organization entered 2002, it was clear that the traditional users of the
Company's  products,   primarily   telecommunication   equipment   manufacturing
organizations,  were  continuing  to suffer from a drastic  reduction in capital
equipment  spending by operators in North America and Europe.  It was also clear
that many of the market's forward-looking initiatives related to next-generation
network infrastructure deployment,  both in the wireline and wireless areas, had
stalled  due  to  a  lack  of  visibility  of  an  economic  recovery.   Ongoing
expenditures in the telecommunications  industry were generally being limited to
maintenance items, with little attention being paid to network expansion and the
use of new  technologies  similar  to those  offered by the  Company.  Other end
markets for embedded systems also experienced slowdowns in business during 2002.
However,  an  encouraging  perspective is that certain  industries  that use the
Company's   embedded  products  and  systems  appear  to  have  shown  signs  of
stabilization by year-end.                                                      

Throughout  2002, most equipment  providers that are customers for the Company's
products  responded to the economic  conditions by  implementing  cost controls,
reducing  workforces and realigning their business models.  This  restructuring,
which occurred in both 2001 and 2002, has  dramatically  reduced the engineering
capabilities  of many of these  companies and is expected to result in a greater
reliance on organizations such as Performance Technologies for "standards-based"
platforms and components to be integrated with their  next-generation  products.
It is  expected  that  outsourcing  of  equipment  and  services,  such as those
provided by the Company will result in these  companies  establishing  strategic
relationships  with fewer vendors who can supply larger parts of their  embedded
system platform requirements.                                                   

During 2002,  many of the  Company's  peers that sell products into the embedded
systems  marketplace  experienced  significant  revenue  declines and  operating
losses.  Almost  all have  undergone  the same kinds of  restructuring  as their
customers by consolidating operations and shedding unprofitable operations.     

In the face of such a demanding economic climate,  management  targeted a number
of  initiatives  and  objectives  to  reposition  the  Company to  operate  more
successfully in these conditions and emerge as a strong leader in its markets as
conditions improve. These initiatives included:                                 

1) Selective Reductions in the Company's Cost Structure: This action was carried
out at two different times during 2002 in response to  deteriorating  conditions
by reducing its workforce by approximately 20% and by consolidating the Raleigh,
North Carolina engineering  operations into the Ottawa,  Canada Signaling Group.
These reductions allowed the Company to remain viable and profitable.  While the
Company's   financial   performance   for  2002  relative  to  prior  years  was
disappointing,  the Company  performed very well compared to its peer group.  It
remained  profitable and ended the year with a positive revenue growth trend and
a noteworthy improvement in the year-end backlog.                               

2) Aggressive Use of the Company's  Balance Sheet Strength for  Acquisitions and
Investments:  In the current  environment,  valuations  have been  substantially
reduced in  comparison  to several years ago. This offers the Company an ongoing
opportunity  to  acquire  products,  technologies  and  organizations  that were
unavailable  during that period. In 2002, the Company  successfully  carried out
one major acquisition and concluded a strategic minority  investment in an early
stage company. These two events were:                                           

         Ziatech  Acquisition:   In  October 2002,  the  Company  completed  its
         acquisition of Intel  Corporation's  Embedded  Communications  Platform
         Division  (formerly Ziatech  Corporation).  The  acquisition  more than
         doubled the Company's  total available  market in the embedded  systems
         space  through  the addition  of  highly  complementary  computing  and
         systems products.  Due to overall industry downsizing,  as noted above,
         equipment  manufacturers  and  integrators  are  looking  to  establish
         strategic relationships with fewer vendors. This acquisition allows the
         Company to immediately offer a broader range of products to a wider set
         of   embedded   applications   in   the   data   communications,  tele-
         communications,  military,  industrial  automation  and  transportation
         markets.   (Details  are  set forth in the  Form  8-K  filed  with  the
Securities and Exchange Commission).                          

         Momentum Computer Investment:  In September 2002, the Company completed
         an agreement to invest $1.5 million for  a  47%  interest  in  Momentum
         Computer,  Inc.,  a  developer  of  specialized  single  board computer
         solutions for the data communications, telecommunications, military and
         aerospace markets. The Company also loaned Momentum $1.0 million  to be
         used for  working capital requirements.  Management  believes  Momentum
         fills an important need in  the  embedded platform market by offering a
         "quick turn" design and delivery capability for  custom  processor  and
         high  performance  I/O  embedded products.  Momentum's  product line is
         closely  aligned,  but does not  compete  with the  Company's  existing
         embedded  switch,  access,  signaling  and   Intel-based  single  board
computer products.                                            

In late  2002,  the  Board  of  Directors  initiated  a review  of the  specific
alternatives  to improve  stockholder  value in the current  business and market
conditions.  An area that offered  opportunities  was a more dedicated effort in
searching for technologies  and acquisitions  that could be added to the Company
to enhance future growth.  In early 2003, the Chairman of the Board of Directors
joined  the  management  staff  as  Chief  Strategic  Officer  to  pursue  these
initiatives on a dedicated full-time basis.                                     

3) Broaden  Market and Product Focus:  In the recent past, the Company  targeted
its component and software products at the data communications  market. With the
expansion  of   telecommunications   in  the  late  1990's,   many   Performance
Technologies  products  were  optimized  for use in embedded  telecommunications
platforms.  As the Company entered 2002, management initiated efforts to broaden
the market and product  focus of the  organization  to become less  dependent on
near-term  growth  in the  telecommunications  arena.  In many  instances,  this
required  minimal  product  modification,  in both hardware and software,  and a
redirection  of the sales and  marketing  programs.  In addition to  redirecting
efforts  related to  existing  products,  the  acquisition  of  Ziatech  and the
investment  in Momentum  accomplished  an immediate  broadening of the Company's
product offering and effective  market coverage into end application  areas such
as military, industrial automation and transportation.                          

4) Continued  New Product  Development:   The Company  continued  an  aggressive
posture with respect to funding new product development during 2002, relative to
the soft  business  conditions.  As the  business  cycle  runs its course and in
anticipation  of  improved  conditions,  it is  management's  objective  for the
Company to be well positioned with a strong and contemporary  product  portfolio
that will provide  opportunities  for accelerated  growth.  In carrying out this
initiative,  the Company continued to develop new and innovative products during
the year, including:                                                            

         Gigabit  Embedded  Ethernet Switch: In March 2002, the Company extended
         its  IPnexus(TM)  switching  product line to include the first embedded
         gigabit  Ethernet  switch.   This product began shipping  in  the third
         quarter  and  there was a  noteworthy  backlog of  orders  for  gigabit
         switches  at  year-end.    In  early  2003,  the Company  began  taking
         evaluation orders for a  beta  version  of a new  product  that  offers
         network routing capabilities important to enhanced  speed  and security
in data networks.                                             

         Network Processing Modules:  In  late  2002, the Company introduced the
         first  in a  family of  network  processor modules as  an  extension to
         Performance Technologies'  industry leading IPnexus  embedded switching
         products.   Trade  named   FlexNAT(TM),   (Flexible   Network   Address
         Translation), it is  the first and only embedded  Ethernet  solution to
         enable integrated high-speed network data packet processing and gigabit
         Ethernet switching. Management expects the network processing  products
         and  the  associated  software   development  investment  made  by  the
         organization during 2002, will form the base technology  for a  variety
  of products the Company will introduce throughout 2003 and 2004.

