Item 1. BUSINESS. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2.
Item 2. PROPERTIES
The Company owned facility, which management considers adequate for the Company's present requirements, is located at 5 Columbia Road, Somerville, NJ. This facility is used for manufacturing, sales and its executive offices and comprises 15,700 square feet.
In September 1998, the Company sold the building and improvements in a sale/leaseback transaction in which the Company is leasing approximately 38% of the total space in a three year rent-free lease.
Credit Facility
Background
On October 25, 1994, the Company and Chase Manhattan Bank (as successor by mergers with Manufacturers Hanover Trust Company and Chemical Bank) (the "Bank") restructured the Company's credit facility ("Credit Facility") between the Company and the Bank that had been in effect since April 5, 1989.
Under the restructured terms the Credit Facility had been extended as follows:
(i) Interest on the Credit Facility was to accrue but not be payable until July 31, 1995. Beginning on that date, interest payments were to be made in arrears on the last day of each month, with all unpaid interest previously accrued becoming due and payable on November 30, 1995.
(ii) All principal on the Credit Facility and other amounts owing to the Bank would become due and payable November 30, 1995.
The principal amount owing to the Bank at January 31, 1995 was $3,789,000 and the unpaid accrued interest was $584,728. The interest rate on the Credit Facility was 9.75% at January 31, 1995.
To secure payment under the Credit Facility, the Company granted the Bank a first priority lien on all accounts receivable, inventory, equipment and general intangibles of the Company and a lien on the Company's real property located at 5 Columbia Road, Somerville, New Jersey 08876.
Payment of liabilities of the Company to the Bank under the Credit Facility was guaranteed by Robert S. Benou, President of Company, to the extent of $965,000 and Arpad J. Havasy, Executive Vice President of the Company, to the extent of $492,500, and each had pledged all of his Common Stock and Series B Preferred Stock to the Bank to secure their respective guarantees.
Terms in Connection with August 1995 Offering
In connection with the August 1995 Offering the Bank and the Company agreed to restructure the Credit Facility as follows:
The Bank received from the proceeds of such offering a cash payment of $250,000 (the "Cash Amount"). The remaining debt, after giving effect to the payment to the Cash Amount was restructured as follows: (1) $1,025,000 was structured as a five- year term loan (the "Term Loan") bearing interest at the Bank's Reference Rate plus 125 basis points, to be amortized over 10 years; $50,000 per year for the first two years, $100,000 per year in the third and fourth years and $112,500 in the fifth year. After the fifth year, the balance of the payments was to be renegotiated at the Bank's option; and secured by the existing collateral; and (2) all debt owing to the Bank in excess of the Cash Amount and the Term Loan was converted into 375,000 shares of Common Stock of the Company (the "Bank Shares").
In addition, the Bank released the existing guarantees of Messrs. Benou and Havasy on the effective date of the August 1995 Public Offering. Finally, pursuant to the restructured 1996 Credit Facility the Bank was granted the right to appoint a member to the Company's Board of Directors
The debt forgiveness of $1,232,728 on restructuring of the obligation less the tax benefit thereon is accounted for as an extraordinary gain to the Company.
Credit Facility and Agreement with CNL Holdings, Inc.
The principal amount owing to the Bank under the Company's Credit Facility at June 30, 1996 and amended as of January 1,1997 was $1,012,500 and the unpaid accrued interest was $48,850. The Bank and the Company entered into the Conolog Corporation Allonge (dated as of September 11, 1996) pursuant to which the Amended and Restated Term Note dated as of August 2, 1995 between the Company and the Bank (the "Note") was further amended to permit the conversion by the Bank of the unpaid principal and interest due under the Note into 1,400,000 shares of the Company's Common Stock and provided for conversion to be exercised by the Bank or its assignee. The Bank deferred all payments of principal and interest under the Note until April 16, 1997.
Subsequently, on September 12, 1996 the bank and CNL Holdings, Inc., a private investor group, entered into an Option and Purchase, Sale and Assignment Agreement dated as of September 12, 1996 (the "Option Agreement"). Under the Option Agreement the Bank granted an option to CNL to purchase all of the Bank's interest in (i)the Amended and Restated Term Loan Agreement dated as of August 2, 1995 between the Company and the Bank, (ii) the Note and (iii) the 375,000 shares of the Company's Common Stock owned by the Bank. CNL paid $150,000 to the Bank for the option, which had an exercise price of $1,500,000 (a balance of $1,350,000) and an expiration date of April 15, 1997.
As part of the aforementioned transaction, CNL agreed to loan up to $2,500,000 to the Company under certain circumstances (as described below) and the Company agreed to file a registration statement (the "Registration Statement") with the Securities and Exchange Commission to register the 375,000 shares of Common Stock owned by the Bank and the 1,400,000 shares of Common Stock into which the Note is convertible (collectively, the "Acquired Shares"). As of January 21, 1998 CNL Holdings, Inc. had loaned the Company $916,235 which was repaid at the closing of the Company's public offering.
Each CNL loan carried interest at the rate of 4% per annum and became due 12 months from the date of such Loan. At maturity, the Company had the option to pay each Loan, together with all accrued interest thereon, or by issuing shares of a new Series C Preferred Stock (the "Series C Preferred") having a value of $5.00 per share for purposes of such repayment.
Had the Series C Preferred been issued, it would have been non-voting and carried a cumulative dividend of 8% per annum which would payable by the issuance of shares of Common Stock valued at $5.00 per share up to a maximum of 40,000 shares per annum. The Series C Preferred would have been convert- ible into common stock at the rate of one share of common stock for each share of Series C Preferred and had a liquidating preference of $5.00 per share.
