On February 1, 2010, the Company issued a press release announcing that it had received advanced orders for its PDR Systems valued at over $1,900,000. At the time of this press release we had advanced orders for $1,900,000. Approximately, two weeks subsequent to the press release we received an actual purchase order in the amount of $638,000. The advance order on this $638,000 actual purchase was $936,000 resulting in a decrease of $298,000 from the advanced orders to the actual purchases by the customer. Other advanced orders related to the $1,900,000 in the amount of $964,000 have been subsequently received and shipped through October 31, 2010.
On February 17, 2010, the Company issued a press release announcing that it had received releases for its PDR 2000 systems valued at $638,000. One of our customers placed one purchase order with the Company for two separate deliveries of the PDR systems totaling $638,000 in revenue. The first shipment was for immediate delivery which commenced February 25, 2010 and completed April 8, 2010. The balance of the shipment was released in January for all digital PDR-2000’s and the remaining analog PDR-2000’s are awaiting technical approval before shipment but is expected in fiscal 2011. The original estimate from the customer for this order was for $936,000 (which was part of the $1,900,000 advance order – as discussed above). The difference between the original estimate of $936,000 and the final order shipped of $638,000 was due to less expensive options and 33 fewer units ordered than estimated. On May 3, 2011, the customer informed the Company that it is canceling the remaining $269,640 on this order.
On March 3, 2011, the Company issued a press release announcing that it had dismissed WithumSmith+Brown, PC (“Withum”), and engaged Wolinetz, Lafazan & Company, CPA’s, P.C. (“Wolinetz”) as the Company’s independent registered public accounting firm. The decision to dismiss Withum and engage Wolinetz was approved by the audit committee of the Company’s board of directors on March 3, 2011.
During the Company’s two most recent fiscal years and through the date of the dismissal, there were no reportable events as defined under Item 304(a)(1)(v) of Regulation S-K adopted by the SEC.
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Status of Certain Press Releases Issued: (continued)
On March 9, 2011, the Company issued a press release announcing that Robert Benou, the chief executive officer and chairman of the Company had made advances to the Company in the amounts of $60,000 on February 8, 2011, $91,350 on February 15, 2011, $30,000 on February 24, 2011 and $30,000 on February 28, 2011. These advances were made to assist the Company in meeting short-term obligations. The advances are payable on demand and do not bear any interest rate and no written agreement was entered into with respect to the advances.
On April 28, 2011, the Company issued a press release announcing that it had received advanced orders for its PDR Systems, from two customers, valued at over $135,000 and $391,000, respectfully, All units included in the $135,000 order have been shipped. Delivery of the units in the $391,000 are scheduled to be shipped in June and July.
LIQUIDITY AND FINANCIAL CONDITION
We have had recurring losses from operations of $1,733,435 and $2,976,461 for the nine months ended April 30, 2011 and 2010, respectively and used cash from operations in the amounts of $899,275 and $1,252,340 for the nine month period ended April 30, 2011 and 2010, respectively. At April 30, 2011, the Company had cash and equivalents of $74,181. On August 13, 2010, an event of default occurred on our outstanding convertible debentures. The Company received a waiver from the note holders and the debentures were converted entirely before January 31, 2011.
At April 30, 2011, the Company had total current assets of $1,056,259 and total current liabilities of $1,241,116, resulting in working capital deficit of $184,857 compared to working capital of $1,508,104 at year ended July 31, 2010. The Company’s current assets consists of $74,181 in cash and cash equivalent, $136,829 in accounts receivable, $755,791 in inventory and $89,458 in prepaid expenses and other current assets. Accounts receivable increased from $67,603 at July 31, 2010 to $136,829 at April 30, 2011. This increase in our accounts receivable is the result of sales increase of $83,795 for the nine months period ended April 30, 2011 and timing of collections.
Cash expenditures have exceeded revenues for the prior year and Management expects this consumption of cash to continue into next year. Our operations have been and will continue to be funded from existing cash balances and private placements of equity funding. During our fiscal year ended July 31, 2010, we raised $2,000,000 from the sale of convertible debentures and $635,070 from the exercise of warrants (See “FINANCING ACTIVITIES”, below). We are dependent on improved operating results and raising additional funds over the next twelve month period. There are no assurances that we will be able to raise additional funding. In the event that we are unable to generate sufficient cash flow or receive proceeds from offerings of debt or equity securities, the Company may be forced to curtail or cease it activities and/or operations.