         Expanded Network Access Products: During 2002, the Company continued to
         expand its line of network access products by  moving  existing designs
         to a broader set of  standards  often found in a variety of  enterprise
         servers  for  applications beyond the typical embedded markets.  During
         2002, the  Company  focused on  expanding its  communications  software
         family marketed  under the trade name  NexusWare(TM) to improve product
         coverage and ease of use.  This software family is based on  the  Linux
         operating  system, which is rapidly growing in popularity.   Management
         believes  the  features  provided  by  NexusWare  offer  distinct  user
         advantages  unmatched  by  competitive  offerings.     This   continued
         enhancement of the Company's broad and  recognized  communications  and
         network  software  capability  generates  higher  margins  than similar
competitive products offered for embedded market applications.

         3000  Series  Signaling  Gateway: Early in 2002, the Company introduced
         the  3000  Series  Signaling  Gateway,  a small,  full-featured  SS7/IP
         inter-networking device for use in current telephony applications.  The
         3000 Gateway is specifically targeted at  telecommunications  operators
         who can use  IP  networks  to reduce the cost of  existing wireline and
         wireless  networks  without  extensive  investments  in overhauling the
existing network infrastructure.                              

Industry Overview                                                               

As the economic downturn  continued  throughout 2002,  equipment  suppliers that
utilize  "standards  based" embedded  technology  (the Company's  customer base)
responded by  implementing  cost controls,  cutting  engineering  workforces and
realigning  their  business  models.  Such  restructuring  has  created  a  more
concentrated  supplier  landscape  for 2003  that is  better  able to adapt to a
fluctuating  market.  It is not just the equipment  vendors who are readjusting.
Across the technology  sector,  equipment  developers and  integrators  who have
recently  downsized are looking to do more outsourcing of equipment and services
and ultimately establish more strategic relationships with fewer vendors.       

The  Company  supplies  technology  products  that are  incorporated  into  open
standards-based  embedded  systems.  These systems are  specifically  configured
using various hardware and software,  often from multiple  suppliers,  to meet a
variety of end applications found in market segments such as  telecommunications
infrastructure,  data  communications  infrastructure,  military,  or industrial
systems.  The  embedded  systems  market is estimated to be over $3.0 billion in
size,  worldwide.  Traditionally,  a large  segment  of  this  market  has  used
proprietary, purpose-built embedded systems and products. Embedded systems built
on "open  standard  designs"  comprise a smaller  segment of this market.  While
proprietary  systems are  expected  to  continue to dominate  this market in the
future,  a noteworthy  growing share of embedded  systems being  implemented are
expected to use "open  standards."  The driving  factors  behind  this  changing
paradigm are twofold.   First,  systems are becoming  increasingly more complex,
requiring  larger  investments  and  longer  lead times to  design.  Second,  as
organizations  have  downsized,  they simply do not have the necessary  staff to
carry out  extensive  new product  development  while  successfully  meeting the
competitive  pressures of "time to market" found in most technology  businesses.
Due to these  changes,  equipment  suppliers  are relying on  companies  such as
Performance Technologies to deliver major building blocks or complete platforms,
allowing  the  supplier  to "layer on" their  "value  add." This can be software
and/or additional hardware elements directed at specific applications.          

In addition,  the current  environment,  which has forced the downsizing of many
engineering and development resources, has also forced reductions in purchasing,
logistics  and supply  groups.  Under these  circumstances,  many  customers are
anxious to limit the number of suppliers,  forming more strategic  relationships
with organizations that have broader capabilities.                              

Management believes that the added capability  resulting from the acquisition of
Ziatech in late 2002 ideally  positions  the Company to service  these  evolving
market needs and opportunities.  The acquisition more than doubled the Company's
total available market in the embedded systems space through the addition of key
computing and systems products. This allows the Company to offer a broader range
of products and embedded  systems  platforms to a customer  base that is seeking
fewer  suppliers and a higher level of integrated  solutions.  During 2002,  the
Company  continued its involvement in promoting and supplying  embedded products
based on the contemporary use of networking technology as an integral element of
the system design.  This new and forward looking  approach to building  embedded
systems was created by  Performance  Technologies  engineers  and has earned the
Company a leading  position in the  industry  when this  innovative  concept was
standardized and widely adopted as the next-generation  benchmark. This standard
is known in the  industry  as the  PICMG  2.16  specification  and  applies  the
concepts  developed for enterprise  Ethernet networks to embedded system design.
While the sluggish  economy has slowed the deployment of equipment built to this
standard,  there is widespread adoption of the concept, and many embedded system
suppliers have incorporated this standard into their  next-generation  products.
Central  to this new  system  architecture  is the use of an  embedded  Ethernet
switch and Ethernet technology for communication between the blades in a system,
rather than older technologies such as PCI.                                     

In support of this new system concept, the Company has aggressively  developed a
comprehensive  line of embedded  Ethernet switches over the past three years. If
the economic  environment  had been more stable,  management  believes  that the
demand for these products would have been significantly stronger.  Nevertheless,
in the  current  environment,  while  most  product  revenues  have been flat or
declining,  the Company's  Ethernet switches have had noteworthy  adoption among
major customers and have actually shown continuing  quarter-over-quarter growth.
However, throughout 2002, there were only limited signs that any of the numerous
"design wins" that management  attributes to this product have actually  reached
full-scale  deployment.  There are customer  indications  that this may start to
change over the course of 2003.  There is also growing market evidence that some
early  competitors  have  relinquished  the  space to the  Company  based on our
comprehensive product offering and aggressive  development program in this area.
It is management's  belief that the Company is in a leading market position with
its embedded  switching  technology  and that this  product  family will provide
substantial growth when the economic cycle improves.                            

Market  intelligence  organizations,  such as the Dell'Oro  Group,  suggest that
revenues in 2003, in networking switches and routers throughout the industry are
projected to be down 7.5% and 25%,  respectively.  However,  the Ethernet switch
market,  which is aligned with the Company's products,  is expected to grow 3.0%
this year. According to Dataquest,  Ethernet switch revenue totaled $2.9 billion
in the third  quarter of 2002,  a 1.3%  increase  from the same  period in 2001.
While the use of Ethernet  switches in embedded systems is a specialized  market
segment,  the  forecasted  growth in this market area validates the viability of
the new embedded system architecture developed by the Company.                  

On  a  broader  but  related   market   observation,   management   expects  the
telecommunications  sector to continue to struggle in 2003 and has  responded by
adjusting  its focus on  healthier  markets  in the near  term such as  selected
commercial, military and industrial applications. However, there are indications
that certain  regions/sectors in the telecommunications  market will continue to
be acquiring  next-generation  equipment  this year.  For example,  the wireless
market is expected to be a sustaining  factor in the  industry,  and Aberdeen is
predicting  wireless  data  services in the form of wireless  LAN (WLAN) will be
among  the  most  successful   applications  for   telecommunications  in  2003,
addressing three distinct markets: enterprises, residences and public hot spots,
such as airports.                                                               

Also,  telecommunications  as a whole is demonstrating  impressive growth in the
Asia-Pacific  region.  While  telecommunications   equipment  manufacturers  and
operators in the United States and Europe continue to report  declining  revenue
and losses,  Asian operators and equipment  manufacturers,  such as NTT, Huawei,
Samsung,  LG and UTStarcom,  are  continuing to show strength.  According to the
International Telecommunication Union (ITU), the number of telephone subscribers
in the  Asia-Pacific  region in 2002 (both  fixed and mobile)  accounted  for 36
percent of the worldwide total. Ten years earlier, the region accounted for less
than 22 percent. This region has added more than one telephone user every second
for the last  decade.  Mobile phone  growth in the  Asia-Pacific  region is also
continuing to grow, and future networks in this region will no doubt be IP-based
because of its low price point and ease of  implementation.  The Company's focus
on products  that support IP networks  suggests  that this is a geographic  area
where there will be new opportunities,  while the telecommunications  markets in
North America and Europe slowly move through a more lengthy recovery process.   

