The majority of the Company’s sales revenue has been generated from sales of the PDR-2000 Teleprotection products. Our total sales revenue increased approximately $513,000 or 43.5% for the fiscal year ended July 31, 2011 to $1,692,000, compared to total revenues of approximately $1,179,000 for the fiscal year ended July 31, 2010. Our PDR-2000 sales increased approximately $725,500 or 97% over the prior year. The increase in our PDR-2000 sales revenues was partially offset by sales declines in all of our other lines of products. PTR-1500 decrease approximately $19,700 or 36% as customers are switching from old analog technology to digital technology, telemetry sales decline of approximately $90,350 or 50% due natural rhythm of our markets, we expect this category to further decline in the coming years, military sales decreased approximately $93,300 due to a military supply contract being completed in the beginning of 2011 and cut backs in the governments military spending for 2011. Spare parts and other sales make up the remaining decrease of approximately $11,000 as compared to the prior year.
Total product cost of goods sold for the fiscal year ended July 31, 2011 amounted to approximately $1,175,000 compared to approximately $694,600 for the fiscal year ended July 31, 2010, an increase of approximately $480,400 or 69.%. The increase in cost of goods sold is a result of the following: (a) sales volume increased 44% versus the prior year resulting in an expected volume increase in cost of goods of approximately $269,400; (b) costs used in material and labor increased slightly but with the additional sales volume material and labor associated manufacturing increased approximately $236,000; (c) inventory obsolescence expense for the year ended July 31, 2011 was $50,000 compared to approximately $75,500 for fiscal year 2010, a decline of approximately $26,000. This decline in the obsolescence expense can be attributed to significant write-down of inventory taken in 2010 due to significant quantities of inventory that were purchased in prior years and now qualified per the Company’s inventory policy to be written-off in 2010.
The decline in our gross profit percentage of 30.6% for the fiscal year ended July 31, 2011, from 41.1% for the fiscal year 2010 can be attributed to mainly lower sales margins achieved in fiscal year 2011 versus the prior year for our largest selling item the PDR-2000, the lower sales margin for the PDR-2000 was mainly due to one order shipped in the second quarter 2011 which had 8% margin versus our normal margin of approximately 40% to 42% due to securing a contract in a competitive bid. Material costs and direct labor costs associated with manufacturing increased slightly but the majority of the decline in the gross profit in 2011 was due to sales pricing.
Operating Expenses:
General and Administrative: For the fiscal year ended July 31, 2011, general and administrative expenses decreased approximately $1,074,000 to $2,685,000 from approximately $3,759,000. This decrease of approximately 28.6% can mostly be attributed to a reduction in Employee Stock Compensation Expense of approximately $1,448,000, which was offset by (a) an increase of approximately $211,000 in Professional Fees due to the restatement of financial data for the fiscal years ended July 31, 2009 and July 31, 2010 and, (b) all other costs associated with non-overhead manufacturing, such as rent, utilities, and telephone increased approximately $162,000.
Research and Development: For the fiscal year ended July 31, 2011 research and development costs were approximately $68,000, a decrease of approximately $72,000 as compared to the prior year total of approximately $140,000. Our research and development costs can mainly be attributed to enhancing the PDR-2000 and GlowWorm products.
Selling Expenses: For the fiscal year ended July 31, 2011 selling expenses were approximately $266,000, an increase of approximately $149,000 versus the prior year total of approximately $117,000, mainly due to the increase in Commission Expense related to increased sales.
Total Other Income and Expenses:
For the fiscal year ended July 31, 2011, other income/expense was expense of approximately $1,817,000, a decrease of approximately $19,698,000 as compared to the fiscal year ended July 31, 2010. This large decrease in other expense is primarily a result of recording a derivative liability associated with a subscription agreement entered into in fiscal year 2010. The subscription agreement entered into on August 3, 2009, had a conversion feature embedded in the Company’s convertible debt and certain warrants that required the recording of a loss on derivative financial instruments in the amount of approximately $18,959,000 in fiscal year 2010.
Income Tax Benefit:
In 1998, the State of New Jersey enacted legislation allowing emerging technology and/or biotechnology companies to sell their unused New Jersey Net Operating Loss (“NOL”) Carryover and Research and Development Tax Credits (“R&D” Credits) to corporate taxpayers in New Jersey. During fiscal years ended July 31, 2010 and 2009, the Company entered into agreements to sell up to $5,594,000 and $4,757,000 of its unused tax losses. The Company received net proceeds of $284,703 and $376,819 during the fiscal years ended July 31, 2010 and 2009 respectively, related to the sale and accordingly recorded them as a tax benefit in the year received. The net tax benefit recorded in the Statement of Operations for 2010 of $137,131 consists of the proceeds received from the sale of the Company’s NJ NOL’s offset by the unrecorded tax provision due to uncertain tax positions of $135,000. In the fiscal year ended July 31, 2011, the Company did not receive any proceeds from the sale of its NOL’s.
Net Loss:
The Company recorded a net loss of approximately $4,323,000 for the fiscal year ended July 31, 2011, as compared to a net loss of approximately $24,911,000 for fiscal year ended July 31, 2010. The decrease in net loss of approximately $20,588,000 can mainly be attributed to noncash transactions related to the subscription agreement entered into in August 2009, which resulted in a loss on derivative financial instrument of approximately $18,959,000. For the fiscal year ended July 31, 2011 gross profit increased approximately $33,000, general and administrative costs were approximately $1,074,000 lower than the prior fiscal year, research and development was also down versus the prior period in the approximate amount of $72,000 but selling expense was approximately $149,000 higher. As a result of the foregoing, the Company reported a net loss applicable to common shares of ($0.43) basic and diluted loss per share compared to ($5.36) basic and diluted loss per share for the fiscal year ended July 31, 2010.
Status of Certain Press Releases Issued:
On January 11, 2011, at the Annual Meeting of Shareholders of the Company, the Company’s shareholders approved the election of Robert S. Benou, Marc R. Benou, Louis S. Massad, Edward J. Rielly and David M. Peison as directors to the Company’s board of directors.
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On February 1, 2011, the Company issued a press release announcing that it had been delisted from the NASDAQ system and its securities would be traded in the OTC market going forward.
On February 28, 2011, the Company issued a press release announcing that it had received advanced orders in January for its PDR Systems valued at over $302,000. Units valued at $290,000 were shipped throughout February and March of 2011.
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.
The report of Withum on our financial statements for each of the past two fiscal years contained no adverse opinion or a disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles, except that, the report expressed substantial doubt about the Company’s ability to continue as a going concern. During our two most recent fiscal years and through the date of dismissal, the Company had no disagreements with Withum on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Withum, would have caused it to make reference to the subject matter of such disagreements in its report on our financial statements for such periods.
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.
On April 28, 2011, the Company issued a press release announcing that it had received advanced orders in February and March for its PDR Systems valued at over $135,000. Units valued at $119,500 were shipped throughout March and April of 2011.
LIQUIDITY AND CAPITAL RESOURCES
We have had recurring losses from operations and used cash from operation in the amount of approximately $1,056,000 and $1,637,000 for the years ended July 31, 2011 and 2010, respectively. At July 31, 2011, the Company had cash and equivalents of $7,907. 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 July 31, 2011, the Company had total current assets of approximately $900,000 and total current liabilities of approximately $1,666,000, resulting in working capital deficit of approximately $766,000 compared to working capital of approximately $1,508,000 at year ended July 31, 2010. The Company’s current assets consists of $7,907 in cash and cash equivalent, approximately $476,000 in accounts receivable, $389,000 in inventory and approximately $26,000 in prepaid expenses and other current assets. Accounts receivable increased from approximately $68,000 at July 31, 2010 to approximately $476,000 at July 31, 2011, resulting from a sales increase of approximately $513,000 for the fiscal year ended July 31, 2011 and the timing of collections.
The Company entered into subscription agreements, as amended, with 14 accredited investors for the issuance and sale of an aggregate of 5,114,072 shares in the Company’s common stock, par value $.01 per share for an aggregate purchase price of $0.10 per share. On October 6, 2011, the Company received proceeds of $511,407 from the subscribers in connection with the Private Placement. The Company intends to use the proceeds of the placement for general corporate purposes, including general and administrative expenses.
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, 2011, we have raised $100,000 from the sale of common stock and $316,350 from loans made to the company by Robert Benou. Mr. Benou has received repayments totaling $60,000 during the fiscal year ended July 31, 2011. 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
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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 approximately $1,056,000 for the fiscal year ended July 31, 2011, as compared to approximately $1,637,000 net cash used in operating activities for the fiscal year ended July 31, 2010, a decrease of approximately $581,000. This decrease in use of cash can be attributed to: (a) cash generated from operational activity decreased approximately $786,000 from the prior year, (b) accounts receivable increased due to the timing of collections, creating a use of cash of approximately $620,000, (c) offsetting these increase in use of cash was reduction of inventory which generated approximately $776,000 in cash, (d) increase in accounts payable and accrued expenses over the prior year resulted in an increase of cash of approximately $1,013,000, and (e) prepaid expense also decrease generating approximately $260,000 in cash.
INVESTING ACTIVITIES
Net cash used in investing activities for the fiscal year ended July 31, 2011 was approximately $5,900 for the purchase of manufacturing equipment. For the fiscal year ended July 31, 2010 net cash used investing activities was approximately $23,000 also for the purchase of equipment.
FINANCING ACTIVITIES
Net cash provided from financing activities was approximately $356,000 for the fiscal year ended July 31, 2011, as compared to approximately $2,345,000 provided in the same twelve month period in 2010. In the fiscal year ended July 31, 2011 the Company received proceeds of $100,000 from sale of common stock and $316,350 from loans from a Company officer. Repayments of $60,000 were made against the loans during the fiscal year ended July 31, 2011. For the twelve months ended July 31, 2010, the Company received $2,000,000 related to the 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.
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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.
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 consolidated 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.
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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, an aggregate $1,000,000 of the February 2010 Debentures and $63,790 of accrued interest were converted in shares of common stock. The Company recognized an induced conversion cost of $649,147 related to these conversions
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 fiscal year ended July 31, 2011, $1,000,000 of convertible debt and $63,790 of accrued interest was converted into 3,562,999 shares of common stock.
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 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,
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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.
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 provided 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. A valuation allowance is recorded when the expected recognition of a deferred tax asset is considered to be unlikely. The guidance also requires that the Company determine whether it is more likely than not that a tax position will not be sustained upon examination by the appropriate taxing authority. If a tax position does not meet the more likely than not recognition criterion, the guidance requires that the tax position be measured at the largest amount of benefit greater than 50 percent not likely of being sustained upon ultimate settlement. Based on the Company’s evaluation, management has concluded that there are significant uncertain tax positions requiring recognition in the consolidated financial statements with respect to the sale of the Company’s New Jersey Net Operating Loss Carryovers. In the event the
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Company receives an assessment for interest and/or penalties by major tax jurisdiction it would be classified in the financial statements as general and administrative expense. See note 6, Income Taxes.
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.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and 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.
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RECENT ACCOUNTING PRONOUNCEMENTS
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, which updated the guidance in ASC Topic 820,Fair Value Measurement.The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and International Financial Reporting Standards. The amendments in this ASU are to be applied prospectively. For public entities, the amendments are effective for interim and annual periods beginning after December 15, 2011, and early application is not permitted. ASU 2011-04 is not expected to have a material impact on the Company’s financial position or results of operations
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.
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.
21
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We do not hold any derivative instruments and do not engage in any hedging activities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements of Conolog Corporation, together with notes and the Independent Registered Public Accountants’ Reports, begin on page F-1, immediately after the signature page.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
On July 23, 2010 the Company engaged Withum Smith+Brown, PC (“Withum”) to serve as the Company’s independent registered public accounting firm. On March 3, 2011, Conolog Corporation (the “Company”), dismissed Withum Smith+Brown, PC (“Withum”), and engaged Wolinetz, Lafazan & Company, 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.
The report of Withum on our financial statements for each of the past two fiscal years contained no adverse opinion or a disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles, except that, the report expressed substantial doubt about the Company’s ability to continue as a going concern.
During our two most recent fiscal years and through the date of dismissal, the Company had no disagreements with Withum on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Withum, would have caused it to make reference to the subject matter of such disagreements in its report on our financial statements for such periods.
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.
ITEM 9A CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
In connection with the preparation of the Company’s Annual Report on Form 10-K, an evaluation was carried out by our management, with participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”) as of the end of the period covered by this report. Disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed and submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified, and that such information is accumulated and communicated to management, included the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
During evaluation of disclosure controls and procedures as of the end of the period covered by this report, conducted as part of the Company’s annual audit and preparation of our annual financial statements, several material weaknesses were identified. As a result of the material weaknesses, described more fully below, our Chief Executive Officer and Chief Financial Officer concluded that, as of July 31, 2011, the Company’s disclosure controls and procedures were ineffective.
The Company instituted and is continuing to implement corrective actions with respect to the deficiencies in our disclosure controls and procedures.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) under the Exchange Act. The Company’s internal control over financial reporting is a
22
process designed to provide reasonable assurance regarding the reliability of the Company’s financial reporting and the preparation of consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness in future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has conducted, with the participation of the Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness of the Company’s internal control over financial reporting as of the end of the period covered by this report. Management’s assessment of internal control over financial reporting was conducted using the criteria set forth in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
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 on a timely basis. Based on management’s assessment of internal control over financial reporting, management believes as of July 31, 2011, the Company’s internal control over financial reporting was not effective due to the following material weaknesses:
| | |
| • | The Company lacks sufficient personnel with an appropriate level of experience and knowledge of generally accepted accounting principles and SEC reporting requirements. |
| • | 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 have caused a restatement of previously reported amounts. |
| • | 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. |
| • | The Company lacks appropriate environmental controls needed to ensure the security and reliability of IT equipment. |
| • | The Company lacks adequate journal entry approval and disclosure controls needed to identify and prevent misstatements in the consolidated financial statements and accompanying footnotes. |
| • | The Company’s control environment does not have adequate segregation of duties; the Company only had one person performing all accounting-related 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:
| | |
| • | 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. |
The Company believes that the consolidated financial statements fairly present, in all material respects, the Company’s consolidated balance sheets as of July 31, 2011 and 2010 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years ended July 31, 2011 and 2010, in conformity with generally accepted accounting principles, notwithstanding the material weaknesses we identified.