OPERATING ACTIVITIES
Net cash used in operating activities was $899,275 for the nine months period ended April 30, 2011, as compared to $1,252,340 net cash used in operating activities for the nine month period ended April 30, 2010, a decrease of $353,065, this decrease in use of cash can be attributed to: (a) cash operating expenses increased approximately $396,000 for the nine months period ended April 30, 2011 versus 2010. Offsetting the increases in uses of cash for the nine months ended April 30, 2011 compared to April 30, 2010, were decreases in (b) prepaid expenses, a reduction versus prior year of approximately $232,000, (c) inventory decreased resulting in a reduction change of approximately $90,000, (d) accounts payable and accrued expense increased, resulting in a reduction of approximately $601,000, (e) accounts receivable increased less than the prior nine months in 2010 resulting in lower use of cash of approximately $48,000 and other assets increased approximately $4,000.
25
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
INVESTING ACTIVITIES
Net cash used in investing activities for the nine month period ended April 30, 2011 was $5,899 for the purchase of manufacturing equipment. For nine month period ended April 30, 2010 net cash used investing activities was $22,781 also for the purchase of equipment.
FINANCING ACTIVITIES
Net cash provided from financing activities was $266,350 for the nine month period ended April 30, 2011, as compared to $2,345,173 provided in same nine month period in 2010. In the nine month period ended April 30, 2011 the Company received proceeds of $100,000 from sale of common stock and $166,350 from a loan from Company officer. For the nine months ended April 30, 2010, the Company received $2,000,000 related to issuance of convertible debentures and $635,070 related to the excising of warrants and incurred $291,507 in expense associated with the loan debentures.
On August 3, 2009, the Company entered into a Subscription Agreement pursuant to which it sold a $500,000 convertible debenture on August 3, 2009 and a $500,000 Debenture on September 24, 2009. (collectively, the “August 2009 Debentures”). The initial interest rate of the August 2009 Debentures is 4% per annum and upon the shareholder Approval the interest rate will be 8% per annum. The August 2009 Debentures have maturity dates of 15 months from their closing dates. Interest shall accrue from the closing date and shall be payable quarterly, in arrears, commencing six months after the closing date. The August 2009 debentures are convertible into shares of the Company’s common stock at a conversion price of $0.78 per share.
Commencing six months after the closing date, the Conversion Price shall be adjusted to the lesser of the $0.78 or 75% of the lowest three closing bid prices for the Company’s common stock for the ten days prior to when the August 2009 Debenture is converted.
In connection with the August 2009 Debentures, the Company issued Class A and Class B warrants. The Class A warrants provide the holder with the option to purchase 2,564,102 shares of the Company’s common stock at an exercise price $1.12 per share. The Class A warrants are exercisable for a period beginning on August 3, 2009 and terminate on August 3, 2014. Additionally, the 40,000 Class B Warrants issued entitles the holder until July 3, 2012, to purchase up to $4,000,000 of principal amount of the Company’s 8% notes on the same terms as the August 2009 Debentures. Upon the exercise of the Class B Warrants, the holder of the Class B Warrant will be issued two Class C Warrants for each share of the Company’s common stock that would be issued on the exercise date of the Class B Warrant assuming the full conversion of the notes issued on such date. The Class C warrants entitle the warrant holder to purchase 10,256,408 shares of the Company’s Common Stock with and exercise price equal to the lesser of 105 % of the closing bid price of the Company’s common stock or the exercise price of the Class A Warrants. For each $100,000 principal of notes purchased pursuant to the Class B Warrants, the holder will surrender 1,000 Class B Warrants.
The August 2009 Debentures cannot be converted to the extent such conversion would cause the Debenture holder, together with such holder’s affiliates, to beneficially own in excess of 4.99% of the of the Company’s outstanding common stock immediately following such conversion. The Company also entered into a Security Agreement pursuant to which it granted the Subscribers a security interest in its assets. The Security Agreement will terminate when the August 2009 Debentures, including outstanding interest due thereon are repaid.