Strategy                                                                        

The Company has a proven history of successfully adapting its products, services
and organization to a constantly changing  technology-driven  marketplace.  This
adaptation has been  demonstrated  through the course of several business cycles
that have occurred since its founding in 1981.  With the Ziatech  acquisition in
October 2002, the Company substantially  broadened both its product offering and
market coverage to include additional  computing and system products that can be
effectively  supplied  to a market  that is twice  the  size of that  which  was
available to the Company prior to the acquisition.                              

Following the acquisition,  a new corporate strategy was defined that integrates
the Company's  technological  innovation and product breadth. The organization's
new business  strategy  emphasizes its expanded  capability to offer a "unified"
solution to the customer base including software,  hardware and system platforms
through a single Performance  Technologies offering.  This new strategy broadens
the  Company's  market  focus  to  more  effectively   address  embedded  system
requirements for communications, military and commercial applications.          

The  Company's  product  strategies  for  2003  are to  effectively  expand  the
Company's traditional focus of supplying embedded technology components, such as
access and switching  products,  to supplying  "comprehensive"  embedded  system
platforms   incorporating   multiple   components  from  the  Company's  product
portfolio.                                                                      

Four initiatives have been identified to carry out the 2003 strategy:           

         Target  the  Company's  Products  to  a  Wider  Set  of Embedded System
         Applications:  Appropriate investments are  being made  to  assure  the
         necessary  product  features  and  services that  will be  required  to
         broaden the customer base in a  variety  of  promising  market segments
outside of the Company's traditional telecommunication focus. 

         Continue Development of Innovative,  Packet-based IP Technology for Use
         in  Embedded  Systems:   It is  management's  intent  to  leverage  the
         demonstrated technical innovation of both the  traditional  Performance
         Technologies  engineering  staff  and  the  newly  acquired engineering
         talent  of  the  former  Ziatech  organization.   Both  have impressive
histories of embedded product and systems innovation.         

         Extend  the   Company's  Significant  Suite  of   Value-add   Software:
         Performance  Technologies  has  comprehensive  software capability in a
         variety of areas.  Management's  objective during 2003 is  to  make the
         necessary investments to  extend this umbrella to include  the  Ziatech
         computing and systems  products  which  traditionally  have  had  lower
margins than the Company's other products.                    

         Increase Market Awareness of the Company's New Capabilities: Leveraging
         the Ziatech acquisition,  management believes the combined organization
         has  the fundamental  elements  to  become  a premier  embedded systems
         provider.  An aggressive 2003 sales  and  marketing  program  is  being
carried out to assure awareness of this in the marketplace.   

Certainly,  there  are  identifiable  risks  associated  with  carrying  out the
Company's new corporate and product  strategies in the current economic climate.
Since many of the  Company's  end  markets  are  forecast  to show  little or no
growth, in order to realize growth in this environment, the Company will have to
take market share from competitors.  However,  management believes that based on
its review and analysis of the marketplace and the Company's  product  portfolio
that  has  numerous  strengths,  this  investment  and its  associated  risk are
worthwhile.   If  successful,   management   believes  these   initiatives  will
effectively  reposition the organization as an important  strategic partner with
many of its customers,  thereby  increasing  their  utilization of the Company's
broadened  product  capabilities.   When  the  business  cycle  starts  to  show
improvement,  it is  further  expected  that these  2003  initiatives  can yield
significant rewards by accelerating revenue growth and profitability.           

To effectively implement this growth strategy, management expects to selectively
add  to  investments  in  marketing  and  sales,  while  sustaining   aggressive
engineering  development  programs  during 2003.  The Company has a proven track
record of profitable  operations,  however in the near term,  these  initiatives
could  result in a loss  posture for 2003 if  revenues do not grow  sufficiently
during the year.                                                                

The acquisition and initial integration of the Ziatech  organization during 2002
has changed the fundamental  landscape of opportunity for the Company.  In order
to continue this momentum,  in January 2003, the Board of Directors expanded the
executive  management team by adding a Chief Strategic Officer   to identify and
facilitate  additional  acquisition   opportunities,   business  and  technology
investments that can accelerate the Company's growth and associated  shareholder
value.                                                                          

Products                                                                        

The Company's products and solutions are based on open-system architectures that
include individual system elements, system platforms, single board computers and
software.  With embedded solutions for both existing and emerging networks,  the
Company serves as a single source vendor for companies involved with industrial,
military, commercial, data communications and telecommunications applications.  

The Company  markets it embedded products under four general groups.  These are:

IPnexus Switching Products                                    
IPnexus Access Products and NexusWare(TM) Software            
Ziatech Single Board Computer and Chassis Products            
SEGway(TM) SS7/IP Signaling Products                          

IPnexus Switching Products.  The Company's IPnexus Switching products operate in
the new CompactPCI  systems  architecture  referred to as PICMG 2.16. This is an
embedded systems  architecture  that was developed by the Company and allows the
many  techniques,  features and  advantages  that were  developed for enterprise
"client-server  networks,"  to be  applied to  embedded system  platforms.  This
innovative approach to building these systems uses a specialized Ethernet switch
as the  "keystone"  of the  architecture.  This  architecture  has distinct cost
advantages  allowing  developers  of  next-generation  systems to reduce  design
complexity while increasing overall system reliability and performance. Based on
these  clear-cut  attributes,  the  adoption of this  standard has occurred at a
record rate among embedded system suppliers and  manufacturers to a wide variety
of industries.                                                                  

As part of the  Company's  initiative  in  creating  the  PICMG  2.16  standard,
engineering  undertook an aggressive  development  program aimed at becoming the
premier supplier of embedded Ethernet switches.  The Company's IPnexus switching
products offer a comprehensive  family that ranges from low cost,  limited speed
to unique higher-end gigabit switches, the latter introduced in 2002. Management
believes that there is substantial  pent-up  demand for the Company's  switching
products based on the number of "design wins" that the Company has realized over
the past twenty-four months. In general, there has been a delay in "design wins"
moving to a production/deployment  status based on the soft business conditions.
However,  management  expects  a number  of these  "design  wins" to  ultimately
achieve  volume  order  rates  as the  economy  improves  and  capital  spending
rebounds. Based on this scenario, the embedded Ethernet switching product family
could be an important growth driver for the Company.                            