Changes in Internal Control over Financial Reporting
Other than described above, there have been no changes in the Company’s internal control over financial reporting during the most recently completed fiscal year ended July 31, 2011, that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
23
Inherent Limitations on Effectiveness of Controls
Our Management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect that there are resources constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.
ITEM 9B - OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The following table and biographical summaries set forth information, including principal occupation and business experience, about our directors and executive officers at [October 26, 2011]:
| | | | | | | | |
NAME | | | AGE | | POSITION | | | OFFICER AND/OR DIRECTOR SINCE |
| | |
| |
| | |
|
|
Robert S. Benou | | 76 | | Chairman, CEO, CFO, Director | | February 1968 |
Marc R. Benou | | 42 | | President | | March 1995 |
Louis S. Massas | | 74 | | Director | | April 1995 |
Edward J. Reilly | | 42 | | Director | | January 1998 |
David M. Peison | | 42 | | Director | | October 2004 |
Michael Horn | | 58 | | Director | | August 2011 |
Robert S. Benou
Robert S. Benou has been the Company’s Chairman and Chief Executive Officer since May 1, 2001. He is also the Company’s Chief Financial Officer. From 1968 until May 1, 2001, he served as the Company’s President. Mr. Benou is responsible for material purchasing and inventory control. From June 2001 until August 2005, Mr. Benou served as a director of Henry Bros. Electronics, Inc. (formerly known as Diversified Security Solutions, Inc.), a publicly held company that is a single-source/turnkey provider of technology-based security solutions for medium and large companies and government agencies. Mr. Benou is also served as a member of the Board of Directors of eXegenics Inc. from February 2004 to December 2006. The common stock of eXegenics Inc. is traded on the OTC Bulletin Board. Mr. Benou is a graduate of Victoria College and holds a BS degree from Kingston College, England and a BSEE from Newark College of Engineering, in addition to industrial management courses at Newark College of Engineering. Robert S. Benou is the father of Marc R. Benou. Mr. Benou’s experience as the Company’s chief executive officer led to the conclusion that Mr. Benou should serve on the Board of Directors, given the Company’s business and structure.
Marc R. Benou
Marc R. Benou has been the Company’s President and Chief Operating Officer since May 1, 2001. Mr. Benou joined the Company in 1991 and is responsible for new product development and supervision of sales and marketing. From March 1995 until May 1, 2001, he served as Vice President. Mr. Benou has been on the Company’s Board and has served as the Company’s assistant secretary since March 1995. Mr. Benou attended
24
Lehigh and High Point University and holds a BS degree in Business Administration and Management. Marc R. Benou is the son of Robert S. Benou, the Company’s Chairman and Chief Executive Officer. Mr. Benou’s experience as the Company’s president and chief operating officer led to the conclusion that Mr. Benou should serve on the Board of Directors, given the Company’s business and structure.
Louis S. Massad
Louis S. Massad has been a Director of the Company since April 1995. Mr. Massad was Chief Financial Officer and a Director of Henry Bros. Electronics, Inc. (formerly known as Diversified Security Solutions, Inc.), from 2000 until August 2003. From 1997 to 2000, Mr. Massad was a consultant to Diversified Security Solutions, Inc. From 1986 to 1997, Mr. Massad was a Vice President, Chief Financial Officer and Director of Computer Power Inc. Mr. Massad holds a BS and MS degree from Cairo University (Egypt) and an MBA from Long Island University, New York. Mr. Massad’s business management and financial experience and knowledge led to the conclusion that Mr. Massad should serve on the Board of Directors, given the Company’s business and structure.
Edward J. Rielly
Edward J. Rielly has been a Director of the Company since January 1998. Mr. Rielly is a Senior Application Developer with Household International, a financial corporation. From March 2000 to November 2001, Mr. Rielly was a Senior Consultant with Esavio Corporation. From February 1998 to February 2000, Mr. Rielly was an Application Developer with Chubb Corporation. From 1993 to 1998, Mr. Rielly was an Application Developer with the United States Golf Association. Mr. Rielly is a graduate of Lehigh University and holds a BS in Computer Science. Mr. Rielly’s technical experience and knowledge led to the conclusion that Mr. Rielly should serve on the Board of Directors, given the Company’s business and structure.
David M. Peison
David M. Peison has been a Director of the Company since October 2004. Since 2005, Mr. Peison has been vice president with the emerging markets division of HSBC. From 2002 until 2005, Mr. Peison was with Deutsche Bank’s global markets division in New York City. From 1992 to 2000, Mr. Peison was in a Private Law Practice in Florida and New York City. Mr. Peison holds an MBA from Emory University in Atlanta, Ga., a JD from The Dickinson School of Law of Pennsylvania State University and is admitted to Florida, New York and Massachusetts Bars. Mr. Peison obtained his BA degree from Lehigh University in Bethlehem, Pa. Mr. Peison’s business management and financial experience and knowledge led to the conclusion that Mr. Peison should serve on the Board of Directors, given the Company’s business and structure
Michael Horn,
Michael Horn has been a Director of the Company since August 2011. Mr. Horn has over 30 years of experience in Information Technology senior management. Mr. Horn has served as the Managing and Operating Partner of VAR Direction LLC, Inc., a management and financial consulting firm, from 2002 through the present. Mr. Horn served as Chief Executive Officer of AccountMate Software, Division of Softline, N.A., a publisher of accounting software, from 2001 to 2002. From 1980 through 2001, Mr. Horn was the Chief Executive Officer of MIBAR Computer Services, a value added reseller and developer of software.
Board of Directors
Directors hold office until the annual meeting of the Company’s stockholders and the election and qualification of their successors. Officers hold office, subject to removal at any time by the Board, until the meeting of directors immediately following the annual meeting of stockholders and until their successors are appointed and qualified.
Board Leadership Structure and Role in Risk Oversight
25
Although we have not adopted a formal policy on whether the Chairman and Chief Executive Officer positions should be separate or combined, we have traditionally determined that it is in the best interests of the Company and its shareholders to combine these roles. Mr. Robert Benou has served as our Chairman since May 2001. Due to the small size of the Company, we believe it is currently most effective to have the Chairman and Chief Executive Officer positions combined.
Family Relationships
Our Chief Executive Officer, Robert S. Benou is the father of our President, Marc R. Benou. There are no other family relationships among our directors, executive officers, or persons nominated or chosen by the Company to become directors or executive officers.
Audit Committee
The Company’s Board of Directors has determined that David M. Peison is the Audit Committee’s Financial Expert and that he is “independent” as defined under National Association of Securities Dealers Automated Quotations system.
The Company has a standing Audit Committee, the members of which are, Louis Massad, Edward J. Rielly and David M. Peison.
Changes in Nominating Procedures
None.
Section 16(a) Compliance
Section 16(a) of the Exchange Act requires the Company’s directors, executive officers and persons who beneficially own 10% or more of a class of securities registered under Section 12 of the Exchange Act to file reports of beneficial ownership and changes in beneficial ownership with the SEC. Directors, executive officers and greater than 10% stockholders are required by the rules and regulations of the SEC to furnish the Company with copies of all reports filed by them in compliance with Section 16(a).
Based solely on our review of certain reports filed with the Securities and Exchange Commission pursuant to Section 16(a) of the Securities Exchange Act of 1934, as amended, the reports required to be filed with respect to transactions in our common stock during the fiscal year ended July 31, 2011, were timely.
Code of Ethics
The Corporation has adopted a Code of Ethics. This Code is publicly available on the Company’s internet website www.conolog.com.
ITEM 11- EXECUTIVE COMPENSATION
The following table sets forth the total compensation paid to and accrued by each executive officer during the prior three fiscal years.
26
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Long Term Compensation | |
| | Annual Compensation | | Awards | | Payouts | |
Name and Principal
Position | | Year | | Salary | | Bonus | | Other Annual
Comp. | | Restricted
Stock
Awards | | Securities
Underlying
Options /SARs | | LTIP Payouts | | Other | |
Robert Benou | | 2011 | | $ | 439,167 | | $ | — | | $ | — | | | — | | $ | — | | $ | — | | $ | 12,000 | * |
Chief Executive Officer | | | | | | | | | | | | | | | | | | | | | | | | |
Chief Financial Officer, Director | | 2010 | | $ | 259,749 | | $ | — | | $ | — | | | 403,200 | | $ | — | | $ | — | | $ | 28,000 | * |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | 2009 | | $ | 110,833 | | $ | — | | $ | — | | | — | | $ | — | | $ | — | | $ | 16,000 | * |
| | | | | | | | | | | | | | �� | | | | | | | | | | |
Mark Benou | | 2011 | | $ | 252,200 | | $ | — | | $ | — | | | — | | $ | — | | $ | — | | $ | — | |
President, COO, Secretary, | | | | | | | | | | | | | | | | | | | | | | | | |
Director | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2010 | | $ | 238,200 | | $ | — | | $ | — | | | 403,200 | | $ | — | | $ | — | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | 2009 | | $ | 208,516 | | $ | — | | $ | — | | | — | | $ | — | | $ | — | | $ | — | |
| | | | | | | | | | | | | | | | | | | |
Name | | Option Awards | | Stock Awards | |
| |
| |
| |
| | Number of
Securities
Underlying
Unexercised
Options (#)
Exercisable | | Number of
Securities
Underlying
Unexercised
Options (#)
Unexercisable | | Equity
Incentive
Plan Awards:
Number of
Securities
Underlying of
Unexercised
Unearned
Options (#) | | Option
Exercise
Price ($) | | Option
Expiration
Date | | Number of
Shares or
Units of
Stock That
Have Not
Vested (#) | | Market
Value of
Shares or
Units of
Stock That
Have Not
Vested ($) | | Equity
Incentive
Plan Awards:
Number of
Unearned
Shares,
Units or
Other Rights
That Have
Not Vested
(#) | | Equity
Incentive
Plan Awards:
Market or
Payout
Value of
Unearned
Shares,
Units or
Other Rights
That Have
Not Vested ($) | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
|
Robert Benou | | 0 | | 0 | | 0 | | 0 | | 0 | | 0 | | 0 | | 0 | | 0 | |
| | | | | | | | | | | | | | | | | | | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | | | | | | | | | |
Marc Benou | | 0 | | 0 | | 0 | | 0 | | 0 | | 0 | | 0 | | 0 | | 0 | |
EMPLOYMENT AGREEMENTS
Mr. Robert Benou is serving under an employment agreement commencing June 1, 1997 and ending May 31, 2002, which pursuant to its terms, renews for one-year terms until cancelled by either the Company or Mr. Benou. Mr. Benou’s annual base salary as of July 31, 2011 was $450,000 ((a) actual 2011 salary drawn was $0, (b) $105,000 has been forgiven by Mr. Benou and he does not hold the Company liable for this amount, (c) $334,167 has been accrued for potential payment in the future). Mr. Benou’s annual base salary increases by $20,000 annually on January 1 st of each year. In addition, Mr. Benou is entitled to an annual bonus equal to 6% of the Company’s annual “income before income tax provision” as stated in its annual Form 10-K. The employment agreement also entitles Mr. Benou to the use of an automobile and to employee benefit plans, such as; life, health, pension, profit sharing and other plans. Under the employment agreement, employment terminates upon death or disability of the employee and the employee may be terminated by the Company for cause.
Mr. Marc Benou is serving under an employment agreement commencing June 1, 1997 and ending May 31, 2002,
27
which pursuant to its terms, renews for one-year terms until cancelled by either the Company or Mr. Benou. Mr. Benou’s annual base salary as of July 31, 2011 was $260,200 ((a) actual 2011 salary drawn was $63,842, (b) $19,208 has been forgiven by Mr. Benou and he does not hold the Company liable for this amount, (c) $169,150 has been accrued for potential payment in the future). He receives annual increases of $6,000 on January 1 st of each year. Mr. Benou is entitled to an annual bonus equal to 3% of the Company’s annual “income before income tax provision” as stated in its annual Form 10-K. The employment agreement also entitles Mr. Benou to the use of an automobile and to employee benefit plans, such as; life, health, pension, profit sharing and other plans. Under the employment agreement, employment is terminated upon death or disability of the employee and employee may be terminated by the Company for cause.
COMPENSATION OF DIRECTORS
No director of the Company receives any cash compensation for their services as such, but directors may receive stock options pursuant to the Company’s stock option plan and grants of the Company’s common stock. Currently, the Company has three directors who are not employees, Messrs. Louis Massad, David Peison and Edward Rielly. No cash or stock compensation has been granted to any director during the year ended July 31, 2011.
RISK MANAGEMENT
The Company does not believe risks arising from its compensation policies and practices for its employees are reasonably likely to have a material adverse effect on the Company.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of July 31, 2011, certain information with respect to the beneficial ownership of our common stock by each stockholder known by us to be the beneficial owner of more than 5% of our common stock and by each of our current directors and executive officers. Each person has sole voting and investment power with respect to the shares of common stock, except as otherwise indicated.
This table is prepared based on information supplied to us by the listed security holders, any Schedules 13D or 13G and Forms 3 and 4, and other public documents filed with the SEC.
Under the rules of the Securities and Exchange Commission, a person is deemed to be a beneficial owner of a security if that person has or shares voting power, which includes the power to vote or direct the voting of the security, or investment power. The person is also deemed to be a beneficial owner of any security of which that person has a right to acquire beneficial ownership within 60 days. Under the Securities and Exchange Commission rules, more than one person may be deemed to be a beneficial owner of the same securities, and a person may be deemed to be a beneficial owner of securities as to which he or she may not have any pecuniary beneficial interest.