In connection with the August 2009 Debenture agreement entered into on August 3, 2009, the Company paid Garden State Securities, Inc., the selling agent, a cash fee of $100,000 and issued warrants to purchase 256,410 shares of the Company’s common stock. The Company calculated the fair value of the warrants on August 3, 2009 at $231,025 using the Black-Scholes option pricing model.
At various times during the year ended July 31, 2010, an aggregate $1,000,000 of the August 2009 Debentures and $36,968 of accrued interest were converted into 1,329,447 shares of the Company’s common stock. As of July 31, 2010 the remaining balance of the August 2009 Debentures were $0.
26
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
FINANCING ACTIVITIES (continued)
On February 24, 2010, holders of the Class B warrants exercised 10,000 Class B Warrants to purchase $1,000,000 in convertible notes (“February 2010 Debentures”). The February 2010 Debentures were issued under the same terms as the August 2009 Debentures. With the exercise of the 10,000 Class B warrants, the Company also issued Class C Warrants to purchase 2,564,104 shares of the Company’s common stock at an exercise price of $1.12.
In connection with the exercise of the Class B warrants and pursuant to Selling Agent Agreement the Company paid Garden State Securities, Inc., a cash fee of $100,000 and issued Garden State additional warrants to purchase 256,410 shares of the Company’s common stock. The Company calculated the fair value of the warrants on March 3, 2010 to be $380,256 using the Black-Scholes option pricing model.
The August 2009 Debentures, February 2010 Debentures, Class A warrants, Class B warrants, Class C warrants and the warrants granted to the selling agent contain provisions whereby if the Company shall offer, issue or agree to issue any common stock or securities into or exercisable for shares of common stock to any person or entity at a price per share or conversion or exercise price per share which shall be less than the conversion price of the August 2009 Debentures and February 2010 Debentures or less than the exercise price of the Class A warrants, Class B warrants, Class C warrants or the warrants granted to the selling agent, then the conversion price and the warrant exercise price shall automatically be reduced to such other lower issue price. Due to this provision, the embedded conversion features of the Debentures and the warrants are not considered indexed to the Company’s stock. Accordingly, these financial instruments have been recorded as a derivative liability.
On June 18, 2010, the Company entered into an amendment with the holders of its outstanding convertible debentures and warrants. Pursuant to the amendments, the parties agreed to the following: (i) remove the above provision which allowed for an adjustment to the conversion price of the debentures or exercise price of the debentures, (ii) the conversion feature of the February 2010 Debentures were adjusted to a fixed conversion price $0.60, (iii) all future Class C Common Stock Purchase Warrants issued upon exercise of the Class B Common warrants shall have an exercise price of $0.50 per share, (iv) the exercise price of the outstanding Class C warrants shall be adjusted to $0.50 per share, (v) the exercise price of the outstanding selling agent warrants shall be adjusted to $0.60 per share.
As a result, of the June 18, 2010 amendments the embedded conversion features of the debentures and the warrants were considered indexed to the Company’s stock. Accordingly, the outstanding derivative liabilities were reclassified to additional paid in capital at their fair value on June 18, 2010 with the change in fair value being recorded in the statement of operation.
After the accounting for the embedded derivatives, induced conversion costs, interest expense, amortization of debt discounts and amortization of deferred financing fees the above financing transactions increased our net loss by $21,514,072. The $21,514,072 had no effect on the Company’s cash flow. Through the accounting for induced conversion costs, exercise of warrants, conversions of convertible debt and the reclassification of derivative liabilities the above financing transactions increased our additional paid in capital by $23,998,405.
On December 1, 2010, the Company reduced the conversion price on its February 2010 debentures from $0.60 to $0.30. As a result of the reduction in the conversion price the Company recognized a beneficial conversion feature in the amount of $300,000.
On December 8, 2010, the Company reduced the exercise price of its outstanding Class C Warrants from $0.50 to $0.10. As a result of the reduction of the exercise price the Company recognized additional interest expense in the amount of $65,253.
At various times during the nine month period ended April 30, 2011, $1,000,000 of convertible debt and $63,790 of accrued interest was converted into 4,784,933 shares of common stock.
27
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
INFLATION
Management believes that the results of operations have not been affected by inflation and management does not expect inflation to have a significant effect on its operations in the future.