IPnexus Access Products.  The Company's IPnexus Access products are available in
a number of formats  that  operate in a broad range of data  communications  and
telecommunications  applications.   Performance  Technologies'  access  products
provide a  connection  between a variety  of  network  interfaces  and  embedded
systems   platforms  that  are  used  to  control  the  network  and/or  process
information  being  transported  over  networks.  This product  family  includes
stand-alone  communication  servers and embedded access products that operate as
part of systems based on the PCIbus standard, the CompactPCI (cPCI) standard and
the new PICMG 2.16 standard.                                                    

An important  element in the  Company's  access  product  group is the extensive
communications software products that can be licensed to customers for a variety
of applications.  This capability includes: standard communication packages such
as X.25 and Frame Relay, specialized software that supports such applications as
radar  protocols  used in weather  tracking  and air  traffic  control,  and SS7
signaling software.                                                             

During 2002, the Company  introduced its NexusWare software suite. This software
package includes a comprehensive  Linux-based  development environment and fully
functional  runtime  software  that is supplied  with each system.  NexusWare is
intended for system  engineers using IPnexus Access products to facilitate rapid
integration  and  development of  packet-based  embedded  systems.  NexusWare is
designed to raise the level at which system  integration  is  performed,  giving
developers  a  simplified  path  to  designing   comprehensive   IPnexus  system
solutions.  This  software  package is  continually  being  enhanced and will be
extended to include the newly acquired Ziatech  computing  products.  Management
believes these software tools and products are an important element in assisting
customers to do product  integration.  This software also  generates  additional
software license revenue for the Company.                                       

The Company's  IPnexus  products  include embedded  Ethernet  switches,  network
access  products  and SS7  signaling  blades.  Announced  customers  for IPnexus
products include: ADC Telecommunications, Inc., ADLINK Technology, Inc., Agilent
Technologies, Alcatel SA, APW/Electronic Solutions, AudioCodes, Boeing Australia
Limited,  Cognitronics  Corporation,  HP/Compaq  Corporation,  General Dynamics,
Kaparel,  Lucent Technologies,  Motorola Corporation,  net.com, Nortel Networks,
Northrup Grumman Information Technology,  Optibase, Ltd., Raytheon,  Siemens AG,
Siemens Carrier Networks LLC, Soma Networks and Sun Microsystems.               

Ziatech Computing and Platform Products. The addition of the Ziatech products to
the product line in October 2002  significantly  expanded the  Company's  target
markets,  enabling  it to  offer a more  comprehensive  solution  to an array of
companies in the data communications, telecommunications, industrial automation,
medical and homeland defense.                                                   

As the original  developer of the widely deployed  CompactPCI  system  standard,
Ziatech  has  always  been  a  market   leader  and  a  driving   force   behind
standards-based  innovation for the embedded market sector. In addition, Ziatech
had  developed  a range of PICMG  2.16  products  that  complement  the  product
offerings  already  being sold by the Company.  The Ziatech  computing  products
provide a complete  range of  Intel-based  single  board  computers  that can be
applied to a broad range of applications.                                       

In addition  to the range of single  board  computers,  the Company now offers a
variety of embedded system chassis and associated chassis  management  products.
This   expanded   capability   allows   Performance   Technologies   to  provide
comprehensive  embedded system platforms  incorporating multiple components from
the Company's portfolio.                                                        

Announced customers for the Ziatech Products include:  Analogic, Copper Mountain
Networks,  Laurel Networks,  Lucent Technologies,  Marconi,  Nortel Networks and
Soma Networks.                                                                  

SEGway SS7 IP Signaling  Products.  The  Company's  SEGway  products are used to
interconnect  traditional  telephone  networks with the growing  packet-switched
(IP) network architectures of today.  Performance  Technologies SEGway signaling
products also reliably transport, concentrate and route SS7 messages between SS7
and IP  entities.  In 2001,  the  Company  introduced  a  product  that  allowed
traditional SS7 messages to be reliably transported over IP networks. One of the
first applications for this technology was the transport of SS7 signals over the
Internet,  allowing  secondary  GSM  cellular/mobile  markets to be added to the
roaming  footprint of a group of European  wireless  operators.  The Company has
since  expanded that  capability to allow  economical  replacement/expansion  of
traditional SS7 networks over IP networks,  at a substantially reduced cost in a
variety of  applications.  While the reduced capital  equipment  spending in the
telecommunications  markets has slowed  deployment of these products,  there are
continued    market    indications   that   the   concept   is   attractive   to
telecommunications  operators  and will grow as the  spending  rebounds  in this
market.                                                                         

The Company also provides  carrier-grade SS7 and SS7/IP networking solutions for
GSM  wireless  roaming  applications  with  deployments  in  over  35  countries
worldwide.                                                                      

The Company's SEGway products include SS7 network replacement  products,  SS7/IP
products and the GSM SS7 signaling platform.  Announced customers for the SEGway
products include:  Alcatel SA, Comfone AG, Ericsson  Telecommunications,  iBasis
Inc.,  Motorola  Corporation,  Nortel Networks,  Swisscom AG, Telefonica Moviles
Espana, Teleglobe and TSI Telecommunications Services.                          

Sales, Marketing and Distribution                                               

The Company  markets its products  worldwide to a spectrum of customers  through
its  direct  sales  force and  various  channels  including  Original  Equipment
Manufacturers  (OEMs),  Value Added Resellers  (VARs),  distributors and systems
integrators. Almost all of the Company's North American business is sold through
the Company's direct sales force.                                               

Due to the highly  technical nature of the Company's  products,  it is essential
that the Company's salespeople are technically oriented and are knowledgeable in
the embedded systems,  networking and  communications  fields. To supplement its
sales force, the Company has field application  engineers who assist prospective
customers in determining if the Company's products will meet their requirements.

Currently,  32 sales,  marketing and sales support  personnel are located in the
Company's Rochester,  New York, Connecticut,  California (2), Ottawa, Canada and
the United Kingdom offices. In addition,  independent sales  representatives and
agents cover  selected  geographic  areas  nationally and  internationally;  and
distributors  or  integrators,   handling  selected  products,   supplement  the
Company's direct sales team on a worldwide basis.                               

The Company executes various ongoing  marketing  strategies  designed to attract
new OEM and  end-user  customers  and to  stimulate  additional  purchases  from
existing  customers.  These strategies  include direct mail and email campaigns,
direct  telemarketing,   special  pricing  programs,   active  participation  in
technical  standards  groups,  participation  in  national,   international  and
regional  trade  shows,   selected  trade  press  advertisements  and  technical
articles,  and an active campaign to direct potential customers to the Company's
Web site.                                                                       

Sales to customers outside of North America  represented 25%, 27% and 30% of the
Company's revenue in 2002, 2001 and 2000,  respectively.  The Company's products
are  currently  sold by the  Company's  direct sales force and by  international
distributors throughout the more industrialized countries in Europe and in Asia.
International  sales are subject to import and export  controls,  transportation
delays  and   interruptions,   foreign  currency  exchange  rates,  and  foreign
governmental  regulations.  Payments  for  shipments  from the United  States to
outside the United  States are generally  made in U.S.  dollars and payments for
shipments from Canada to Canada are generally made in Canadian dollars.         

Customers                                                                       

The  Company  has  over  50  active  customers   worldwide,   primarily  in  the
telecommunications  and embedded  systems  markets.  Many of the Company's major
customers are Fortune 500  companies in the United States or of similar  stature
in Europe and Asia. In 2002, the largest single customer  (Lucent  Technologies)
represented 9% of revenue, and the four largest customers (Lucent  Technologies,
Teleglobe,  HP/Compaq  Computer and UTStarcom)  represented 28% of the Company's
revenue.                                                                        

At  year-end  2002,  approximately  70% of the  Company's  customers  are in the
telecommunications  industry and the Company's products are generally integrated
into   products  for   wireline,   wireless  and   next-generation   IP  network
infrastructure.  These  products  are  targeted at  customers  in the  following
sectors:  telecommunication equipment manufacturers,  telecommunications service
providers  and   operators,   international   wireless   carriers  and  platform
manufacturers.                                                                  

The  Company's  other  customers  represent  a  range  of  industries  utilizing
open-architecture  embedded systems.  Due to the addition of the Ziatech product
line and the current weakness in the telecommunications industry, the Company is
focusing  more  marketing  and sales  emphasis on the overall  embedded  systems
market than in recent years.                                                    

Backlog                                                                         

At January 31, 2003, the scheduled backlog of orders was $8.4 million,  compared
to $3.2 million at February 10, 2002.  A  substantial  portion of the  Company's
revenue in each  quarter  results  from  orders  placed  within the  quarter and
shipped in the final month of the quarter. Orders are subject to cancellation in
the normal  course of business;  however,  historically,  the Company has filled
most of its firm  orders.  (See  Management's  Discussion  &  Analysis  included
elsewhere in this report).                                                      

Seasonality                                                                     

The Company's  business is not generally subject to large seasonal swings.  Much
of the Company's business is project-related,  driven by customer demand,  which
can cause quarterly fluctuations in revenue.                                    