Shares of common stock which an individual or group has a right to acquire within 60 days pursuant to the exercise or conversion of options are deemed to be outstanding for the purpose of computing the percentage ownership of such individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table. The applicable percentage of ownership at July 31, 2011 is based on 12, 455,380 shares issued and outstanding.
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| | | | | | | | | |
Name and Address (1) | | Beneficial
Relationship to
Company | | Outstanding
Common Stock | | Percentage of
OwnershipCommon Stock | |
| |
| |
| |
| |
| | | | | | | | | |
Robert S Benou, | | CEO, Chairman,
Chief Financial,
Officer, Director | | 720,027 | | | 5.78 | % | |
| | | | | | | | | |
Marc R. Benou | | President, Chief
Operating Officer,
Secretary and
Director | | 471,250 | | | 3.78 | % | |
| | | | | | | | | |
Louis Massasd | | Director | | 37,500 | | | 0.30 | % | |
| | | | | | | | | |
Edward J. Reilly | | Director | | — | | | — | | |
| | | | | | | | | |
David M. Peison | | Director | | 64,250 | | | 0.52 | % | |
| | | | | | | | | |
Michael Horn | | Director | | — | | | — | | |
| | | | | | | | | |
Officers and Directors Total | | 6 | | 1,293,027 | | | 10.38 | % | |
| | |
| (1) | Unless otherwise indicated, the address of each beneficial owner listed above is C/O Conolog Corporation 5 Columbia Road, Somerville, NJ 08876. |
Preferred Stock
| | | | | | | |
Name | | Beneficial
Relationship to
Company | | Outstanding
Preferred Stock | | Percentage of
Ownershipof Preferred
Stock | |
| |
| |
| |
| |
| | | | | | | |
Robert S Benou, | | CEO, Chairman,
Chief Financial,
Officer, Director | | — | | — | |
| | | | | | | |
Marc R. Benou | | President, Chief
Operating Officer,
Secretary and
Director | | — | | — | |
| | | | | | | |
Louis Massasd | | Director | | — | | — | |
| | | | | | | |
Edward J. Reilly | | Director | | — | | — | |
| | | | | | | |
David M. Peison | | Director | | — | | — | |
| | | | | | | |
Michael Horn | | Director | | — | | — | |
| | | | | | | |
Officers and Directors Total | | 6 | | — | | — | |
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTORS INDEPENENCE
Certain relationships and Related Transactions
Marc Benou, President, Chief Operating Officer, Secretary and Director is the son of Robert Benou, Chairman, Chief Executive Officer, Chief Financial Officer and Director.
Board determination of Independence
29
Messrs. Massad, Rielly and Peison are each “independent” as that term is defined under the National Association of Securities Dealers Automated Quotation system.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fee
WithumSmith+Brown, PC billed the Company in the aggregate amount of $397,475 for professional services rendered for their audit of our annual financial statements for the fiscal year ended July 31, 2010, the restatement of the financial statements for fiscal year ended July 31, 2009, including the opening balances as of August 1, 2008 and restatement of unaudited quarterly financial statements for the fiscal year ended July 31, 2010 and 2009, also included was their review of the financial statements included in our Form 10-Q for the period ended October 31, 2010. Wolinetz, Lafazan & Company, PC billed the Company in the aggregate amount of $45,088 for professional services rendered for their audit of our annual financial statements for the fiscal year ended July 31, 2011 and their review of the financial statements included in our Forms 10-Q for the periods ended January 31, 2011 and April 30, 2011.
Audit-Related Fees
No fees were billed during the years ended July 31, 2011 and 2010 for assurance and related services by either WithumSmith+Brown, PC or Wolinetz, Lafazan & Company, PC that are reasonably related to the performance of the audit or review of the Company’s financial statements and are not reported under the category Audit Fees described above.
Tax Fees
No fees were billed during the years ended July 31, 2011 and 2010 for tax compliance, tax advice, or tax planning services by either WithumSmith+Brown, PC or Wolinetz, Lafazan & Company, PC that are reasonably related to the performance of the audit or review of the Company’s financial statements and are not reported under the category Audit Fees described above.
All Other Fees
No fees were billed to the Company by WithumSmith+Brown, PC or Wolinetz, Lafazan & Company, PC during the years ended July 31, 2011 and 2010 for services not described above.
It is the policy of the Company’s Board of Directors that all services other than audit, review or attest services, must be pre-approved by the Board of Directors. All of the services described above were approved by the Board of Directors.
30
PART IV
ITEM 15 – EXHIBITS
| Exhibit No. | Description of Exhibits |
| | |
| 3.1 | Certificate of Incorporation** - |
| | |
| 3.1.1 | Certificate of Amendment of Certificate of Incorporation - ** |
| | |
| 3.1.2 | Certificate of Amendment of Certificate of Incorporation of DSI Systems, Inc. ** |
| | |
| 3.1.3 | Certificate of Ownership and Merger with respect to the merger of Data Sciences (Maryland) into the Registrant and the change of Registrant’s name from “Data Sciences Incorporated” to “DSI Systems, Inc.”** |
| | |
| 3.1.4 | Certificate of the Designation, Preferences and Relative, Participating, Option or Other Special Rights and Qualifications, Limitations or Restrictions thereof of the Series A Preferred Stock (par value $.50) of DSI Systems, Inc.** |
| | |
| 3.1.5 | Certificate of the Designation, Preferences and Relative, Participating, Option or Other Special Rights and Qualifications, Limitations or Restrictions thereof of the Series B Preferred Stock (par value $.50) of DSI Systems, Inc.** |
| | |
| 3.1.6 | Certificate of Ownership and Merger of Conolog Corporation (New Jersey) by DSI Systems, Inc.** |
| | |
| 3.1.7 | Certificate of Amendment of Certificate of Incorporation.** |
| | |
| 3.2 | Amended By-Laws - incorporated by reference to Exhibit 3(h) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended July 31, 1981. |
| | |
| 4.1 | Promissory Note in the amount of $65,000, issued by Conolog Corporation in favor of Robert Benou (incorporated by reference to exhibit 4.1 of the Registrants Current Report on Form 8-K filed with the Commission on August 4, 2011) |
| | |
| 4.2 | Promissory Note in the amount of $191,350, issued by Conolog Corporation in favor of Robert Benou (incorporated by reference to exhibit 4.1 of the Registrants Current Report on Form 8-K filed with the Commission on August 4, 2011) |
31
| Exhibit No. | Description of Exhibits |
| | |
| 10.1 | Employment Agreement dated June 1, 1997 between Robert Benou and Conolog Corporation (incorporated by reference to Exhibit 10.1 of the Registrants Annual Report on Form 10-K filed with the Commission on November 30, 2010). |
| | |
| 10.1.1 | Amendment Employment Agreement dated February 18, 1999 between Robert Benou and Conolog Corporation (incorporated by reference to Exhibit 10.1.1 of the Registrants Annual Report on Form 10-K filed with the Commission on November 30, 2010). |
| | |
| 10.2 | Employment Agreement dated June 1, 1997 between Marc Benou and Conolog Corporation (incorporated by reference to the Registrant’s Registration Statement on Form S-1 (File No. 0-8174) as filed with the Commission on September 12, 1997). |
| | |
| 10.3 | Securities Purchase Agreement by and between the Company and Robert Benou (incorporated by reference to Exhibit 99.1 of the Registrants Current Report on Form 10-K filed with the Commission on January 6, 2011). |
| | |
| 10.4 | Director Agreement, dated August 12, 2011, by and between the Company and Mr. Michael Horn (incorporated by reference to Exhibit 10.1 of the Registrants Current Report on Form 8-K filed with the Commission on August 17, 2011). |
| | |
| 10.5 | Form of Subscription Agreement by and among Conolog Corporation and the subscribers named therein (incorporated by reference to Exhibit 10.1 of the Registrants Current Report on Form 8-K filed with the Commission on October 12, 2011). |
| | |
| 10.6 | Amendment to Subscription Agreement by and among Conolog Corporation and the subscribers named therein (incorporated by reference to Exhibit 10.2 of the Registrants Current Report on Form 8-K filed with the Commission on October 12, 2011). |
| | |
| 14.1 | Code of Ethics (incorporated by reference to Registrant’s Annual Report on Form 10-KSB for the fiscal year ended July 31, 2003, filed with the Commission on November 14, 2003) |
| | |
| 23.1 | Incorporated by reference to the Registrants Registration Statements on Forms S-8 filed on May 25, 2007, July 8, 2008 and February 1, 2010. |
| | |
| 23.2 | Consent of WithumSmith+Brown, PC* |
| | |
| 31.1 | Rule 13a-14a/15d-14a Certification of Robert Benou (PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER)* |
| | |
| 32.1 | Section 1350 Certification of Robert Benou (PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER)* |
| | |
| * | Filed herewith |
| ** | Incorporated by reference to the Registrant’s Statement on Form SB-2 filed with the Securities and Exchange on February 18, 2005. |
32
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Conolog Corporation
| | |
| |
| By: | /s/ Robert S. Benou |
| |
|
| |
November 15, 2011 | Chairman, Chief Executive Officer |
| Chief Financial Officer |
In accordance with the Exchange Act of 1934, this report has been signed below by the following persons, on behalf of the registrant and in the capacities and on the dates indicated.
| | |
November 15, 2011 | /s/Robert S. Benou |
|
|
| | |
| Chairman, Chief Executive Officer and |
| Chief Financial Officer |
| | |
November 15, 2011 | /s/Marc R. Benou |
|
|
| |
| President, Chief Operating Officer, Secretary and Director |
| |
November 15, 2011 | /s/Louis S. Massad |
|
|
| |
| Director |
| |
November 15, 2011 | /s/Edward J. Rielly |
| |
| Director |
| |
November 15, 2011 | /s/David M. Peison |
| |
| Director |
| | |
November 15, 2011 | /s/ Michael Horn |
|
|
| |
| Director |
33
PART F/S
INDEX TO FINANCIAL STATEMENTS
AUDITED FINANCIAL STATEMENTS
34
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Conolog Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheet of Conolog Corporation and Subsidiaries (“the Company”) as of July 31, 2011 and the related consolidated statements of operations, stockholders’ equity (deficiency) and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Also, an audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Conolog Corporation and Subsidiaries at July 31, 2011, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has incurred a loss from operations in the amount of $2,502,084 for the year ended July 31, 2011 and used cash from operations in the amount of $1,055,549 for the year ended July 31, 2011. In addition, at July 31, 2011 the Company has a working capital deficiency of $765,966 and stockholders’ deficiency of $678,608. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans regarding those matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
WOLINETZ, LAFAZAN & COMPANY, P.C.