CRITICAL ACCOUNTING POLICIES
The Company’s condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, at the date of the financial statements and reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management uses its best judgment in valuing these estimates and may, as warranted, solicit external professional advice and other assumptions believed to be reasonable. The following critical accounting policies, some of which are impacted significantly by judgments, assumptions and estimates, affect the Company’s consolidated financial statements.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The estimates and assumptions made by management as based upon available current information, historical experience and other factors that are believed to be reasonable under the circumstances. The estimates and assumptions made by management involve risks and uncertainties which could cause reported amounts to differ materially from actual future results. If management’s estimates and assumptions are inaccurate, the Company’s reported amounts and disclosures of contingent assets and liabilities could be materially and adversely affected. Management considers its reserve for inventory and accounting for derivative liabilities to be significant estimates.
REVENUE RECOGNITION
Revenue is recorded in accordance with the guidance of the SEC’s Staff Accounting Bulletin (SAB) No. 104, which supersedes SAB No. 101. Revenue from product sales are recognized at the time of shipment (when title has passed) upon fulfillment of acceptance terms; products are not sold on a conditional basis. Therefore, when delivery has occurred the sale is complete as long as the collection of the resulting receivable is probable.
RECEIVABLES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
The preparation of financial statements requires our management to make estimates and assumptions relating to the collectability of our accounts receivable. Management specifically analyzes historical bad debts, customer credit worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. The Company has a concentration risk in trade accounts receivable with significant sales to the government and local agencies. The credit evaluation process has mitigated the credit risk, such losses have been minimal, and within management expectations.
INVENTORY VALUATIONS, COMPONENTS AND AGING
Inventories are valued at lower of cost or market using the first-in, first-out (“FIFO”) method. Finished goods costs included raw materials, labor and manufacturing overhead costs. Excess and obsolete inventory costs are expensed and a reserve for slow-moving inventory is made on management’s estimates.
Finished goods are products that have been completed in connection with specific orders and are awaiting shipment. Work-in-Process represents raw material components that have been requisitioned from the warehouse and are being assembled in the manufacturing area. Raw Materials consist of components parts purchased from various suppliers and are used to build our finished products. Various raw material parts are also maintained to support warranty claims for commercial and military products. Typical raw material products include PC boards, digital screen assemblies, guide rails, capacitors, terminals, power supplies, process chips, resistors, keypads, relays and face plates.
28
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
INVENTORY VALUATIONS, COMPONENTS AND AGING (continued)
The Company provides a twelve-year warranty on all commercial products and is required by government regulation to design and produce military products with a minimum 25-year operating life in addition to shelf life.
The Company maintains a significant amount of raw material component parts and some of this raw material inventory is not expected to be realized within a twelve month operating cycle from the balance sheet date. For any raw material part which has not been purchased within the last twelve months from the balance sheet date, it is evaluated as part of the slow moving inventory and is part of our reserve review. The Company estimated a usage rate for its raw material component parts for what it expects to use over a 36 month period. Any excess inventory based on this projected usage rate is written off as excess and obsolete. The Company then reserves 100% of the estimated usage that is over 12 months and less than 36 months. Certain raw material parts which have been written down to a zero value, may still be maintained in inventory to satisfy possible requirements under the warranty programs but are valued at zero. Ongoing, the Company evaluates the inventory parts based on their age and usage over a 36 month period to determine inventory and obsolescence and reserve adjustments.
WARRANTY
The Company provides a twelve-year warranty on its commercial products and 25 years on its military products: the warranty covers parts and labor. The Company, at its option, repairs or replaces products that are found defective during the warranty period providing proper preventive maintenance procedures have been followed by customers. Repairs necessitated by misuse of such products are not covered by our warranty. In cases of defective products, the customer typically returns them to the Company’s facility in Somerville, New Jersey. The Company’s service personnel will replace or repair the defective items and ship them back to the customer. All servicing is completed at the Company’s main facility and customers are charged a fee for those service items that are not covered by the warranty. We do not offer our customers any formal written service contracts. Our warranty costs have historically been insignificant and therefore a provision was not warranted. Management continues to monitor the costs and will provide a warranty provision if circumstances change.