Environmental Matters                                                           

The Company does not believe that compliance  with federal,  state or local laws
or regulations  relating to the protection of the environment  have any material
effect on its capital expenditures, earnings or competitive position.           

Competition                                                                     

The  acquisition  of the  Ziatech  product  line in 2002  enabled the Company to
reposition  itself  from being an  embedded  components  supplier  to  supplying
comprehensive  embedded  systems,  incorporating  these  components.  This added
product capability  increased the Company's  addressable markets and altered the
Company's  competitive  landscape.                                              

The embedded systems market continues to be characterized by rapid technological
innovations  resulting in new product  introductions  and  frequent  advances in
price/performance  ratios.  Competitive  factors in this market include  product
performance,  functionality,  product quality and reliability,  customer service
and support,  marketing capability,  corporate reputation and brand recognition,
and changes in relative price/performance ratios.                               

For computing and platform  products,  the Company faces a group of  competitors
including Motorola Computer Group, Force Computers,  Radisys Corporation and SBS
Technologies.  These competitors are split into two categories: the full systems
suppliers  noted above,  and  technology  component  suppliers  offering  either
computing  components or platforms.  Management believes that computing products
is the cornerstone of the embedded systems market, and product functionality and
quality,  time-to-market  and  price/performance  are key factors to winning new
accounts.                                                                       

The Company's  first embedded IP Ethernet switch products were introduced to the
embedded  systems market in 2000 and the first PICMG 2.16 compliant  models were
introduced  in the fall of 2001.  Initially,  there were several small and large
competitors  offering one or two different  models of IP switches to the market.
Today,  some of these  competitors  are  withdrawing  products  from the market,
without introducing new products.  Management believes this has occurred because
the technological requirements, both hardware and software, were underestimated.
Current competitors include Zynx and Ramix, small private companies. The size of
this  market is small  compared  to the  enterprise  switch  market  and  larger
companies  in that  market are not  expected  to enter this  segment  due to the
customization  requirements  and  relatively  low  volumes,  as  compared to the
enterprise market.                                                              

In the network access market, the Company believes its key differentiations from
its  competitors are its depth of market  experience and suite of  communication
software,  known as NexusWare. The Company's products compete with products from
Adax Incorporated, Audiocodes Ltd., Artesyn Technologies, Interphase Corporation
and NMS Communications.                                                         

In the  signaling  market,  the Company  generally  focuses its  engineering  on
products that use Internet Protocol (IP) to carry signaling traffic.  Since this
is a  newer  area  in the  signaling  market,  the  Company  believes  it has an
advantage over competitors' products.  Companies such as Ulticom, Inc., Tekelec,
NMS  Communications  and several  larger  companies  that have  proprietary  SS7
technology or products could develop and sell products more directly competitive
with the Company's signaling products.                                          

Research and Development                                                        

The Company's research and development expenses were approximately $6.9 million,
$7.9  million and $8.9  million  for 2002,  2001 and 2000,  respectively.  These
expenses consist  primarily of employee costs,  material  consumed in developing
and designing new products, and amounts expended for software license/tools. The
Company  expects to continue to invest  heavily in research and  development  in
order to create innovative new products for the embedded systems market.        

The Company has developed significant core competencies  applicable to computing
platforms,   single  board  computers,  voice  and  data  communications,   high
availability, hot swap, redundant technologies and signaling communications. The
Company  also has  significant  software  expertise  that it expects to apply to
embedded systems and platforms.                                                 

Proprietary Technology                                                          

The  Company's  success  depends upon  retaining  and  maximizing  the Company's
proprietary  technologies.  To date,  the  Company has relied  principally  upon
trademark,   copyright  and  trade  secret  laws  to  protect  its   proprietary
technology.  The  Company  generally  enters  into  confidentiality  or  license
agreements with its customers, distributors and potential customers that contain
confidentiality  provisions,  and limits  access to,  and  distribution  of, the
source  code to its  software  and  other  proprietary  information.  All of the
Company's  employees are subject to the Company's  employment  policy  regarding
confidentiality. The Company's software products are provided to customers under
license,  generally in the form of object code,  which provides a high degree of
confidentiality with respect to the intellectual property value.                

Suppliers                                                                       

In the fast paced  technology  environment, manufacturers frequently  "obsolete"
electronic  components.  Furthermore,  more  situations  are  arising  where the
Company is utilizing  sole or limited  source  components on its  products.  The
Company has generally been able to obtain adequate supplies of components or has
redesigned  specific  products when adequate  components are not available.  The
Company obtains components on a purchase order basis and does not generally have
long-term contracts with any of its suppliers.                                  

Manufacturing                                                                   

The Company maintains a  state-of-the-art  manufacturing  facility in Rochester,
New York where it  manufactures  its network  access,  switching  and  signaling
products.  The Computing  Products Group  (formerly  Ziatech)  manufactures  its
products under contract and performs system level  manufacturing and integration
in-house.  Management  intends to  transition  the higher  volume,  contemporary
computing products to its Rochester manufacturing operation during 2003.        

Rochester  manufacturing operates under an integrated MRP system that assists in
managing inventory levels and facilitates demand forecast. The Rochester surface
mount  manufacturing  facility  and quality  management  systems  are  currently
certified  to ISO 9002  standards.  Many of the  Company's  products  have  high
software  content and are  generally  produced in low  volumes.  By utilizing an
in-house  manufacturing  capability,  management  believes  that the Company has
achieved   some  safety  from  the  risks   inherent   in   utilizing   contract
manufacturing.  These risks typically include the sub-contractor's  inability to
meet   flexible   manufacturing   requirements,   inventory   control  and  cost
containment.  In addition,  use of in-house manufacturing enables the Company to
maintain a high quality  level for its products  and greater  responsiveness  to
customer's  delivery  requirements.  Management  expects these  attributes to be
applied to the Ziatech  products  as selected  products  are  transitioned  from
contract manufacturing to the Company's in-house facility.                      

The Company has limited alternative capabilities through third parties, however,
to perform such  manufacturing  activities.  In the event of an  interruption of
production  at its  manufacturing  facility,  the  Company's  ability to deliver
products in a timely fashion would be  compromised,  which would have a material
adverse effect on the Company's results of operations.                          

Employees                                                                       

During  2002,  the  Company  improved  its  cost  structure   primarily  through
reductions  in  the  Company's  staff  and  by  consolidating   the  engineering
operations  from its Raleigh,  North Carolina  facility into its Ottawa,  Canada
Signaling Group. The programs were performed during the first and third quarters
of 2002 as the continuing  decline in capital  spending in the Company's  target
markets  resulted  in lower  demand for the  Company's  products  and lower than
anticipated  Company revenue.  These  reductions  involved  approximately  forty
employees and were initiated throughout the organization.                       

In October 2002,  the Company added  approximately  seventy  employees  with the
acquisition of the new Computing Products Group (formerly Ziatech Corporation). 