Rockville Centre, New York
November 15, 2011
F-1
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Conolog Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of Conolog Corporation and Subsidiaries as of July 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. Conolog Corporation’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Conolog Corporation and Subsidiaries as of July 31, 2010 and 2009, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 3 to the consolidated financial statements for the year ended July 31, 2010, the Company has restated their July 31, 2009 financial statements to correct a misstatement.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully discussed in Note 1 to the consolidated financial statements, the Company has had recurring losses from operations of $3,532,645 and $1,620,877 and used cash from operations in the amounts of $1,636,745 and $1,264,121 for the years ended July 31, 2010 and 2009, respectively. At July 31, 2010 the Company had cash equivalents of $713,005. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
WithumSmith+Brown, PC
Somerville, New Jersey
November 30, 2010
F-1
CONOLOG CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
| | | | | | | | | |
| | | | July 31,
2011 | | July 31,
2010 | |
| | | |
| |
| |
ASSETS | | | | | | | |
Current Assets: | | | | | | | |
Cash and equivalents | | $ | 7,907 | | $ | 713,005 | |
Accounts receivable, net of allowance | | | 476,435 | | | 67,603 | |
Inventory, net of reserve for obsolescence | | | 389,489 | | | 826,079 | |
Prepaid expenses | | | 25,932 | | | 248,297 | |
Other current assets | | | 259 | | | 5,000 | |
| |
|
| |
|
| |
Total Current Assets | | | 900,022 | | | 1,859,984 | |
| |
|
| |
|
| |
Property and equipment: | | | | | | | |
Machinery and equipment | | | 1,362,952 | | | 1,357,053 | |
Furniture and fixtures | | | 430,924 | | | 430,924 | |
Automobiles | | | 34,097 | | | 34,097 | |
Computer software | | | 231,002 | | | 231,002 | |
Leasehold improvements | | | 30,265 | | | 30,265 | |
| |
|
| |
|
| |
Total property and equipment | | | 2,089,240 | | | 2,083,341 | |
Less: accumulated depreciation | | | (2,001,882 | ) | | (1,987,284 | ) |
| |
|
| |
|
| |
Net Property and Equipment | | | 87,358 | | | 96,057 | |
| |
|
| |
|
| |
Other Assets: | | | | | | | |
Deferred financing fees, net of amortization | | | — | | | 382,132 | |
| |
|
| |
|
| |
| | | | | | | |
Total Other Assets | | | — | | | 382,132 | |
| |
|
| |
|
| |
TOTAL ASSETS | | $ | 987,380 | | $ | 2,338,173 | |
| |
|
| |
|
| |
| | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIENCY) | | | | | | | |
Current Liabilities: | | | | | | | |
Accounts payable | | $ | 376,636 | | $ | 150,880 | |
Accrued expenses | | | 1,033,002 | | | 201,000 | |
Notes payable - officer | | | 256,350 | | | — | |
| |
|
| |
|
| |
Total Current Liabilities | | | 1,665,988 | | | 351,880 | |
| |
|
| |
|
| |
Non-Current Liabilities: | | | | | | | |
Convertible debenture, net of discount of $720,687 at July 31, 2010 | | | — | | | 279,313 | |
| |
|
| |
|
| |
Total Liabilities | | | 1,665,988 | | | 631,193 | |
| |
|
| |
|
| |
| | | | | | | |
Stockholders’ Equity (Deficiency): | | | | | | | |
Preferred stock, par value $.50; Series A; 4% cumulative; 500,000 shares authorized; 155,000 shares issued and outstanding at July 31, 2011 and 2010, respectively. | | | 77,500 | | | 77,500 | |
Preferred stock, par value $.50; Series B; $.90 cumulative; 500,000 shares authorized; 1,197 shares issued and outstanding at July 31, 2011 and 2010, respectively; | | | 597 | | | 597 | |
Common stock, par value $0.01; 30,000,000 shares authorized; 12,455,380 shares issued at July 31, 2011 and 6,967,881 shares issued at July 31, 2010, respectively. | | | 124,554 | | | 69,679 | |
Contributed capital | | | 79,971,148 | | | 78,088,878 | |
Accumulated deficit | | | (80,720,673 | ) | | (76,397,940 | ) |
Less: Treasury shares at cost - 2 shares | | | (131,734 | ) | | (131,734 | ) |
| |
|
| |
|
| |
Total Stockholders’ Equity (Deficiency) | | | (678,608 | ) | | 1,706,980 | |
| |
|
| |
|
| |
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIENCY) | | $ | 987,380 | | $ | 2,338,173 | |
| |
|
| |
|
| |
The accompany notes are an integral part of these consolidated financial statements
F-2
CONOLOG CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended July 31, 2011 and 2010
| | | | | | | |
| | 2011 | | 2010 | |
| |
| |
| |
OPERATING REVENUES | | | | | | | |
Product revenue | | $ | 1,691,852 | | $ | 1,178,673 | |
| |
|
| |
|
| |
| | | | | | | |
Cost of product revenue | | | | | | | |
Materials and labor used in production | | | 1,125,038 | | | 618,990 | |
Inventory obsolesence | | | 50,000 | | | 75,564 | |
| |
|
| |
|
| |
Total Cost of product revenue | | | 1,175,038 | | | 694,554 | |
| |
|
| |
|
| |
| | | | | | | |
Gross Profit from Operations | | | 516,814 | | | 484,119 | |
| |
|
| |
|
| |
| | | | | | | |
Selling, general and administrative expenses | | | | | | | |
General and adminitsrative | | | 2,685,049 | | | 3,759,490 | |
Research and development | | | 68,022 | | | 139,951 | |
Selling expenses | | | 265,827 | | | 117,323 | |
| |
|
| |
|
| |
Total selling, general and admiminstrative expenses | | | 3,018,898 | | | 4,016,764 | |
| |
|
| |
|
| |
| | | | | | | |
Loss from operations | | | (2,502,084 | ) | | (3,532,645 | ) |
| |
|
| |
|
| |
| | | | | | | |
OTHER INCOME (EXPENSES) | | | | | | | |
Loss on derivative financial instruments | | | — | | | (18,958,801 | ) |
Beneficial conversion feature | | | — | | | (457,692 | ) |
Incremental consideration for modificationof debt warrants | | | — | | | (107,863 | ) |
Interest expense | | | (75,230 | ) | | (44,546 | ) |
Interest income | | | 339 | | | 3,630 | |
Other income - legal settlement | | | 10,000 | | | — | |
Induced conversion cost | | | (649,147 | ) | | (150,201 | ) |
Amortization of debt discount | | | (720,687 | ) | | (1,279,313 | ) |
Amortization of financing fees | | | (382,132 | ) | | (520,656 | ) |
| |
|
| |
|
| |
Total Other Income (Expense) | | | (1,816,857 | ) | | (21,515,442 | ) |
| |
|
| |
|
| |
| | | | | | | |
Net Loss before income taxes benefit (expense) | | | (4,318,941 | ) | | (25,048,087 | ) |
| |
|
| |
|
| |
| | | | | | | |
Income tax benefit (expense) | | | (3,792 | ) | | 137,331 | |
| |
|
| |
|
| |
| | | | | | | |
NET LOSS APPLICABLE TO COMMON SHARES | | $ | (4,322,733 | ) | $ | (24,910,756 | ) |
| |
|
| |
|
| |
| | | | | | | |
Net Loss per basic and diluted common share | | $ | (0.43 | ) | $ | (5.36 | ) |
| |
|
| |
|
| |
| | | | | | | |
Weighted Average number of common shares outstanding | | | 10,104,933 | | | 4,650,113 | |
| |
|
| |
|
| |
The accompany notes are an integral part of these consolidated financial statements
F-3
|
CONOLOG CORPORATION AND SUBSIDIARIES |
Consolidated Statements of Changes in Stockholders’ Equity (Deficiency) |
For the Years Ended July 31, 2011 and 2010 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Series A | | Series B | | | | | | | | Total
Stockholders’
Equity | |
| |
|
|
| | | | | | | Treasury Stock | | |
| | Preferred Stock | | Preferred Stock | | Common Stock | | Contributed | Accumulated | |
| | |
| | Shares | | Amount | | Shares | | Amount | | Shares | | Amount | | Capital | | Deficit | | Shares | | Amount | | |
| |
|
|
|
|
|
|
|
|
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|
|
|
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|
|
|
|
|
|
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| |
|
|
|
|
|
|
|
|
|
|
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|
|
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|
|
|
|
|
|
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|
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|
|
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|
Balance at July 31, 2009 | | | 155,000 | | $ | 77,500 | | | 1,197 | | $ | 597 | | | 1,842,485 | | $ | 18,425 | | $ | 52,221,727 | | $ | (51,487,184 | ) | | 2 | | $ | (131,734 | ) | $ | 699,331 | |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
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|
|
|
|
|
|
|
|
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Conversion of convertible debenture | | | | | | | | | | | | | | | 1,328,645 | | | 13,287 | | | 1,024,662 | | | | | | | | | | | | 1,037,949 | |
Exercise of warrants | | | | | | | | | | | | | | | 2,746,192 | | | 27,462 | | | 607,608 | | | | | | | | | | | | 635,070 | |
Interest paid with issuance of common stock | | | | | | | | | | | | | | | 50,559 | | | 505 | | | 39,041 | | | | | | | | | | | | 39,546 | |
Shares issued for services to be provided | | | | | | | | | | | | | | | 265,000 | | | 2,650 | | | 506,150 | | | | | | | | | | | | 508,800 | |
Induced conversion costs associated with convertible debt | | | | | | | | | | | | | | | | | | | | | 150,201 | | | | | | | | | | | | 150,201 | |
reclassification of derivative liability | | | | | | | | | | | | | | | | | | | | | 21,570,084 | | | | | | | | | | | | 21,570,084 | |
Incremental consideration for reduction of exercise price of Series C warrants | | | | | | | | | | | | | | | | | | | | | 107,863 | | | | | | | | | | | | 107,863 | |
Common shares issued to officers, directors and employees | | | | | | | | | | | | | | | 735,000 | | | 7,350 | | | 1,403,850 | | | | | | | | | | | | 1,411,200 | |
Beneficial conversion feature on February 2010 debentures in consideration of modifying terms | | | | | | | | | | | | | | | | | | | | | 457,692 | | | | | | | | | | | | 457,692 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | — | |
Net loss for the Year | | | | | | | | | | | | | | | | | | | | | | | | (24,910,756 | ) | | | | | | | | (24,910,756 | ) |
| |
|
|
|
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at July 31, 2010 | | | 155,000 | | $ | 77,500 | | | 1,197 | | $ | 597 | | | 6,967,881 | | $ | 69,679 | | $ | 78,088,878 | | $ | (76,397,940 | ) | | 2 | | $ | (131,734 | ) | $ | 1,706,980 | |
| |
|
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Conversion of convertible debentures and accrued interest | | | | | | | | | | | | | | | 3,562,999 | | | 35,630 | | | 1,677,307 | | | | | | | | | | | | 1,712,937 | |
Issuance of common stock in exercise of Class C warrants in cashless transaction | | | | | | | | | | | | | | | 1,646,723 | | | 16,467 | | | (16,467 | ) | | | | | | | | | | | — | |
Sale of common stock to officer | | | | | | | | | | | | | | | 277,777 | | | 2,778 | | | 97,222 | | | | | | | | | | | | 100,000 | |
Forgiveness of officers salary | | | | | | | | | | | | | | | | | | | | | 124,208 | | | | | | | | | | | | 124,208 | |
Net loss for the Year | | | | | | | | | | | | | | | | | | | | | | | | (4,322,733 | ) | | | | | | | | (4,322,733 | ) |
| |
|
|
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|
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|
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|
|
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|
|
|
|
Balance at July 31, 2011 | | | 155,000 | | $ | 77,500 | | | 1,197 | | $ | 597 | | | 12,455,380 | | $ | 124,554 | | $ | 79,971,148 | | $ | (80,720,673 | ) | | 2 | | $ | (131,734 | ) | $ | (678,608 | ) |
| |
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|
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|
|
The accompany notes are an integral part of these consolidated financial statements
F-4
CONOLOG CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended July 31, 2011 and 2010
| | | | | | | |
| | 2011 | | 2010 | |
| |
| |
| |
CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | | |
Net loss | | $ | (4,322,733 | ) | $ | (24,910,756 | ) |
Adjustments to reconcile net loss to net cash used in operations: | | | | | | | |
Depreciation | | | 14,598 | | | 27,230 | |
Bad debt expense | | | 32,866 | | | — | |
Reserve of obsolete inventory parts | | | (25,000 | ) | | (14,000 | ) |
Write down of obsolete inventory parts | | | 50,000 | | | 89,564 | |
Amortization of deferred financing fees | | | 382,132 | | | 520,656 | |
Common stock issued ot officers, directors and employees | | | — | | | 1,411,200 | |
Amortization of common stock issued for services | | | 80,000 | | | 428,800 | |
Induced conversion costs associated with convertible debt and warrants | | | 649,147 | | | 150,201 | |
Amortization of discount of convertible debentures | | | 720,687 | | | 1,279,313 | |
Beneficial conversion feature | | | — | | | 457,692 | |
Incremental consideration of modification of warrants | | | — | | | 107,863 | |
Loss on derivative financial instruments | | | — | | | 18,958,801 | |
Forgiveness of salaries by officers of company | | | 124,208 | | | | |
| | | | | | | |
Changes in assets and liabilities | | | | | | | |
(Increase) decrease in accounts receivable | | | (441,698 | ) | | 178,377 | |
(Increase) decrease in prepaid expenses | | | 142,364 | | | (117,666 | ) |
(Increase) decrease in inventories | | | 411,590 | | | (313,861 | ) |
(Increase) in other current assets | | | 4,742 | | | — | |
Increase (decrease) in accounts payable | | | 225,756 | | | (66,575 | ) |
Increase (decrease) in accrued expenses | | | 895,792 | | | 176,416 | |
| |
|
| |
|
| |
Net cash used in operations | | | (1,055,549 | ) | | (1,636,745 | ) |
| |
|
| |
|
| |
CASH FLOWS FROM INVESTING ACTIVITIES | | | | | | | |
Purchase of property and equipment | | | (5,899 | ) | | (22,781 | ) |
| |
|
| |
|
| |
Net cash used in investing activities | | | (5,899 | ) | | (22,781 | ) |
| |
|
| |
|
| |
CASH FLOWS FROM FINANCING ACTIVITIES | | | | | | | |
Proceeds from issuance of convertible debentures | | | — | | | 2,000,000 | |
Proceeds from exercise of warrants | | | | | | 635,070 | |
Proceeds from issuance of common stock | | | 100,000 | | | — | |
Proceeds from officers loans | | | 316,350 | | | — | |
Payments of loans from officers | | | (60,000 | ) | | | |
Payments for deferred loan costs | | | | | | (291,507 | ) |
Proceeds from note receivable | | | | | | 1,610 | |
| |
|
| |
|
| |
Net cash provided by financing activities | | | 356,350 | | | 2,345,173 | |
| |
|
| |
|
| |
| | | | | | | |
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | | | (705,098 | ) | | 685,647 | |
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR | | | 713,005 | | | 27,358 | |
| |
|
| |
|
| |
CASH AND CASH EQUIVALENTS - END OF YEAR | | $ | 7,907 | | $ | 713,005 | |
| |
|
| |
|
| |
The accompany notes are an integral part of these consolidated financial statements
F-5
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Conolog Corporation (the “Company”) is in the business of design, manufacturing and distribution of small electronic and electromagnetic components and subassemblies for use in telephone, radio and microwave transmissions and reception and other communication areas. The Company’s products are used for transceiving various quantities, data and protective relaying functions in industrial, utility and other markets. The Company’s customers include primarily industrial customers, which include power companies located primarily throughout the United States, and various branches of the military.
The Company formed a wholly owned Subsidiary, Nologoc Corporation. In September 1998, Nologoc Corporation purchased the assets of Atlas Design, Incorporated. In January, 2001, Nologoc Corporation purchased the assets of Prime Time Staffing, Incorporated and Professional Temp Solutions Incorporated. Atlas Design, Prime Time Staffing and Professional Temp Solutions provide short-term and long-term qualified engineering and technical staff, as well as human resource consulting to various industries. In March 2004 the Company ceased operating its staffing business. The assets of the Company’s wholly-owned subsidiary, Nologoc, Inc. trading as Atlas Design, were sold to the Company’s vice-president of operations of Atlas Design.
Going Concern
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has had recurring losses from operations of $2,502,084 and $3,532,645 for the years ended July 31, 2011 and 2010, respectively, and used cash from operations in the amounts of $1,055,549 and $1,636,745 for the years ended July 31, 2011 and 2010, respectively. At July 31, 2011, the Company had a working capital deficiency of $765,966 and a stockholders deficiency of $678,608. These factors raise substantial doubt as to the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from this uncertainty.