INCOME TAXES
The Company follows the authoritative guidance for accounting for income taxes. Deferred income taxes are determined using the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Based upon the company’s evaluation, management has concluded that there are no significant uncertain tax positions requiring recognition in the consolidated financial statements or adjustments to deferred tax assets and related valuation allowance. A valuation allowance is recorded when the expected recognition of a deferred tax asset is considered to be unlikely
DERIVATIVE LIABILITY
Derivative liabilities consist of certain common stock warrants, and conversion features embedded in our convertible Debenture notes. These financial instruments are recorded in the balance sheet at fair value, determined using the Black-Scholes option pricing model, as liabilities. Changes in fair value are recognized in the statement of operations in the period of change.
STOCK BASED COMPENSATION
The Company follows the authoritative guidance for accounting for stock-based compensation. This guidance requires that new, modified and unvested share-based payment transactions with employees, such as grants of stock options and restricted stock, be recognized in the financial statements based upon their fair value at the grant date and recognized as compensation expense over their vesting periods. The Company also follows the guidance for equity instruments issued to consultants.
29
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable, other current assets, accounts payable, accrued expenses and short term convertible Debentures approximates fair value because of the short maturity of these instruments. The recorded value of long-term debt approximates its fair value as the terms and rates approximate market rates.
FAIR VALUE MEASUREMENTS
The authoritative guidance for fair value measurements defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or the most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact. The guidance describes a fair value hierarchy based on the levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:
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Level 1 – | Quoted prices in active markets for identical assets or liabilities. |
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Level 2 – | Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or corroborated by observable market data or substantially the full term of the assets or liabilities. |
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Level 3 – | Unobservable inputs that are supported by little or no market activity and that are significant to the value of the assets or liabilities. |
DEBT DISCOUNT
The Company follows the authoritative guidance for accounting for debt discount and valuation of detachable warrants the Company recognized the value of detachable warrants issued in conjunction with issuance of the secured convertible Debenture notes. The Company valued the warrants using the Black-Scholes pricing model. The Company recorded the warrant relative fair value as an increase to additional paid-in capital and discount against the related debt. The discount attributed to the value of the warrants is amortized over the term of the underlying debt using the effective interest method.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In December 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-29, “Business Combinations (ASC Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations.” The amendments in this ASU affect any public entity as defined by ASC Topic 805 that enters into business combinations that are material on an individual or aggregate basis. The amendments in this ASU specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The Company does not expect adoption of ASU 2010-29 to have a material impact on the Company’s results of operations or financial condition.
30
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS (continued)
In December 2010, the FASB issued ASU 2010-28, “Intangibles - Goodwill and Other (ASC Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance and examples, which require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The Company does not expect the adoption of ASU 2010-28 to have a material impact on the Company’s results of operations or financial condition.
In April 2010, the FASB issued ASU 2010-17,Revenue Recognition — Milestone Method(“ASU 2010-17”). ASU 2010-17 provides guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. A vendor can recognize consideration that is contingent upon achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. The following criteria must be met for a milestone to be considered substantive. The consideration earned by achieving the milestone should (i) be commensurate with either the level of effort required to achieve the milestone or the enhancement of the value of the item delivered as a result of a specific outcome resulting from the vendor’s performance to achieve the milestone; (ii) be related solely to past performance; and (iii) be reasonable relative to all deliverables and payment terms in the arrangement. No bifurcation of an individual milestone is allowed and there can be more than one milestone in an arrangement. Accordingly, an arrangement may contain both substantive and non-substantive milestones. ASU 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Management evaluated the potential impact of ASU 2010-17 and does not expect its adoption to have a material effect on the Company’s results of operations or financial condition.
In January 2010, the FASB issued ASU 2010-06,Improving Disclosures about FairValue Measurements. ASU 2010-06 amends ASC 820 to require a number of additional disclosures regarding fair value measurements. The amended guidance requires entities to disclose the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers, the reasons for any transfers in or out of Level 3, and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. The ASU also clarifies the requirements for entities to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. The amended guidance is effective for interim and annual financial periods beginning after December 15, 2009. The adoption of ASU 2010-06 did not have a significant effect on the Company’s financial statements.