As of January 31, 2003, the Company had 220 full-time employees,  five part-time
and contract  employees  and five  Engineering  Cooperative  student  employees.
Management  believes its relations  with its  employees are good.  The Company's
employees are not subject to collective bargaining agreements.                  

The Company's fulltime employees work in the following areas:                   

      Research and Development                        95
      Marketing and Sales                             32
      Manufacturing                                   67
      General and Administrative                      26

Management believes that the Company's future success will depend on its ability
to continue to attract and retain qualified personnel.                          

Risk Factors                                                                    

Technological Change and New Product Introductions. The market for the Company's
products  is   characterized   by  rapid   technological   change  and  frequent
introduction  of  products  based  on  new  technologies.  As new  products  are
introduced,  the industry standards change.  Additionally,  the overall embedded
systems market, particularly the telecommunications industry, is volatile as the
effects of new technologies,  new standards,  new products and short life cycles
contribute   to  changes  in  the  market  and  the   performance   of  industry
participants.  The  Company's  future  revenue  will depend  upon the  Company's
ability  to  anticipate  technological  changes  and to  develop  and  introduce
enhanced  products of its own on a timely  basis that  comply with new  industry
standards. New product introductions, or the delays thereof, could contribute to
quarterly  fluctuations in operating results as orders for new products commence
and orders for existing products decline. Moreover, significant delays can occur
between a product  introduction  and  commencement  of  volume  production.  The
inability  to develop  and  manufacture  new  products in a timely  manner,  the
existence of reliability,  quality or  availability  problems in its products or
their  component  parts,  or the failure to achieve  market  acceptance  for its
products  would have a material  adverse  effect on the  Company's  revenue  and
operating results.  Further, in a poor economic climate,  such as today, current
technologies may become obsolete before being replaced by new technologies.     

Competition.  The embedded systems market,  particularly the  telecommunications
industry,  is extremely  competitive and the Company faces a number of large and
small competitors.  Many of the Company's principal competitors have established
brand name  recognition  and market  positions  and have  substantially  greater
experience and financial resources to deploy on promotion, advertising, research
and product development than the Company.  In addition,  as the Company broadens
its product  offerings,  it expects to face  competition  from new  competitors.
Companies in related markets could offer products with functionality  similar or
superior to that offered by the Company's products.  Increased competition could
result in price  reductions,  reduced  margins and loss of market share,  all of
which would materially and adversely affect the Company's  revenue and operating
results.  Large  companies  have  recently  acquired  several  of the  Company's
competitors.  These acquisitions are likely to permit the Company's  competition
to devote  significantly  greater  resources to the development and marketing of
new competitive  products and the marketing of existing  competitive products to
their larger installed bases. The Company expects that competition will increase
substantially  as a result  of  these  and  other  industry  consolidations  and
alliances,  as  well  as the  emergence  of  new  competitors.  There  can be no
assurance  that  the  Company  will be able to  compete  successfully  with  its
existing or new competitors or that  competitive  pressures faced by the Company
will not have a material  adverse effect on the Company's  revenue and operating
results.                                                                        

Dependence  on Key  Customers.  There  can be no  assurance  that the  Company's
principal  customers  will  continue  to purchase  products  from the Company at
current levels.  Customers typically do not enter into long-term volume purchase
contracts with the Company, and customers have certain rights to extend or delay
the shipment of their  orders.  The loss of one or more of the  Company's  major
customers,  and the reduction,  delay or cancellation  of orders,  or a delay in
shipment  of the  Company's  products to such  customers,  would have a material
adverse effect on the Company's revenue and operating results. (See Management's
Discussion and Analysis included elsewhere in this report).                     

Design Wins. A design win is when a customer or  prospective  customer  notifies
the  Company  that its product has been  selected  to be  integrated  with their
product. Ordinarily, there are a number of steps between the design win and when
customers initiate production shipments. Typically, design wins reach production
volumes at varying rates.  Historically,  this gestation  period prior to volume
orders has been twelve to eighteen months or more after the design win occurs. A
variety of risks such as schedule delays, cancellations, and changes in customer
markets  and  economic  conditions  can  adversely  affect a design  win  before
production is reached or during deployment. While management still believes that
design  wins  continue  to be an  important  metric  in  evaluating  the  market
acceptance  of the Company's  products,  unfortunately  in the current  economic
climate,  fewer  customers are doing new design activity and a smaller number of
these design wins are moving into production than in the past.                  

Potential  Fluctuations in Annual and Quarterly  Results.  The Company's  future
annual and  quarterly  operating  results can vary  significantly  depending  on
factors  such as the timing and  shipment  of  significant  orders,  new product
introductions by the Company and its competitors,  market  acceptance of new and
enhanced versions of the Company's products,  changes in pricing policies by the
Company and its competitors,  the mix of distribution channels through which the
Company's products are sold,  inability to obtain sufficient supplies of sole or
limited source components for the Company's  products,  and seasonal and general
economic  conditions.  The Company's  expense levels are based,  in part, on the
Company's  expectations as to future revenue. Since a substantial portion of the
Company's  revenue in each quarter results from orders placed within the quarter
and often  shipped  in the  final  weeks of that  quarter,  revenue  levels  are
extremely  difficult  to  predict.  If revenue  levels  are below  expectations,
revenue and operating  results will be adversely  affected.  Net income would be
disproportionately  affected  by a  reduction  in revenue  because  only a small
portion of the Company's net expenses varies with its revenue. (See Management's
Discussion and Analysis included elsewhere in this report).                     

Dependence on Third Party Component  Suppliers.  Certain  components used in the
Company's products are currently  available to the Company from one or a limited
number of  sources.  There can be no  assurance  that  future  supplies  will be
adequate  for the  Company's  needs or will be  available  on  prices  and terms
acceptable  to the  Company.  The  Company's  inability  in the future to obtain
sufficient  limited-source  components, or to develop alternative sources, could
result in delays in product  introduction or shipments,  and increased component
prices could negatively affect the Company's gross margins, either of which will
have a material adverse effect on the Company's revenue and operating results.  

Dependence  on  Internal  Manufacturing.  In order to avoid  relying  on outside
contract manufacturers,  the Company manufactures its network access, switch and
signaling  products at its  Rochester,  New York facility.  The Company's  newly
acquired  Ziatech  computing  and platform  products have been  manufactured  at
contract  manufacturers.  The Company  does not have  alternative  manufacturing
capabilities,  either  internally  or through  third  parties,  to  perform  its
manufacturing  functions except it expects to begin manufacturing certain of the
Ziatech computing products in its Rochester  manufacturing facility during 2003.
Even if the  Company  were able to  identify  alternative  third-party  contract
manufacturers,  there  can be no  assurance  that the  Company  would be able to
retain their services on terms and conditions  acceptable to the Company. In the
event of an interruption in production, the Company would not be able to deliver
products on a timely basis,  which would have a material  adverse  effect on the
Company's  revenue and  operating  results.  Although the Company  currently has
business interruption  insurance, no assurances can be given that such insurance
will  adequately  cover  the  Company's  lost  business  as a result  of such an
interruption.                                                                   

Dependence on Proprietary  Technology.  The Company's  success  depends upon the
Company's proprietary technologies.  To date, the Company has relied principally
upon  trademark,  copyright  and trade  secret laws to protect  its  proprietary
technologies.  The  Company  generally  enters into  confidentiality  or license
agreements with its customers,  distributors and potential  customers and limits
access  to and  distribution  of the  source  code  to its  software  and  other
proprietary  information.  The Company's  employees are subject to the Company's
employment policy regarding confidentiality.  There can be no assurance that the
steps  taken  by the  Company  in  this  regard  will  be  adequate  to  prevent
misappropriation  of its  technologies or to provide an effective  remedy in the
event of a misappropriation by others.                                          