The Company plans to raise additional capital through debt and equity placements and increase revenue through new product development. In the event that the Company cannot generate sufficient cash flow from its operations or raise proceeds from offering debt or equity securities, the Company may be forced to curtail or cease its activities. There can be no assurance that the Company will be successful in achieving its goals.
Principles of Consolidation
The consolidated financial statements include the accounts of Conolog Corporation and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated.
NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Equivalents
For the purpose of the statements of cash flows, cash equivalents include time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less. The Company maintains cash and cash equivalents balances at financial institutions and are insured by the Federal Deposit Insurance Corporation up to $250,000. At times during the year, balances in certain bank accounts may exceed the FDIC insured limits. Cash equivalents consist of highly liquid investments with an original maturity of three months or less when purchased. At July 31, 2011 the Company did not have any cash equivalents.
Receivables and Allowance for Doubtful Accounts
Trade Receivables are non-interest bearing, uncollateralized customer obligations and are stated at the amounts billed to customers. The preparation of financial statements requires our management to make estimates and assumptions relating to the collectivity 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 allowance for doubtful accounts at July 31, 2011 and 2010 was $1,000 and $1,000, respectively.
F-6
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The Company has a concentration risk in trade accounts receivable with significant sales to the government and local agencies. Two customers accounted for approximately 93% and 4% of accounts receivable as of July 31, 2011. Two customers accounted for approximately 50% and 31% of accounts receivable as of July 31, 2010. The credit evaluation process has mitigated the credit risk.
Inventories
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.
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 obsolescence and reserve adjustments.
Property and Equipment
Property and equipment are carried at cost, less allowances for depreciation. Depreciation is computed by the straight-line method over the estimated useful lives of the assets which range between three and seven years. Depreciation was $14,598 and $27,230 for the years ended July 31, 2011 and 2010, respectively. Repairs and maintenance expenditures which do not extend the useful lives of the related assets are expensed as incurred. Gains and losses on depreciable assets retired or sold are recognized in the consolidated statement of operations in the year of disposal.
Deferred Financing Costs
The Company follows authoritative guidance for accounting for financing costs as it relates to convertible debt issuance cost. These costs are deferred and amortized over the term of the debt period or until redemption of the convertible Debentures. As of July 31, 2011 and 2010, $0 and $382,132, respectively of deferred financing costs remained to be amortized. Amortization of deferred financing costs amounted to $382,132 and $520,656 for years ended July 31, 2011 and 2010, respectively.
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.
F-7
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Effective August 1, 2009, the Company adopted the provisions of the Financial Accounting Standards Board Accounting Codification Topic 815-40-15-5, “Evaluating Whether an Instrument Involving a Contingency is Considered Indexed to an Entity’s Own Stock” (“FASB ASC 815-40-15-5”). FASB ASC 815-40-15-5 provides guidance in assessing whether an equity linked financial instrument (or embedded feature) is indexed to an entity’s own stock for purposes of determining whether the equity-linked instrument (or embedded feature) qualifies as a derivative instrument. We have determined that our convertible Debentures and certain of our warrants issued after the adoption of FASB ASC 815-40-15-5 contain features that are not indexed to our own stock and therefore, were classified as derivative instruments. Upon adoption of FASB ASC 815-40-15-5 we did not record a cumulative effect of a change in accounting principle as it did not apply to any outstanding convertible Debentures or warrants at that time.
On June 18, 2010, the Company’s common stock warrants and convertible notes were amended. As a result of these amendments we determined that the equity-linked instruments (or embedded features) are indexed to our Company’s stock within the meaning of FASB ASC 815-40-15-5 and no longer qualify as a derivative instrument.
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.
Impairment of Long-Lived Assets
We review our long-lived assets for impairment whenever events and circumstances indicate that the carrying value of an asset might not be recoverable. An impairment loss, measured as the amount by which the carrying value exceeds the fair value, is recognized if the carrying amount exceeds estimated undiscounted future cash flows.
Research and Development
Research and Development costs are expensed as incurred. Research and Development costs were $68,022 and $139,951 for the years ended July 31, 2011 and 2010, respectively.
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 and risks and rewards of ownership have 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.
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 provided 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.
F-8
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Advertising / Public Relations Costs
Advertising/Public Relations costs are charged to operations when incurred. These expenses were $15,000 and $72,329 for the years ended July 31, 2011 and 2010, respectively.
Shipping and Handling Costs
Shipping and handling costs are expensed as incurred and amounted to $16,545 and $37,416 for the years ended July 31, 2011 and 2010, respectively.
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 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.
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:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
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.
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.
The Company’s financial instruments include cash and cash equivalents, accounts receivable, other current assets, accounts payable, accrued expenses, and convertible debentures. All of these items were determined to be Level 1 fair value measurements.
The carrying amounts of cash and 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.
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. A valuation allowance is recorded when the expected recognition of a deferred tax asset is considered to be unlikely. The guidance also requires that the Company determine whether it is more likely than not that a tax position will not be sustained upon examination by the
F-9
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
appropriate taxing authority. If a tax position does not meet the more likely than not recognition criterion, the guidance requires that the tax position be measured at the largest amount of benefit greater than 50 percent not likely of being sustained upon ultimate settlement. Based on the Company’s evaluation, management has concluded that there are significant uncertain tax positions requiring recognition in the consolidated financial statements with respect to the sale of the Company’s New Jersey Net Operating Loss Carryovers. In the event the Company receives an assessment for interest and/or penalties by major tax jurisdiction it would be classified in the financial statements as general and administrative expense. See note 4, Income taxes.
Other State Tax Benefits
In 1998, the State of New Jersey enacted legislation allowing emerging technology and/or biotechnology companies to sell their unused New Jersey Net Operating Loss (“NOL”) Carryover and Research and Development Tax Credits (“R&D” Credits) to corporate taxpayers in New Jersey. During fiscal year ended 2010, the Company entered into agreements to sell its unused NOLs. Recognition of this asset and income have been in accordance with the guidance of SAB Topic 13 and are recorded upon the State of New Jersey’s approval of the technology tax benefit transfer certificate and receipt of a contract to purchase a fixed amount of these NOLs.
Loss Per Share of Common Stock
Basic loss per share of common stock is computed by dividing the Company’s net loss by the weighted average number of shares of Common Stock outstanding during the period. The preferred dividends are not reflected in arriving at the net loss as they are not material and would have no effect on loss per share available to common shareholders. Diluted loss per shares is based on the treasury stock method and includes the effect from potential issuance of common stock such as shares issuable pursuant to the exercise of warrants and conversions of debentures. The Company did not have any dilutive securities for the year ended July 31, 2011 and 2010. Potentially dilutive securities at July 31, 2011 consist of 982,837 common shares from outstanding warrants and 155,006 common shares from preferred stock. Potentially dilutive securities at July 31, 2010 consist of 2,939,036 common shares from outstanding warrants, 1,666,667 common shares from convertible debt and 155,006 common shares from preferred stock.
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 are 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.
Future Impact of Recently Issued Accounting Standards
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, which updated the guidance in ASC Topic 820,Fair Value Measurement.The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and International Financial Reporting Standards. The amendments in this ASU are to be applied prospectively. For public entities, the amendments are effective for interim and annual periods beginning after December 15, 2011, and early application is not permitted. ASU 2011-04 is not expected to have a material impact on the Company’s financial position or results of operations
F-10
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Future Impact of Recently Issued Accounting Standards (continued)
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.
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.
F-11
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 2- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Future Impact of Recently Issued Accounting Standards (continued)
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.
NOTE 3- INVENTORY
Inventory consisted of the following as of July 31, 2011 and 2010
| | | | | | | |
| | 2011 | | 2010 | |
| |
|
|
| |
Finished goods | | $ | 162,507 | | $ | 587,835 | |
Work-in-process | | | 87,664 | | | 83,441 | |
Raw materials | | | 188,318 | | | 228,803 | |
| |
|
|
|
|
| |
| | | 438,489 | | | 900,079 | |
Less Inventory reserve | | | 49,000 | | | 74,000 | |
| |
|
|
|
|
| |
Inventory, net | | $ | 389,489 | | $ | 826,079 | |
| |
|
|
|
|
| |
The Company, on an annual basis, reviews finished goods and raw material inventory on-hand and provides a reserve for obsolete product based on the results of the review.
As of July 31, 2011 and 2010, inventory reserves amounted to $49,000 and $74,000, respectively. For the years ended July 31, 2011 and 2010, inventory written off as obsolete, amounted to $50,000 and $89,565, respectively, and was charged to cost of sales.
NOTE 4 – INCOME TAXES
The income tax (benefit) is comprised of the following:
| | | | | | | |
| | 2011 | | 2010 | |
| |
| |
| |
Current: | | | | | | | |
Federal | | $ | — | | $ | — | |
State | | | 3,792 | | | (137,331 | ) |
Deferred: | | | | | | | |
Federal | | | — | | | — | |
State | | | — | | | — | |
| |
|
| |
|
| |
|
Total tax benefit | | $ | 3,792 | | $ | (137,331 | ) |
| |
|
| |
|
| |
F-12
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 4 – INCOME TAXES (continued)
The U.S. federal statutory income tax rate is reconciled to the effective rate at July 31, 2011 and 2010, as follows:
| | | | | | | |
| | 2011 | | 2010 | |
| |
| |
| |
Income tax expense at U.S. federal statutory rate | | | (34.0 | %) | | (34.0 | %) |
New Jersey state statutory rate | | | (5.8 | %) | | (5.8 | %) |
Change in valuation allowance | | | 22.6 | % | | 2.3 | % |
Loss on derivative financial instruments | | | 0.0 | % | | 30.1 | % |
Common stock issue for services | | | 0.7 | % | | 2.9 | % |
Amortization of debt discount and deferred financing fees | | | 10.2 | % | | 2.9 | % |
Benefits and modification of debt | | | 0.0 | % | | .9 | % |
Induced conversion cost | | | 6.2 | % | | .2 | % |
| |
|
| |
|
| |
| |
Effective tax benefit | | | 0.1 | % | | (0.5 | %) |
| |
|
| |
|
| |
In 1998, the State of New Jersey enacted legislation allowing emerging technology and/or biotechnology companies to sell their unused New Jersey Net Operating Loss (“NOL”) Carryover and Research and Development Tax Credits (“R&D” Credits) to corporate taxpayers in New Jersey. During fiscal year ended July 31, 2010, the Company entered into agreements to sell up to $5,594,000 of its unused tax losses. The Company received net proceeds of $284,703 during the fiscal year ended July 31, 2010, related to the sale and accordingly recorded them as a tax benefit in the year received. The net tax benefit recorded in the Statement of Operations consists of the proceeds received from the sale of the company’s NJ NOL’s offset by the unrecorded tax benefit due to uncertain tax positions of $135,000 in 2010.
Deferred taxes are recognized for temporary differences between the bases of assets and liabilities for financial statement and income tax purposes, and net operating losses. The temporary differences causing deferred tax benefits are primarily due to net operating loss carry forwards.
At July 31, 2011 and 2010, the Company has net operating loss carry forward for federal income tax purpose of approximately $29,218,000 and $26,890,000 respectively, which is available to offset future Federal taxable income through 2030. At July 31, 2011 and 2010, the Company has net operating loss carryforward toward state income tax purposes of approximately $9,223,000 and $6,900,000 respectively, to offset future state taxable income through 2030.
There was a provision for income taxes of $3,792 for the year ended July 31, 2011 and no provision for income taxes for the year ended July 31, 2010. The Company has no open tax years prior to 2006 for the State of New Jersey and 2003 for the federal income tax purposes which are subject to examination.
F-13
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 4 – INCOME TAXES (continued)
The components of the net deferred tax assets (liabilities) at July 31, 2011 and 2010 are as follows:
| | | | | | | |
| | 2011 | | 2010 | |
| |
| |
| |
| | | | | | | |
Deferred tax asset | | | | | | | |
Net operating loss | | $ | 10,689,000 | | $ | 9,708,000 | |
Reserves | | | 20,000 | | | 63,000 | |
| | | | | | | |
| |
|
| |
|
| |
Total deferred tax assets | | | 10,709,000 | | | 9,771,000 | |
| | | | | | | |
Deferred tax liability | | | — | | | — | |
| |
|
| |
|
| |
| | | | | | | |
Net deferred tax asset | | | 10,709,000 | | | 9,771,000 | |
| |
|
| |
|
| |
Less: Valuation allowance | | | (10,709,000 | ) | | (9,771,000 | ) |
| |
|
| |
|
| |
Net deferred tax asset | | $ | — | | $ | — | |
| |
|
| |
|
| |
The Company periodically assesses the likelihood that it will be able to recover its deferred tax assets and determines if a valuation allowance is necessary. As a result of this analysis the Company concluded that it is more likely than not that its deferred tax assets will not be recovered and, accordingly, recorded 100% of the deferred tax asset to a valuation allowance as of July 31, 2011 and July 31, 2010.
The Company accounts for the recognition, measurement, presentation and disclosure of uncertain tax positions in accordance with the provisions of ASC 740-10, Accounting for Uncertainty in Income Taxes. The Company evaluates these unrecognized tax benefits each reporting period. As of July 31, 2011, the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $135,000. The unrecognized tax benefit is the result of the Company’s position to deduct the write off of the obsolete inventory for income tax purposes. The Company maintains some of its obsolete inventory utilization in repairing its products previously sold in accordance with the Company’s warranty program.
The Company, over the years, has discarded obsolete inventory; however, the company did not keep a detailed log of the inventory that was discarded. These inventory items were written down to zero in the Company’s inventory system as they were deemed to have no value and therefore the Company deducted the amounts on its income tax returns.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
| | | | |
| | July 31, 2011 | |
| |
| |
Balance at beginning of period | | $ | 135,000 | |
| | | | |
Additions based on tax positions related to current year | | | — | |
| |
|
| |
Balance at end of period | | $ | 135,000 | |
| |
|
| |
F-14
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 4 – INCOME TAXES (continued)
The Company and its subsidiaries are subject to United States federal income tax as well as income tax of multiple state jurisdictions. These uncertain tax positions are related to the Sale of the Company’s NJ NOL’s and are within the tax years that remain subject to examination by the relevant taxing authorities.