In October 2009, the FASB issued guidance on multiple deliverable revenue arrangements which eliminates the residual method of allocation and requires the relative selling price method when allocating deliverables of a multiple-deliverable revenue arrangement. The determination of the selling price for each deliverable requires the use of a hierarchy designed to maximize the use of available objective evidence including, vendor specific objective evidence, third party evidence of selling price, or estimated selling price. This guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and must be adopted in the same period using the same transition method. If adoption is elected in a period other than the beginning of a fiscal year, the amendments in these standards must be applied retrospectively to the beginning of the fiscal year. Full retrospective application of these amendments to prior fiscal years is optional. Early adoption of these standards may be elected. The adoption of this guidance did not have a significant impact on the Company’s consolidated financial statements.
Management does not believe that any other recently issued, but not currently effective, accounting standards if currently adopted would have a material effect on the accompanying consolidated financial statements.
31
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
FORWARD LOOKING STATEMENTS
This document and the documents incorporated in this document by reference contain forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact contained in this document and the materials accompanying this document are forward-looking statements.
The forward-looking statements are based on the beliefs of our management, as well as assumptions made by information currently available to our management. Frequently, but not always, forward-looking statements are indentified by the future tense and by words such as “believes’, “expects”, “anticipates”, “intends”, “will”, “may”, “could”, “would”, “projects”, “continues”, “estimates”, or similar expressions. Forward-looking statements are not guarantees of future performance and actual results could differ materially from those indicated by the forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements.
Forward-looking statements are expressly qualified in their entirely by this cautionary statement. The forward-looking statements included in this document are made as of the date of this document and, except as may required under applicable securities laws, we do not undertake any obligation to update forward-looking statements to reflect new information, subsequent events or otherwise.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
N/A
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our principal executive officer (chief executive officer) and principal financial officer (chief financial officer), conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on this evaluation, and due to the material weaknesses in our internal control over financial reporting (as described in the“Material Weakness in Internal Control over Financial Reporting” below), our chief executive officer and chief financial officer concluded our disclosure controls and procedures were not effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
Material Weaknesses in Internal Control over Financial Reporting
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected in a timely basis.
32
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
ITEM 4. CONTROLS AND PROCEDURES (continued)
Material Weaknesses in Internal Control over Financial Reporting (continued)
Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as April 30, 2011, because of the material weaknesses in internal control over financial reporting as discussed below:
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• | The Company lacks sufficient personnel with an appropriate level of experience and knowledge of generally accepted accounting principles and SEC reporting rules and requirements. |
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• | The Company lacks adequate accounting resources to address non routine and complex transactions and financial reporting matters on a timely basis. Consequently various accounts were materially misstated in the previously issued financial statements which has caused a restatement of previously reported amounts. |
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• | The Company lacks adequate segregation of duties control concerning Information Technology (“IT”). IT personnel perform accounting transactions, programming function and controls security function with the Company for IT. |
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• | The Company lacks appropriate environmental controls needed to ensure the security and reliability of IT equipment. |
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• | The Company lacks adequate journal entry approval and disclosure controls needed to identify and prevent misstatements in the consolidated financial statements and accompanying footnotes. |
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• | The Company’s control environment does not have adequate segregation of duties; the Company only had one person performing all accounting-related functions on-site duties. |
Remediation of Material Weaknesses in Internal Control over Financial Reporting
The Company has commenced efforts to address the material weaknesses in its internal control over financial reporting and its control environment through the following actions:
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| · | Supplementing existing resources with technically qualified third party consultants. |
| · | Institute a more stringent approval process for financial transactions |
| · | Perform additional procedures and analysis for significant transactions as a mitigating control in the control environment due to segregation of duties issues. |
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings – None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds: During the quarter ended April 30, 2011, Note Holders exercised conversion rights to convert $291,809 of principal and $35,769 of interest to 1,108,960 unregistered shares of common stock. In connection with the foregoing, the Company relied upon the exemption from securities registration afforded by Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”). No advertising or general solicitation was employed in offering the securities. The offerings and sales were made to a limited number of persons, all of whom were accredited investors, and transfer was restricted by the Company in accordance with the requirements of the Securities Act.