Although  management believes that the Company's products do not infringe on the
proprietary rights of third parties, there can be no assurance that infringement
claims will not be asserted, resulting in costly litigation in which the Company
may not ultimately  prevail.  Adverse  determinations  in such litigation  could
result in the loss of the Company's  proprietary rights,  subject the Company to
significant liabilities, require the Company to seek licenses from third parties
or prevent the Company from manufacturing or selling its products,  any of which
will have a material  adverse  effect on the  Company's  revenue  and  operating
results.                                                                        

Because of the existence of a large number of patents in the computer networking
industry and the rapid rate of new patents  granted or new standards  developed,
or new technology,  it may be necessary for the Company to enter into technology
licenses  from  others.  There  can  be no  assurance  that  these  third  party
technology licenses will be available to the Company on commercially  reasonable
terms.  The loss of, or inability to obtain,  any of these  technology  licenses
could result in delays or  reductions in product  shipments.  Any such delays or
reductions  in  product  shipments  will have a material  adverse  effect on the
Company's revenue and operating results.                                        

Dependence  on  Personnel.  The  Company's  success  depends  on  the  continued
contributions of its personnel, many of whom would be difficult to replace. Over
the past several years,  one of the incentives  used to retain key personnel has
been the issuance of stock options.  Unfortunately,  in the current market,  the
Company's  stock price has declined  such that almost all of those stock options
are below the grant price,  thereby  negating the retention  attributes of those
instruments.                                                                    

Through  mid-2001,  competition  for  engineering  personnel  in  the  Company's
marketplace was intense.  Since mid-2001,  engineering personnel seem to be more
readily available. Although the Company's employees are subject to the Company's
employment  policy  regarding   confidentiality  and  ownership  of  inventions,
employees are generally not subject to employment  agreements or non-competition
covenants.  Changes in personnel could adversely affect the Company's  operating
results.                                                                        

Notes:    IPnexus,  NexusWare,  FlexNat,  Ziatech,  and SEGway are trademarks of
Performance Technologies, Inc.                              

ITEM 2 - Properties                                                             

The Company's corporate headquarters are located in 57,000 square feet of office
and manufacturing space in Rochester,  New York. Corporate  headquarters include
the  executive   offices,   along  with  sales,   marketing,   engineering   and
manufacturing operations.  The Company relocated these operations to this leased
facility in April 2002. This lease expires in 2012. There is sufficient room for
growth  in  the  intermediate  term  in  this  facility  and  it is  capable  of
accommodating  a variety of expansion  options.  In 2001, the Company  purchased
land adjacent to this facility to accommodate future expansion.                 

The Company's Computing Products Group (formerly Ziatech Corporation) is located
in 61,000  square  feet of office  and  manufacturing  space  leased in San Luis
Obispo, California. This lease expires in 2008. This facility includes sales and
marketing  personnel,  and  engineering  and  manufacturing  operations  for the
computing  products.  Approximately  12,000  square  feet  of this  facility  is
currently  sublet to a tenant  and  there is  sufficient  room for this  group's
intermediate-term growth in this facility.                                      

The Company has sales and marketing personnel,  and signaling  engineering staff
located in 13,000  square feet of office space  leased in a building  located in
downtown Ottawa,  Canada. The office lease agreements in this building expire in
May 2003.  The Company has the option to renew these leases for a future  period
of one or two years.  The Company  expects to exercise its renewal options under
these leases.  The Signaling Group also had 7,000 square feet of office space in
downtown Raleigh,  North Carolina.  In September 2002, the engineering functions
at this facility were consolidated into the Ottawa, Canada signaling operations.
The Company is attempting to sublet this space,  however,  the commercial office
space  market in downtown  Raleigh is very soft.  This office  lease  expires in
February 2005.                                                                  

The Company also leases sales and engineering  offices in San Diego,  California
and sales offices in Connecticut and the United Kingdom.                        

ITEM 3 - Legal Proceedings                                                      

From time to time,  the  Company is involved  in  litigation  relating to claims
arising  out of its  operations  in the  normal  course  of  business.  With the
exception of the following  items,  the Company is not a party to any such legal
proceedings,  the adverse  outcome of which,  individually  or in the aggregate,
would have a material  adverse  effect on the Company's  results of  operations,
financial condition or cash flows.                                              

Following the Company's  announcement  on May 19, 2000 regarding its preliminary
results of operations for the second quarter, several class action lawsuits were
filed in the United States  District Court for the Western  District of New York
against the Company, as well as several of its officers and directors,  alleging
violations  of federal  securities  laws.  On September  25,  2002,  the Company
announced it had signed a Memorandum of Understanding  for the settlement of the
class action litigation.  The Company recorded a charge of $143,000 in the third
quarter of 2002 in connection with the settlement of the  litigation.  The terms
of the settlement  outlined in the memorandum  between the Company and the class
action  plaintiffs  have been submitted to the Court in the form of a settlement
agreement.  This proposed  settlement  will be subject to Court  acceptance  and
approval.                                                                       

ITEM 4 - Submission of Matters to a Vote of Security Holders                    

No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter 2002.                                                                   

PART II                                                                         

ITEM 5 - Market  for  the  Registrant's  Common  Equity  and Related Stockholder
Matters                                                       

The Company's  common stock is traded on the Nasdaq National Market System under
the trading symbol  "PTIX." The following  table sets forth the high and the low
quarterly  closing  prices of the common stock during the two most recent years,
as  reported  on the Nasdaq  National  Market  System.  These  prices  represent
quotations  among  securities  dealers  without  adjustments for retail markups,
markdowns or commissions and may not represent actual transactions.             

             2002                                High              Low
         -----------------------------------------------------------------------
     First Quarter                               $13.57           $ 7.65
     Second Quarter                                8.60             6.25
     Third Quarter                                 6.31             3.43
     Fourth Quarter                              $ 4.74           $ 3.20

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             2001                                High              Low
         -----------------------------------------------------------------------
     First Quarter                               $15.75           $10.06
     Second Quarter                               16.49            10.00
     Third Quarter                                17.40             8.22
     Fourth Quarter                              $13.55           $ 8.00

As of February 28, 2003,  there were 189 stockholders of record of the Company's
common stock.                                                                   

To date,  the Company has not paid cash dividends on its common stock and has no
intention to do so for the foreseeable future.                                  

Equity Plan Information:                                                        

The Performance  Technologies,  Incorporated 2001 Stock Option Plan was approved
by the Company's stockholders at the 2001 Annual Meeting.                       