It is reasonably possible that the amount of unrecognized tax benefits will increase or decrease in the next twelve months. These changes may be the result of new state audits. It is also expected that the statute of limitations for certain unrecognized tax benefits will expire in the next 12 months resulting in a reduction of the liability for unrecognized tax benefits of approximately $22,000. The balance of the unrecognized tax benefits is primarily related to uncertain tax positions for which there are no current ongoing federal or state audits and therefore, an estimate of the range of the reasonably possible outcomes cannot be made.
The Company has recorded accrued interest of $16,000 and $5,000 as of July 31, 2011 and 2010, respectively which has been included in accrued expenses in the Balance Sheet. During the fiscal year ended July 31, 2011 and 2010, the Company has included $11,000 and $5,000, respectively of interest expense in the statement of operations.
NOTE 5– PROFIT SHARING PLAN
The Company sponsors a contributing thrift and savings plan which qualifies under Section 401(k) of the Internal Revenue Code that covers eligible employees meeting age and service requirements. Eligible participating employees may elect to contribute up to the maximum allowed under the IRS code to an investment trust. For tax year 2011 and 2010 this maximum allowable deferred contribution was $16,500 ($22,500 for employee over age 50). Employer contributions to the plan are discretionary and determined annually by management. The Company made matching contributions to the plan of $0 for both the fiscal years ended July 31, 2011 and 2010, respectively.
NOTE 6– STOCKHOLDERS’ EQUITY (DEFICIENCY)
The Series A Preferred Stock provides 4% cumulative dividends, which were $130,083 ($0.84 per share) and $126,983 ($0.82 per shares) in arrears at July 31, 2011 and 2010, respectively. In addition, each share of Series A Preferred Stock may be exchanged for one share of Common Stock upon surrender of the Preferred Stock and payment of $5,760,000 (due to reverse stock splits) per share. The Company may redeem the Series A Preferred Stock at $.50 per share plus accrued and unpaid dividends. The liquidation preference of the Series A Preferred Stock was $207,583 and $204,483 at July 31, 2011 and 2010, respectively.
The Series B Preferred Stock provides cumulative dividends of $0.90 per share, which were $43,173 ($36.06 per share) and $42,096 ($35.17 per share) in arrears at July 31, 2011 and 2010, respectively. In addition, each share of Series B Preferred Stock is convertible into .005 of one share of Common Stock. The liquidation preference of the Series B Preferred Stock is the dividend in arrears plus $15 per share. The liquidation preference was $61,131 and $60,051 at July 31, 2011 and 2010, respectively.
On January 14, 2011, at the a Special Meeting of Shareholders of Conolog Corporation (the “Company”), the Company’s shareholders approved an amendment to the Certificate of Incorporation of the Company to effect a reverse stock split of the company’s common stock, par value $.001 per share, at a ratio not less than two-for-one and not greater than five-for-one, with the exact ratio to be set within such range in the discretion of the Board of Directors, without further approval or authorization of the Company’s shareholders, provided that the Board of Directors determines to effect the reverse stock split and such amendment is filed with the Delaware Secretary of State no later than August 1, 2011.
F-15
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 6– STOCKHOLDERS’ EQUITY (DEFICIENCY) (continued)
On January 6, 2011, Conolog Corporation (the “Company”) entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with Robert Benou, the Company’s Chief Executive Officer and Chairman of the Company’s Board of Directors, pursuant to which the Company sold to Robert Benou a total of 277,777 shares of its Common Stock at a price per share of $0.36 for an aggregate purchase price of $100,000.
At various times during the years ended July 31, 2011 and 2010, $1,000,000 and $1,037,949 of convertible debt, respectively, were converted into 3,333,333 and 1,328,645 shares of common stock, respectively.
At various times during the years ended July 31, 2011 and 2010, $88,177 and $39,546 of interest expense, respectively, were converted into 229,666 and 50,559 shares of common stock, respectively.
At various times during the years ended July 31, 2011 an aggregate 1,955,782 Class C Warrants were exercised in cashless exercises into 1,646,723 shares of common stock.
On January 31, 2011, the Company received notice from the Listing Qualifications Staff of the NASDAQ Stock Market (“NASDAQ”) indicating that the Company had failed to regain compliance with NASDAQ Listing Rule 5550(b), which requires the Company to have a minimum of $2,500,000 in stockholders’ equity (the “Rule”), and that, accordingly, its common stock will be delisted from The NASDAQ Capital Market and that trading of its common stock was suspended, effective with the open of business on February 2, 2011. The Company securities have traded on the OTCQB under the symbol “CNLG” since the suspension of trading on NASDAQ. The Company intends to continue to file periodic reports with the SEC pursuant to the requirements of the Securities Exchange Act of 1934, as amended.
During the year ended July 31, 2010, the Company issued 265,000 common shares to consultants for services to be provided. The common shares were valued at $508,800 for the year ended July 31, 2010.
During the years ended July 31, 2010, the Company issued 735,000 common shares to officers, directors and employees as compensation. The common shares were valued at $1,411,200 for the year ended July 31, 2010.
During the year ended July 31, 2010, investors were issued 2,746,192 common shares for the exercise of warrants. The Company received proceeds of $635,070 from the exercise of these warrants during the years ended July 31, 2010.
F-16
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 6– STOCKHOLDERS’ EQUITY (DEFICIENCY) (continued)
A summary of the Company’s warrant activity is as follows:
| | | | | | | | | |
| | Number of
Warrants | | Strike Price | | Expiration
Date | |
| |
|
|
|
|
| |
| | | | | | | | | |
2/18/2005 Warrants | | | 6,321 | | $ | 150.00 | | 2/18/2010 | |
7/16/2005 Warrants | | | 12,000 | | $ | 202.70 | | 7/16/2010 | |
1/19/2006 Warrants | | | 417 | | $ | 25.00 | | 1/19/2011 | |
3/12/2007 Warrants | | | 84,750 | | $ | 21.00 | | 3/12/2012 | |
11/2/2007 Warrants | | | 33,355 | | $ | 33.20 | | 11/2/2012 | |
| |
|
| | | | | | |
| | | | | | | | | |
Outstanding Balance at July 31, 2009 | | | 136,843 | | | | | | |
| | | | | | | | | |
Issued: | | | | | | | | | |
Class A Warrants | | | 2,564,102 | | $ | 1.12 | | 8/3/2014 | |
Class C Warrants | | | 2,564,104 | | $ | 1.12 | | 2/26/2015 | |
Selling Agent Warrants | | | 256,410 | | $ | 1.12 | | 8/3/2014 | |
Selling Agent Warrants | | | 256,410 | | $ | 1.12 | | 2/26/2015 | |
| | | | | | | | | |
Exercised: | | | | | | | | | |
Class A Warrants | | | (1,929,032 | ) | $ | 0.01 | | 8/3/2014 | |
Class A Warrants | | | (635,070 | ) | $ | 1.00 | | 8/3/2014 | |
Selling Agent Warrants | | | (256,410 | ) | $ | 1.12 | | 8/3/2014 | |
| | | | | | | | | |
Cancelled: | | | | | | | | | |
2/18/2005 Warrants | | | (6,321 | ) | $ | 150.00 | | 2/18/2010 | |
7/16/2005 Warrants | | | (12,000 | ) | $ | 202.70 | | 7/16/2010 | |
| |
|
| | | | | | |
| | | | | | | | | |
Outstanding Balance at July 31, 2010 | | | 2,939,036 | | | | | | |
| |
|
| | | | | | |
| | | | | | | | | |
Exercised: | | | | | | | | | |
Class C Warrants | | | (1,955,782 | ) | $ | 1.12 | | 2/26/2015 | |
| | | | | | | | | |
Cancelled: | | | | | | | | | |
2/18/2005 Warrants | | | | | | | | | |
1/19/2006 Warrants | | | (417 | ) | $ | 25.00 | | 1/19/2011 | |
| | | | | | | | | |
| |
|
| | | | | | |
Outstanding Balance at July 31, 2011 | | | 982,837 | | | | | | |
| |
|
| | | | | | |
F-17
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
The above table excludes our Class B warrants for which 40,000 were issued and 10,000 were exercised during the year ended July 31, 2010. During the fiscal year ended July 31, 2010, the Company issued Class B Warrants to purchase up to $4,000,000 of principal amount of the Company’s 8% convertible notes on the same revised 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, and Class C warrants which entitle the warrant holder to purchase 10,256,416 shares of the Company’s Common Stock with an 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. The Class B Warrants expire on January 30, 2013.
All of our outstanding warrants (with the exception of the Class B warrants) contain a cashless exercise provision, whereby, the holder is entitled to receive a number of shares of common stock equal to (x) the excess of the market price of our common stock as of the trading day immediately prior to the exercise date over the total cash exercise price of the portion of the warrant then being exercised, divided by (y) the market price of our common stock as of the trading day immediately prior to the date of exercise.
For further information regarding the Company’s warrants please see Notes 9 and 10.
NOTE 7 – NOTES RECEIVABLE
The Company entered into an Agreement to Rescind an Asset Purchase Agreement, dated October 22, 2002. This Agreement requires the repayment of $148,640, consisting of principal and interest accrued to July 31, 2004. Payments of $1,607 (principal of $1,239 and interest at 5% of $368) begin December 30, 2004 and were to have continued monthly until the full balance was repaid. During fiscal 2009, the maker of the note stopped making payments and the Company reserved $83,100 at July 31, 2009. During fiscal 2010 the principal made only one payment of $1,610. The Company filed legal action and a Judgment was granted in favor of the Company. On March 28, 2011, the Company entered into a settlement agreement with Independent Computer Maintenance Corporation in which the Company received a payment of $10,000. This case is now closed.
NOTE 8 – NOTES PAYABLE - OFFICER
On July 28, 2011, Conolog Corporation issued a promissory note in favor of Robert Benou in the principal amount of $191,350, consisting of amounts previously advanced by Mr. Benou to the Company between January 24, 2011 and June 20, 2011. Mr. Benou is the Chief Executive Officer and Chairman of the Company. The Note is payable on demand and does not bear interest. The Note is subject to various default provisions and the occurrence of such an Event of Default will cause the outstanding principal amount under the Note, together with any and all other amounts payable under this Note, to become immediately due and payable to Mr. Benou.
On July 28, 2011, Conolog Corporation issued a promissory note in favor of Robert Benou in the principal amount of $65,000, consisting of amounts advanced by Mr. Benou to the Company on July 12, 2011 and July 18, 2011. Mr. Benou is the Chief Executive Officer and Chairman of the Company. The Note is payable on demand and does not bear interest. The Note is subject to various default provisions, and the occurrence of such an Event of Default will cause the outstanding principal amount under the Note, together with any and all other amounts payable under the Note, to become immediately due and payable to Mr. Benou.
F-18
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 9 – CONVERTIBLE DEBENTURES
August 2009 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 Debentures are converted. Additionally, the conversion price of the debenture is adjustable upon the occurrence of certain events. Accordingly, the conversion feature of the debenture was accounted for as a discount to the August 2009 debentures in the amount of $1,000,000 at their commitment dates.
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 10,256,416 shares of the Company’s Common Stock with an 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 Class A and Class B Warrants were accounted for as derivative liabilities resulting in a charge to derivative liability with a corresponding charge to the statement of operations at the commitment date of the August 2009 Debenture in the amount of $16,975,954.
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 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 accordance with the terms of the August 2009 Debentures, the occurrence of any of the following events shall, at the option of the note holder, make all sums of principal and interest then remaining unpaid immediately due and payable, upon demand:
| |
• | Failure to pay principal or interest when due and such failure continues for a period of five (5) business days after the due date. |
• | The Company breaches any material covenant or other term or condition of the subscription agreement and convertible debenture in any material respect and such breach, if subject to cure, continues for a period of ten (10) business days after written notice to the Company from the note holder. |
• | Breach of any material representation or warranty of the Company made in the subscription agreement or convertible debenture or in any agreement, statement or certificate given in writing shall be false or misleading in any material respect as of the date made and the closing Date. |
• | The Company or any Subsidiary of Company shall make an assignment for the benefit of creditors, or apply for or consent to the appointment of a receiver or trustee for them or for a substantial part of their property or business; or such a receiver or trustee shall otherwise be appointed. |
F-19
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
| |
| NOTE 9– CONVERTIBLE DEBENTURES (continued) |
| |
• | Any money judgment, writ or similar final process shall be entered or filed against the Company or any subsidiary of the Company or any of their property or other assets for more than $100,000, and shall remain unvacated, unbonded or unstayed for a period of forty-five (45) days. |
• | The Company shall have received a notice of default, which remains uncured for a period of more than twenty (20) business days, on the payment of any one or more debts or obligations aggregating in excess of One Hundred Thousand Dollars (US $100,000.00) beyond any applicable grace period; |
• | Bankruptcy, insolvency, reorganization or liquidation proceedings or other proceedings or relief under any bankruptcy law or any law, or the issuance of any notice in relation to such event, for the relief of debtors shall be instituted by or against the Company or any subsidiary of the Company and if instituted against them are not dismissed within sixty (60) days of initiation. |
• | Failure of the Common Stock to be quoted or listed on the NASDAQ National Market System; failure to comply with the requirements for continued listing on the Bulletin Board for a period of seven consecutive trading days; or notification from the Bulletin Board or the NASDAQ National Market System that the Company is not in compliance with the conditions for such continued listing on the NASDAQ National Market System. |
• | An SEC or judicial stop trade order or a NASDAQ National Market System trading suspension with respect to Borrower’s Common Stock that lasts for five or more consecutive trading days. |
• | The Company’s failure to timely deliver Common Stock to the note holder pursuant to and in the form required by this convertible note or subscription agreement, and, if requested by Company, a replacement convertible note, and such failure continues for a period of five (5) business days after the due date. |
• | The Company effectuates a reverse split of its Common Stock without twenty days prior written notice to the note holder. |
• | A default by the Company of a material term, covenant, warranty or undertaking of any agreement to which the Company and note holder are parties, or the occurrence of a material event of default under any such other agreement which is not cured after any required notice and/or cure period. |
In connection with the August 2009 Debentures 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. The assumptions used in computing the fair value are a closing stock price of $1.14, expected volatility of 108% over the remaining contractual life of five years and a risk free rate of 2.66%. The Company recorded the cash fee and the fair value of the warrants issued to Garden State Securities, Inc. plus $40,000 fee paid to an attorney totaling $371,025 as deferred financing costs. The deferred financing costs are being amortized over the term of the August 2009 Debenture agreement. As of July 31, 2011, the remaining balance was $0.