Item 3. Defaults upon Senior Securities – Defaults upon Senior Securities – On June 23, 2010, the Company received a NASDAQ Staff Deficiency Letter stating that the Company no longer complied with the NASDAQ Listing Rules (the “Listing Rules”) for continued listing on The NASDAQ Stock Market (“NASDAQ”) because the Company had not maintained a minimum of $2,500,000 in stockholders’ equity as required by Listing Rule 5550(b)(1), and because the Company’s Form 10-Q for the period ended April 30, 2010, had not yet been reviewed in accordance with Statement of Auditing Standards No. 100, as required by Rule 8-03 of Regulation S-X, pursuant to Listing Rule 5250(c)(1). Thereafter, on June 23, 2010, the Company received a NASDAQ Staff Determination Letter indicating that the Staff had concluded that the Company had not solicited proxies or held its annual meeting within the timeframe required by Listing Rules 5620(a) and 5620(b) and accordingly, determined to initiate procedures to delist the Company’s securities from NASDAQ. Finally, on August 13, 2010, the Company received a NASDAQ Staff Deficiency Letter stating that, as the bid price of the Company’s common stock had closed below the minimum $1.00 per share requirement set forth in by NASDAQ Listing Rule 5550(a)(2), and in accordance with Listing Rule 5810(c)(3)(A), the Company had been provided 180 calendar days, or until February 9, 2011, to regain compliance with that requirement.
On September 16, 2010, the Company attended a hearing before the NASDAQ Listing Qualifications Panel (the “Panel”) to present its plan to evidence compliance with all applicable Listing Rules and to request an extension of time within which to do so. By decisions dated October 19, 2010, November 3, 2010, November 23, 2010 and December 13, 2010, the Panel determined to continue the Company’s listing on NASDAQ, subject to certain conditions.
In particular, the December 13, 2010 Panel decision required that:
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| 1. On or before January 14, 2011, the Company shall inform the Panel that it has held its annual shareholders’ meeting, and, |
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| 2. On or before January 31, 2011, the Company shall disclose on Form 8-K that it has regained compliance with the NASDAQ stockholders’ equity requirement of $2.5 million. The Company shall also, by this date, provide information to the Panel sufficient to demonstrate to the Panel’s satisfaction that the Company can maintain compliance with the equity requirement throughout the coming year. |
The December 13, 2010, determination follows the Panel’s initial decision, dated October 19, 2010, the terms of which were reported on a Form 8-K filed with the Securities and Exchange Commission (“SEC”) on October 22, 2010, as modified by the Panel’s determination, dated November 3, 2010, granting an extension to the Company the terms of which were reported on a Form 8-K filed with the SEC on November 3, 2010, as modified by the Panel’s determination on November 23, 2010, granting an extension to the Company the terms of which were reported on a Form 8-K filed on November 24, 2010.
In accordance with Listing Rule 5800, the Company requested a hearing before the NASDAQ Listing Qualifications Panel, which ultimately granted the Company an extension through January 31, 2011, to evidence compliance with the Rule. The Company did not timely regain compliance with the Rule, however. Accordingly, on January 31, 2011, NASDAQ notified the Company that its common stock will be delisted from The NASDAQ Capital Market and that trading of its common stock will be suspended, effective with the open of business on February 2, 2011.
As a result of the NASDAQ Staff Determination Letter, an event of default under the February 2010 Debenture occurred. The note holders did not exercise their rights upon an event of default and on November 27, 2010 the Company received a waiver from the note holders. Pursuant to the waiver, the note holders waived any event of default (as defined in the Notes pursuant to Article IV Section 4.8, “Events of Default”) including any increase in the interest rate of the Notes which may have occurred and which may occur from the date of the inception of the agreement until July 31, 2011, as a result of notification from the NASDAQ that the Company is not in compliance with the conditions for such continued listing. The note holders did not exercise their right upon an event of default and December 2010, the Company received a waiver from note holders.
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Item 4. Removed and Reserved
Item 5. Other Information – None
Item 6. Exhibits
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Exhibit Number | | Description | |
| | | | |
31.1 | | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act. |
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32 | | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto and duly authorized.
CONOLOG CORPORATION
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Date: June 17, 2011 | By /s/ Robert S. Benou | |
| | |
| Robert S. Benou |
| Chief Executive Officer, |
| (Principal Executive Officer) |
| Chief Financial Officer |
| (Principal Financial Officer) |
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