The following table provides certain information  regarding the Company's equity
compensation plan.                                                              

                                                        [Enlarge/Download Table]
                                                                                               

                                        (a)                 (b)                   (c)          
                                      Number of                                                
                                  securities to be                                             
                                    issued upon        Weighted average         Number of      
              Plan Category         exercise of       exercise price of        securities      
                                    outstanding          outstanding            remaining      
                                 options, warrants    options, warrants       available for    
                                     and rights           and rights         future issuance   
                                 -------------------  -------------------  --------------------
Equity compensation plans                                                                      
   approved by security holders      2,146,680               $10.46               875,050      

Equity compensation plans not                                                                  
   approved by security holders                                                                
                                 -------------------  -------------------  --------------------
   Total                             2,146,680               $10.46               875,050      
                                 ===================  ===================  ====================

The Company has no equity compensation  plans that have not been approved by its
stockholders.                                                                   

ITEM 6 - Selected Financial Data                                                
-----------------------                                       
(in thousands, except per share amounts)                    

                                                        [Enlarge/Download Table]
                                                                                                                         

For the Years Ended December 31:                    2002           2001            2000           1999           1998    
----------------------------------------------- ----------- -- ----------- --- ----------- -- ----------- -- ------------

Sales                                              $27,014        $36,517         $38,963        $44,494         $34,118 
Income from operations                                 326          5,186           7,050          6,226           6,047 
Basic earnings per share:                                                                                                
  Net income from operations (1)                   $   .03        $   .42         $   .54        $   .47         $   .46 
  Weighted average common shares                    12,263         12,282          13,106         13,165          13,077 
Diluted earnings per share:                                                                                              
  Net income from operations (1)                   $   .03        $   .41         $   .51        $   .45         $   .45 
  Weight average common and                                                                                              
    common equivalent shares                        12,373         12,708          13,769         13,789          13,517 

Excluding non-recurring expenses (2) (3)                                                                                 
  Income from operations                           $ 1,186        $ 5,186         $ 7,050        $ 7,970         $ 6,047 
  Basic earnings per share                         $   .10        $   .42         $   .54        $   .61         $   .46 
  Diluted earnings per share                       $   .10        $   .41         $   .51        $   .58         $   .45 

At December 31:                                     2002           2001            2000           1999           1998    
----------------------------------------------- ----------- -- ----------- --- ----------- -- ----------- -- ------------
Working capital                                    $32,130        $34,728         $36,975        $39,009         $32,221 
Total assets                                        45,204         42,954          44,758         49,142          40,122 
Long-term debt, less current portion                                                                                   6 
Total stockholders' equity                         $38,809        $38,342         $39,468        $40,828         $34,180 

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         (1) All per share amounts have been adjusted where appropriate, for the
three-for-two stock split effected in September 1999. 

         (2) In  2002,  using  an  effective  tax rate of 31%,  amounts  exclude
             non-recurring expenses amounting to $.9 million, or $.07 per share.
        In 1999, amounts exclude a $1.7 million charge for acquisition
expenses.                                             

         (3) This data is a non-GAAP  measure that should be read in conjunction
with GAAP disclosures herein.                         

ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations                                                 

The  Company'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 section  appearing  in ITEM 1 of this Form 10-K under the heading
"Risk  Factors."  The  Company's  future  operating  results  may be affected by
various  trends  and  factors  which are  beyond the  Company's  control.  These
include, among other factors, general business and economic conditions, rapid or
unexpected  changes in  technologies,  cancellation  or delay of customer orders
including those relating to design wins,  changes in the product or customer mix
of sales, delays in new product development, customer acceptance of new products
and customer delays in qualification of products. In addition,  during difficult
economic periods,  customer's  visibility  deteriorates  causing delays in their
placement of orders.  These factors often result in a substantial portion of the
Company's  revenue  being  derived  from  orders  placed  within the quarter and
shipped in the final month of the quarter.                                      

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.  The Company's  actual results could
differ materially from those discussed in the forward-looking statements.       

Overview                                                                        

Industry:  2002 was a challenging  year with  continuing  erosion in the general
business environment, as well as the Company's target markets. In these markets,
the  telecommunications  industry is the largest  sector which was burdened with
overcapacity  and a slowing  economy that  resulted in reduced  prices,  stifled
competition  and severely  limited capital  expenditures.  Other end markets for
embedded  systems also  experienced  business  slowdowns during 2002, but not as
severe  as  the  telecommunications  industry.  Management  responded  to  these
demanding  market  conditions  through a series of initiatives  that allowed the
Company to maintain  profitability while many comparable  organizations suffered
large  financial  losses  that,  in  some  cases,   threatened  their  continued
operations.  Please refer to PART 1, Item 1, under the caption "Business", for a
discussion of the industry,  economic environment and the Company's  initiatives
during 2002.                                                                    

Traditionally,  "design  wins" have been an important  metric for  management to
judge the Company's  product  acceptance in its marketplace.  Typically,  design
wins  reach   production   volumes  at  varying   rates,   generally   beginning
twelve-to-eighteen  months after the design win occurs.  A variety of risks such
as schedule delays, cancellations,  and changes in customer markets and economic
conditions  can  adversely  affect a design win before  production is reached or
during deployment.  While management still believes that design wins continue to
be an important  metric in  evaluating  the market  acceptance  of the Company's
products,  unfortunately  in the current economic  climate,  fewer customers are
doing new design  activity and a smaller  number of these design wins are moving
into production than in the past. During 2002, the Company received notification
for  twenty-four new design wins for its IPnexus  Switching (8),  IPnexus Access
(12),  Ziatech Computing and Platform (2), and SEGway SS7 IP Signaling  products
(2),  compared to  thirty-five  new design wins during 2001. Not all design wins
are expected to result in production orders.                                    

Financial:  On  October  2,  2002,  the  Company  acquired  a  portion  of Intel
Corporation's  Embedded   Communications  Platform  Division  (formerly  Ziatech
Corporation).  Beginning  in the  fourth  quarter,  the  Company's  revenue  and
expenses reflect the Ziatech operations.                                        

In 2002, the following  non-recurring items affected the comparability of income
between years:                                                                  

  o  restructuring  charges  ($.6  million  pre-tax,  or $.03 per  share);
    o  in-process research and development expense ($.4 million after-tax,  or
$.03 per share);  and                                           
     o  class action settlement costs ($.1 million pre-tax,  or $.01 per share).

Revenue for 2002 amounted to $27.0  million,  compared to $36.5 million in 2001.
The  continuing   decline  in  capital  spending  in  the   communications   and
telecommunications  markets  dramatically  impacted the Company's network access
and signaling  product  revenue in 2002. The newly acquired  Ziatech  operations
contributed  $5.0  million to revenue in 2002.  Sales  outside of North  America
amounted to $6.9 million and $9.7 million in 2002 and 2001, respectively.       

Net  income  in 2002  amounted  to $.3  million,  or $.03 per  share,  including
non-recurring  expenses,  and  amounted  to $1.2  million,  or $.10  per  share,
excluding  non-recurring  expenses,  based on 12.4 million  shares  outstanding.
Using an effective  income tax rate of 31%,  non-recurring  expenses during 2002
amounted  to $.9  million  after  tax,  or $.07 per  share.  Net  income in 2001
amounted  to $5.2  million,  or $.41 per  share,  based on 12.7  million  shares
outstanding.                                                                    

Cash, cash equivalents and marketable  securities  amounted to $24.1 million and
$26.9 million at December 31, 2002 and 2001, respectively, and no long-term debt
existed at either date. During 2002 and 2001, the Company generated $5.5 million
and $9.0 million of cash from operating  activities,  respectively.  During 2002
and 2001, the Company  expended $.1 million and $6.9 million,  respectively,  to
buy back its shares in the open market.  In September 2002, the Company invested
$1.5 million for a 47% minority interest in Momentum  Computer,  Inc. and loaned
Momentum an additional $1.0 million to be used for working  capital.  In October
2002,  the  Company   acquired  a  portion  of  Intel   Corporation's   Embedded
Communications Platform Division (formerly Ziatech Corporation) for $3.0 million
in cash.                                                                        

Results of Operations                                                           

The  following  table sets forth for the years  indicated  certain  consolidated
financial  data  expressed as a percentage of sales and is included as an aid to
understanding  the Company's  results and should be read in conjunction with the
selected  financial data and Consolidated  Financial  Statements  (including the
notes  there