At various times during the fiscal 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 July31, 2011 and July 31, 2010 the remaining balance of the August 2009 debentures were $0.
February 2010 Debentures
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. Accordingly, the conversion feature of the debenture was accounted for as a liability resulting in a discount to the February 2010 debentures in the amount of $1,000,000 at their commitment dates. 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 a 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 assumptions used in computing the fair value are a closing stock price of $1.12, expected volatility of 108% over the remaining contractual life of five years and a risk free rate of
F-20
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
2.27%. The Company recorded the cash fee and the fair value of the warrants totaling $480,256 issued to Garden State as deferred financing costs. The deferred financing costs are being amortized over the term of the February 2010 Debenture agreement. As of July 31, 2011 the remaining balance was $0.
F-21
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 9 – CONVERTIBLE DEBENTURES (continued)
February 2010 Debentures (continued)
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 operations.
The February 2010 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 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 February 2010 Debentures, including outstanding interest due thereon are repaid.
In accordance with the terms of the February 2010 Debentures, the occurrence of any of the following events shall, at the option of the note holder, make all sums of principal and interest then remaining unpaid immediately due and payable, upon demand:
| |
• | Failure to pay principal or interest when due and such failure continues for a period of five (5) business days after the due date. |
• | The Company breaches any material covenant or other term or condition of the subscription agreement and convertible debenture in any material respect and such breach, if subject to cure, continues for a period of ten (10) business days after written notice to the Company from the note holder. |
• | Breach of any material representation or warranty of the Company made in the subscription agreement or convertible debenture or in any agreement, statement or certificate given in writing shall be false or misleading in any material respect as of the date made and the closing Date. |
• | The Company or any Subsidiary of Company shall make an assignment for the benefit of creditors, or apply for or consent to the appointment of a receiver or trustee for them or for a substantial part of their property or business; or such a receiver or trustee shall otherwise be appointed. |
• | Any money judgment, writ or similar final process shall be entered or filed against the Company or any subsidiary of the Company or any of their property or other assets for more than $100,000, and shall remain unvacated, unbonded or unstayed for a period of forty-five (45) days. |
• | The Company shall have received a notice of default, which remains uncured for a period of more than twenty (20) business days, on the payment of any one or more debts or obligations aggregating in excess of One Hundred Thousand Dollars (US $100,000.00) beyond any applicable grace period; |
• | Bankruptcy, insolvency, reorganization or liquidation proceedings or other proceedings or relief under any bankruptcy law or any law, or the issuance of any notice in relation to such event, for the relief of debtors shall |
F-22
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 9 – CONVERTIBLE DEBENTURES (continued)
February 2010 Debentures (continued)
| |
• | Be instituted by or against the Company or any subsidiary of the Company and if instituted against them are not dismissed within sixty (60) days of initiation |
• | Failure of the Common Stock to be quoted or listed on The NASDAQ Stock Market; failure to comply with the requirements for continued listing on the Bulletin Board for a period of seven consecutive trading days; or notification from the Bulletin Board or NASDAQ that the Company is not in compliance with the conditions for such continued listing on The NASDAQ Capital Market. |
• | An SEC or judicial stop trade order or a NASDAQ National Market System trading suspension with respect to Borrower’s Common Stock that lasts for five or more consecutive trading days. |
• | The Company’s failure to timely deliver Common Stock to the note holder pursuant to and in the form required by this convertible note or subscription agreement, and, if requested by Company, a replacement convertible note, and such failure continues for a period of five (5) business days after the due date. |
• | The Company effectuates a reverse split of its Common Stock without twenty days prior written notice to the note holder. |
• | A default by the Company of a material term, covenant, warranty or undertaking of any agreement to which the Company and note holder are parties, or the occurrence of a material event of default under any such other agreement which is not cured after any required notice and/or cure period. |
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, an aggregate $1,000,000 of the February 2010 Debentures and $63,790 of accrued interest were converted into an aggregate of 3,562,999 shares of common stock. The Company recognized an induced conversion cost of $649,147 related to these conversions.
As of July 30, 2011 the remaining balance of the February 2010 Debentures were $0.
Event of Default
On June 23, 2010, the Company received a NASDAQ Staff Deficiency Letter. As a result of the NASDAQ Staff Deficiency Letters, an event of default under the February 2010 Debenture occurred. The note holders did not exercise their rights upon an event of default and in December 2010 the Company received a waiver from note holders.
NOTE 10 – LOSS ON DERIVATIVE FINANCIAL INSTRUMENTS
Embedded Conversion Feature of August 2009 Debentures
The August 2009 Debentures contained a provision whereby we have the obligation to reduce the conversion price if we 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 is less than the conversion price of the August 2009 Debentures. Accordingly the embedded conversion feature was accounted for as a derivative liability. The Company calculated the fair value of the embedded conversion feature on August 3, 2009 and September 24, 2009 (commitment dates) to be $1,466,538 ($1,000,000 of which was recorded as debt discount and $466,538 was recorded as a loss on derivative financial instruments) using the Black-Scholes option pricing model. The weighted average assumptions used in computing the fair values are a closing stock price of $1.83, expected volatility of 117.4% over the remaining contractual life of one year and five months and a risk free rate of 2.46%. At various times throughout the three months ended October 31, 2009, the holders of the August 2009 Debentures converted $221,256 of the debentures into common shares of the Company’s stock. At each conversion date the Company marked to market the fair value of the derivative and reclassified it to additional paid in capital. The amounts reclassified to additional paid in capital aggregated $328,395 and were calculated using the Black-Scholes option pricing. The weighted average assumptions used in computing the fair value are a closing stock price of $1.99, expected volatility of 117.4% over the remaining contractual life of 1 year and a risk free rate of 2.37%. The fair value of the derivative increased by $277,475 during the year ended July 31, 2010, which has been recorded in the statements of operations.
F-23
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
NOTE 10 – LOSS ON DERIVATIVE FINANCIAL INSTRUMENTS (continued)
August 2009 Selling Agent Warrants
In connection with the August 2009 debentures, the Company issued to the selling agent, warrants to purchase 256,410 shares of common stock at an exercise price of $1.12. Under the original terms of the August 2009 Selling Agent Warrants we had the obligation to reduce the exercise price if we 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 is less than the exercise price of the August 2009 Selling Agent Warrants. Accordingly the warrants were accounted for as a derivative liability. The Company calculated the fair value of the warrants on August 3, 2009 at $231,025 using the Black-Scholes option pricing model. The assumptions used in computing the fair value are a closing stock price of $1.14, expected volatility of 108% over the remaining contractual life of five years and a risk free rate of 2.66%. The fair value of the derivative increased by $487,205 during the year ended July 31, 2010, respectively, which has been recorded in the statements of operations.
The February 2010 Debentures contain a provision whereby we have the obligation to reduce the conversion price if we 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 is less than the conversion price of the February 2010 Debentures. Accordingly the embedded conversion feature was accounted for as a derivative liability. The Company calculated the fair value of the embedded conversion feature on February 26, 2010 and March 3, 2010 (commitment dates) to be $1,714,462 using the Black-Scholes option pricing model. The weighted average assumptions used in computing the fair values are a closing stock price of $1.86, expected volatility of 240% over the remaining contractual life of one year and six months and a risk free rate of 2.28%. On June 18, 2010, the February 2010 Debentures were amended whereby the above anti-dilution provision was eliminated. As a result the embedded conversion feature of the February 2010 Debentures were no longer accounted for as a derivative. The Company calculated the fair value of the embedded conversion feature on June 18, 2010 using the Black-Scholes option pricing model. The weighted average assumptions used in computing the fair value as of June 18, 2010 are a closing stock price of $1.19, expected volatility of 151.7% over the remaining contractual life of one year and two months and a risk free rate of 0.30%. The fair value of the derivative at June 18, 2010 was $1,032,667 which was reclassified to additional paid in capital. The fair value of the derivative decreased by $681,795 which has been recorded in the statement of operations for the year ended July 31, 2010.
February 2010 Selling Agent Warrants
In connection with the February 2010 debentures, the Company issued to the selling agent, warrants to purchase 256,410 shares of common stock at an exercise price of $1.12. Under the terms of the February 2010 Selling Agent Warrants we have the obligation to reduce the exercise price if we 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 is less than the exercise price of the February 2010 Selling Agent Warrants. Accordingly the warrants were accounted for as a derivative liability. The Company calculated the fair value of the warrants on February 26, 2010 at $380,256 using the Black-Scholes option pricing model. The assumptions used in computing the fair value are a closing stock price of $1.98, expected volatility of 108% over the remaining contractual life of five years and a risk free rate of 2.30%. On June 18, 2010, the February 2010 Selling Agent Warrants were amended whereby the above anti-dilution provision was eliminated. As a result the warrants were no longer accounted for as a derivative. The Company calculated the fair value of the 256,410 exercised warrants on June 18, 2010 using the Black-Scholes option pricing model. The assumptions used in computing the fair value as of June 18, 2010 are a closing stock price of $1.12, expected volatility of 143.4% over the remaining contractual life of four years and eight months and a risk free rate of 2.04%. The fair value of the derivative at June 18, 2010 was $271,538 which was reclassified to additional paid in capital. The fair value of the derivative decreased by $108,717 which has been recorded in the statement of operations for the year ended July 31, 2010.
Class A Warrants
In connection with the August 2009 debentures, the Company issued Class A Warrants to purchase 2,564,102 shares of common stock. The warrants were issued with an exercise price of $1.12. Under the terms of the Class A Warrants we have the obligation to reduce the exercise price if we 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 is less than the exercise price of the Class A Warrants. Accordingly the warrants were accounted for as a derivative liability. The Company calculated the fair value of the warrants on August 3, 2009 at $2,310,256 using the Black-Scholes option pricing model. The assumptions used in computing the fair value are a closing stock price of $1.14, expected volatility of 108% over the remaining contractual life of five years and a risk free rate of 2.66%. The fair value of the derivative increased by $1,332,305 during the year ended July 31, 2010 which has been recorded in the statements of operations.
Class B Warrants
In connection with the August 2009 debentures, the Company issued Class B Warrants to purchase up to $4,000,000 of principal amount of the Company’s 8% convertible 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, and Class C warrants which entitle the warrant holder to purchase
F-24
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
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. The financial instruments underlying the Class B Warrants contain provisions whereby we will have the obligation to reduce the exercise price if we 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 is less than the exercise price of the Class C Warrants or conversion price of the 8% convertible notes. Accordingly the Class B Warrants were accounted for as a derivative liability. The Company calculated the fair value of the Class B Warrants on August 3, 2009 at $14,665,698 consisting of a fair value for the underlying Class C Warrants of $10,369,894 and a fair value for the underlying embedded conversion feature of the 8% convertible notes of $4,295,804. The Company used the Black-Scholes option pricing model. The assumptions used in computing the fair value of the Class C Warrants are a closing stock price of $1.14, expected volatility of 138.26% over the remaining contractual life of five years and a risk free rate of 2.66%. The assumptions used in computing the fair value of the embedded conversion feature of the 8% convertible notes are a closing stock price of $1.14, expected volatility 159.87% over the remaining contractual life of one year and six months and a risk free rate of 1.18%. The fair value of the derivative decreased by $3,218,370 during the years ended July 31, 2010 which has been recorded in the statements of operations.
F-25
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
| |
| NOTE 10 – LOSS ON DERIVATIVE FINANCIAL INSTRUMENTS (continued) |
| |
| Class C Warrants |
| |
| In connection with the February 2010 debentures, the Company issued Class C Warrants to purchase 2,564,102 shares of common stock. The warrants were issued with an exercise price of $1.12. Under the terms of the Class C Warrants we have the obligation to reduce the exercise price if we 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 is less than the exercise price of the Class C Warrants. Accordingly the warrants were accounted for as a derivative liability. The Company calculated the fair value of the warrants on February 26, 2010 and March 3, 2010 (commitment dates) at $3,974,618 using the Black-Scholes option pricing model. The weighted average assumptions used in computing the fair value are a closing stock price of $1.86, expected volatility of 108% over the remaining contractual life of five years and a risk free rate of 2.28%. On June 18, 2010, the Class C Warrants were amended whereby the above anti-dilution provision was eliminated. As a result the warrants were no longer accounted for as a derivative. The Company calculated the fair value of the 2,564,102 Class C warrants on June 18, 2010 using the Black-Scholes option pricing model. The weighted average assumptions used in computing the fair value as of June 18, 2010 are a closing stock price of $1.19, expected volatility of 143.4% over the remaining contractual life of four years and eight months and a risk free rate of 2.04%. The fair value of the derivative at June 18, 2010 was $2,713,745 which was reclassified to additional paid in capital. The fair value of the derivative decreased by $1,260,873 which has been recorded in the statement of operations for the year ended July 31, 2010.
On December 8, 2010, the Company reduced the exercise price of its outstanding Class C Warrants from $0.50 to $0.10. |
The following is a roll forward schedule of the Company’s derivative liability and components of the embedded conversion features for fiscal year ending 2010. There was no activity during fiscal year ending 2011:
| | | | | | | | | Number of | | | | | | | |
| | | Number of | | Number of | | Number of | | Warrants | | Face Value of | | Total | |
| | | Class A | | Class B | | Class C | | Issued to | | Convertible | | Derivative | |
| | | Warrants | | Warrants | | Warrants | | Selling Agent | | Debt | | Liability | |
| | | | | | | | | | | | | | | | |
| Balance 8/1/09 | | — | | — | | — | | — | | $ | — | | $ | — | |
| Granted | | 2,564,102 | | 40,000 | | — | | 256,410 | | | — | | | (17,206,979 | ) |
| Debt Issuance | | — | | — | | — | | — | | | 1,000,000 | | | (1,466,538 | ) |
| Debt Conversion | | — | | — | | — | | — | | | (221,256 | ) | | 328,395 | |
| Change in Fair Value of Derivative | | — | | — | | — | | — | | | — | | | (7,107,807 | ) |
| Balance 10/31/09 | | 2,564,102 | | 40,000 | | — | | 256,410 | | | 778,744 | | | (25,452,929 | ) |
| | | | | | | | | | | | | | | | |
| Reclassification due to Change in Exercise Price To $0.01 for 1,929,032 A Warrants | | — | | — | | — | | — | | | — | | | 2,723,600 | |
| Exercised | | (635,070 | ) | — | | — | | — | | | — | | | 918,961 | |
| Debt Conversion | | — | | — | | — | | — | | | (489,344 | ) | | 926,993 | |
| Change in Fair Value of Derivative | | — | | — | | — | | — | | | — | | | (9,178,209 | ) |
| Balance 1/31/10 | | 1,929,032 | | 40,000 | | — | | 256,410 | | | 289,400 | | | (30,061,583 | ) |
| | | | | | | | | | | | | | | | |
| Exercise (no impact as these were reduced to $0.01) | | (1,929,032 | ) | — | | — | | — | | | — | | | — | |
| Exercise | | — | | (10,000 | ) | — | | (256,410 | ) | | — | | | 718,230 | |
| Debt Issuance | | — | | — | | — | | — | | | 1,000,000 | | | (1,714,462 | ) |
| Debt Conversion | | — | | — | | — | | — | | | (289,400 | ) | | 488,625 | |
| Granted | | — | | — | | 2,564,104 | | 256,410 | | | — | | | (4,354,874 | ) |
| Change in Fair Value of Derivative | | — | | — | | — | | — | | | — | | | 13,743,309 | |
| Balance 4/30/10 | | — | | 30,000 | | 2,564,104 | | 256,410 | | | 1,000,000 | | | (21,180,755 | ) |
| | | | | | | | | | | | | | | | |
| Change in Fair Value of Derivative | | — | | — | | — | | — | | | — | | | 5,715,478 | |
| Reclassification to APIC | | — | | — | | — | | — | | | — | | | 15,465,277 | |
| Balance 7/31/10 | | — | | 30,000 | | 2,564,104 | | 256,410 | | $ | 1,000,000 | | $ | — | |
Fair Value Assumptions Used in Accounting for Derivative Warrant Liability
The Company has determined its derivative warrant liabilities to be a Level 2 fair value measurement and used the Black-Scholes pricing model to calculate the fair value at the adoption and for the first, second and third quarters of the fiscal year ended July 31, 2010. Key weighted average assumptions used in the Black-Scholes fair value calculation were as follows:
| | | July 31, | | April 30, | | January 31, | | October 31, | |
| | | 2010* | | 2010 | | 2010 | | 2009 | |
| | | | | | | | | | |
| | Expected term (in years) | | N/A | | 3.94 | | 3.86 | | 3.93 | |
| Volatility | | N/A | | 143.34 | % | 150.82 | % | 141.71 | % |
| Risk-free interest rate | | N/A | | 2.10 | % | 1.88 | % | 1.96 | % |
| Dividend yield | | N/A | | 0.00 | % | 0.00 | % | 0.00 | % |
| | | | | | | | | | |
* Inputs are not applicable as there are no derivative liabilities outstanding at July 31, 2010.
| |
| NOTE 11 – STOCK-BASED COMPENSATION |
| |
| 2002 Stock Option Plan |
| |
| On April 23, 2002, the Board of Directors of the Company adopted the 2002 Stock Option Plan (“the 2002 Plan”). Under the 2002 Plan, the Company may grant up to 158 shares of common stock as either incentive stock options under Section 422A of the Internal Revenue Code or nonqualified stock options. Subject to the terms of the 2002 Plan, options may be granted to eligible persons at any time and under such terms and conditions as determined by the 2002 Stock Option Committee (‘the Committee”). Unless otherwise determined by the Committee, each stock option shall terminate no later than ten years (or such shorter time as may be fixed by the Committee) after the date in which it was granted. The exercise price for incentive stock options must be at least one hundred percent (100%) of the fair market value of common stock as determined on the date of the grant. The exercise price for nonqualified stock options may not be granted at less than eighty-five percent (85%) of the fair market value of the shares on the date of grant.
As of July 31, 2011 and 2010, there had been no shares granted under the 2002 Plan. |
| |
| Stock Incentive Plans |
| |
| The Company has Stock Incentive Plans pursuant to which the Company may grant a number of shares of the Company’s Common Stock to the Company’s officers, directors, employees and consultants. The Company’s 2008 and 2009 Stock Incentive Plan was approved by its shareholders, authorizing the Board to, from time-to-time, issue up to 800,000 shares of the Company’s Common Stock to the Company’s officers, directors, employees and consultants under each plan.
The specific number of shares of the Company’s Common Stock granted to any officer, director employee or consultant will be determined by the Board.
Pursuant to the Corporation’s 2009 Stock Incentive Plan, 800,000 common shares of Company stock were issued to current officers, directors, employees and consultants. These shares were recorded at a value of $1,536,000 for the year ended July 31, 2010. The shares are fully vested and non-cancelable when granted therefore, the entire amount of stock grant compensation expense was recognized at the date the shares were authorized by the board of directors to be granted. |
F-26
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
| |
| Securities Issued for Services |
| |
| During the fiscal year ended July 31, 2010, the Company issued a total of 265,000 shares of common stock to non-employees for services rendered during the period or to be rendered in future periods. These services were valued at $508,800. Services to be performed beyond fiscal year 2010, will be amortized and expensed to general and administrative expenses. The unamortized amount of prepaid services at July 31, 2011 is $0. These services were valued at their fair value of consideration received at the date of the agreement in accordance with ASC 505 “Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than Employees”. |
| |
| NOTE 12 - MAJOR CUSTOMERS |
| |
| The following summarizes sales to major customers (each 10% or more of net sales) by the Company: |
| | | | | | | | | | | | | |
Year Ended | | Total Revenue | | Sales to Major
Customers | | Number of Customers | | Percentage of Total | |
|
|
|
|
|
|
|
|
|
|
|
|
| |
2011 | | $ | 1,691,852 | | $ | 1,373,787 | | | 3 | | | 81.2 | % |
2010 | | $ | 1,178,673 | | $ | 509,796 | | | 2 | | | 43.3 | % |
| |
| NOTE 13 – COMMITMENTS |
| |
| Total rental expense for all operating leases of the Company amounted to approximately $66,120 and $53,540 during the years ended July 31, 2011 and 2010, respectively. The Company currently leases its facilities on a month-to-month basis |
| |
| The Company’s Chief Executive Officer is serving under an employment agreement commencing June 1, 1997 and ending May 31, 2002, which pursuant to its terms, renews for one-year terms until cancelled by either the Company or the Chief Executive Officer. His annual base salary as of July 31, 2011 was $450,000 and increases by $20,000 annually on January 1st of each year. In addition, the Chief Executive Officer is entitled to an annual bonus equal to 6% of the Company’s annual “income before income tax provision” as stated in its annual Form 10-K. The employment agreement also entitles Chief Executive Officer to the use of an automobile and to employee benefit plans, such as; life, health, pension, profit sharing and other plans. Under the employment agreement, employment terminates upon death or disability of the employee and the employee may be terminated by the Company for cause. During the year ended July 31, 2011, the Company’s CEO forgave $105,000 of his accrued salary which was recorded as an addition to paid-in-capital. For the year ended July 31, 2011 $334,167 of the CEO’s salary has been accrued. |
| |
| The Company’s President and Chief Operating Officer is serving under an employment agreement commencing June 1, 1997 and ending May 31, 2002, which pursuant to its terms, renews for one-year terms until cancelled by either the Company or employee. His annual base salary as of July 31, 2011 was $260,200 and he receives annual increases of $6,000 on January 1st of each year. The Company’s President and Chief Operating Officer is entitled to an annual bonus equal to 3% of the Company’s annual “income before income tax provision” as stated in its annual Form 10-K. The employment agreement also entitles him to the use of an automobile and to employee benefit plans, such as life, health, pension, profit sharing and other plans. Under the employment agreement, employment is terminated upon death or disability of the employee and employee may be terminated by the Company for cause. During the year ended July 31, 2011 the Company’s President and Chief Operating Officer forgave $19,208 of his accrued salary which has been recorded as an addition to paid-in-capital. For the year ended July 31, 2011, $169,150 of the Company’s President and Chief Operating Officer’s salary has been accrued. |
| |
| The Company has an outstanding balance with its former auditors Withum, Smith & Brown (“WS+B”) and has agreed to pay the balance of $129,500 as follows: |
| | | |
| | • | Monthly installment payments of $1,000 commencing March 25, 2011. |
| | | |
| | • | 8% of all additional net financing received by Conolog over the next 22 months beginning February 25, 2011 and ending December 31, 2012. |
| | | |
| | • | Payment of $36,000 has been made based on the additional financing. |
| | | |
| | • | If there is still a remaining balance after December 31, 2012, the balance will be paid in Conolog common stock at the fair market value of the stock on December 31, 2012. |
| | | |
| | | On September 29, 2010 the Company received a subpoena from the Securities and Exchange Commission (the “Commission”) in connection with an informal fact finding inquiry, which as noted by the Commission should not be construed as an indication by the Commission or its staff that any violation of the law has occurred or as an adverse reflection upon any person, entity or security. The Company responded to the subpoena in November 2010. From November 2010 through the date of the filing of this Form 10-K, there has been no further correspondence from the Commission with respect to the subpoena. |
F-27
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
| |
| NOTE 14 – SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION |
| | | | | | | |
| | Year Ended
July 31, 2011 | | Year Ended
July 31, 2010 | |
CASH PAID DURING THE PERIOD FOR: | | | | | | | |
Interest expense | | $ | — | | $ | — | |
| |
|
| |
|
| |
Income Taxes | | $ | — | | $ | 11,099 | |
| |
|
| |
|
| |
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES: | | | | | | | |
Debt converted to equity | | $ | 1,000,000 | | $ | 1,037,949 | |
| |
|
| |
|
| |
Common stock issued for services to be provided | | | — | | $ | 508,800 | |
| |
|
| |
|
| |
Common stock issued for accrued interest | | $ | 63,790 | | $ | 39,545 | |
| |
|
| |
|
| |
Warrants granted to broker | | $ | — | | $ | 611,281 | |
| |
|
| |
|
| |
Cashless exercise of warrants | | $ | 16,467 | | $ | — | |
| |
|
| |
|
| |
| |
| NOTE 15 - SUBSEQUENT EVENTS |
| |
| On August 12, 2011 the Board of Directors of Conolog Corporation appointed Mr. Michael Horn as a member of the Board. In connection with the appointment, on August 15, 2011, the Company entered into a Director Agreement with Horn. The term of the Director Agreement is from August 15, 2011, up to the Company’s next annual stockholders’ meeting. The Director Agreement may, at the option of the Board, be automatically renewed on such date that Horn is re-elected to the Board. Horn is not due any compensation under the Director Agreement. On October 6, 2011, the Company completed its initial closing of the Private Placement. At the closing, the Company issued and sold an aggregate of 5,114,072 shares to 14 accredited investors at a purchase price of $0.10 per share receiving proceeds of $511,407. The subscription agreement contains representations and warranties that the parties made to, and solely for the benefit of, the other in the context of all of the terms and conditions of that agreement and in the context of the specific relationship between the parties. The provisions of the subscription agreement, including the representations and warranties contained therein, are not for the benefit of any party other than the parties to such agreements, and are not intended as documents for investors and the public to obtain factual information about the current state of affairs of the parties to those documents and their agreements.
These securities were not registered under the Securities Act of 1933, as amended (the “Securities Act”), but qualified for exemption under Section 4(2) of the Securities Act. The securities were exempt from registration under Section 4(2) of the Securities Act because the issuance of such securities by the Company did not involve a “public offering,” as defined in Section 4(2) of the Securities Act, due to the insubstantial number of persons involved in the transaction, size of the offering, manner of the offering and number of securities offered. The Company did not undertake an offering in which it sold a high number of securities to a high number of investors. In addition, these shareholders had the necessary |
| |
F-28
CONOLOG CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2011 AND 2010
| |
| NOTE 15 - SUBSEQUENT EVENTS (continued) |
| |
| investment intent as required by Section 4(2) of the Securities Act since they agreed to, and received, share certificates bearing a legend stating that such securities are restricted pursuant to Rule 144 of the Securities Act. This restriction ensures that these securities would not be immediately redistributed into the market and therefore not be part of a “public offering.” Based on an analysis of the above factors, the Company has met the requirements to qualify for exemption under Section 4(2) of the Securities Act. During the period August 1, 2011 through November 15, 2011 the Company repaid an aggregate of $106,350 of the notes payable to an officer (see Note 8). The balance owed at November 15, 2011 was $150,000. |
F-29