The Agreement also provided that for the two year period commencing on the issuance of any shares of Series C Preferred (the "Registration Period") CNL may have elected to include its Series C Preferred in any post-effective amendment to the Registration Statement or any new registration statement under the Securities Act of 1933, as amended. In addition, the Agreement also provided that during the Registration Period, CNL may have given notice to the Company to the effect that it desired to register its shares under the Act for public distribution in which case the Company would file a post - -effective amendment to a then current registration statement or a new registration statement.
Management believes that these transactions benefited the Company and its stockholders. The exercise by CNL of its option under the Option Agreement converted the Remaining Debt Claim. The Company had the opportunity to, in effect, exchange its debt for equity and eliminated the Company's default under the Credit Facility.
Bridge Loan
In December 1996 and January 1997, the Company obtained Bridge financing from seven (7) lenders in the amount of $200,000. These lenders were the individuals identified as "Selling Security holders." In exchange for making the loans to the Company, each Selling Security holder received two (2) promissory notes (the "Bridge Notes"). Certain Bridge Notes were in the aggregate principal amount of $150,000 (the "Principal Bridge Notes") and the other Bridge Notes were in the aggregate principal amount of $50,000 (the "Convertible Bridge Notes"). Each of the Bridge Notes bore interest at the rate of eight percent (8%) per annum.
The Bridge Notes were due and payable upon the earlier of (i) January 31, 1999 or (ii) the date on which the next public offering closed. The Convertible Bridge Notes were convertible into a total of 1,200,000 Class A Warrants. The proceeds of the bridge financing were used by the Company to pay certain expenses in connection with this offering and to increase working capital. Each Class A Warrant contained in the Convertible Bridge Notes was identical to the Class A Warrants offered therein.
The Company's agreement with the Selling Security holders provided that the Company would include in its registration statement a prospectus covering the Class A Warrants owned by the Selling Security holders.
On September 12, 1997 the Company filed a Registration Statement on Form S-1 with the Securities and Exchange Commission. This statement covered the primary offering of securities of the Company and the offering of other securities by certain selling Security Holders. The Company registered, under a primary Prospectus 805,000 Units, each Unit consisting of one (1) share of common stock and four (4) Class A warrants. The selling Security Holders registered, under an alternate prospectus, 1,200,000 Class A warrants.
The costs were subsequently deducted from the proceeds of the sale of stock.
The Bridge loans were repaid on January 28, 1998 at the closing of the Company's Public Offering.
Item 3.
Item 3. LEGAL PROCEEDINGS
The Company is not subject to any material pending legal proceedings.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fiscal quarter ended January 31, 1997, shareholders of the Company approved an amendment to the Certificate of Incorporation to increase the total number of authorized shares of all classes of stock from 6,500,000 (of which 500,000 shares were classified as Preferred Stock and 6,000,000 shares are classified as Common Stock) to 22,000,000 shares of which 2,000,000 shares are classified as Preferred Stock and 20,000,000 shares are classified as Common Stock.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET PRICE FOR COMMON STOCK AND CLASS A WARRANTS
The Company's Common Stock and Warrants are thinly traded on the Nasdaq SmallCap Market, under the symbols CNLG and CNLGW, respectively. Prior to the August 1995 Offering, the Common Stock was traded on the OTC Bulletin Board.
The following table sets forth, for the periods indicated, the high and low prices of the Company's Units (which no longer trade), Common Stock and Warrants traded on the Nasdaq SmallCap Market for 1996, 1997 and the first, second and third quarters of 1998. As of October 22, 1998, the Company's Common Stock was held by approximately 817 shareholders of record.
Units Common Stock Warrants
High Low High Low High Low
First 15.00 11.00 8.125 3.875 2.00 .9375 Quarter
Second 11.25 11.25 6.5625 4.25 1.00 1.0156 Quarter
Third __ ___ 6.25 2.25 1.50 .5625 Quarter
Fourth __ ___ 3.875 2.375 1.25 .50 Quarter
First ___ ____ 5.875 3.00 .9375 .625 Quarter
Second ___ ____ 6.125 2.375 1.000 .375 Quarter
Third ___ ____ 5.675 2.250 .875 .250 Quarter
Fouth Quarter ___ ____ 4.250 2.500 1.000 .250
First Quarter ___ ____ 6.00 2.000 2.1875 .4375
Second Quarter ___ ____ 3.875 1.375 1.000 .375
Third Quarter ___ ____ 2.00 0.4375 0.4375 .0625
DIVIDENDS
Holders of Common Stock are entitled to receive such dividends as may be declared by the Board of Directors of the Company. To date, the Company has neither declared nor paid any dividends on its Common Stock or on its Preferred A or Preferred B share. The Company anticipate that no such dividends will be paid in the foreseeable future. Rather, the Company intends to apply any earnings to the expansion and development of its business. Any payment of cash dividends on any of its securities in the future will be dependent upon the future earnings of the Company, including its financial condition, capital requirement and other factors which the Board of Directors deems relevant
Item 6.
Item 6. SELECTED FINANCIAL DATA Year Ended July 31, (in thousands, except 1998 	 1997 1996 1995 1994 per share amounts)
Operations Summary: Net sales and other $746 $1,123 $1,924 $2,091 $2,045 income
Net income (loss) from (1,765) (3,810) 292 (537) (1,183) continuing operations
Income (loss) from continuing operations per primary (.54) (2.41) 0.28 (0.12) (0.27) share
Income (loss) from continuing operations after giving retroactive effect to a 1 for - 		 - - (12.36)(27.22) 100 reverse stock split on August 16, 1995 Balance Sheet Summary: Total assets $4,819 $4,340 $3,928 $3,882 $3,739 Long-term debt and capitalized lease 	 - 	 - $5 $34 $3,830 obligations
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
In order to summarize the Company's operating results for the past three years, the following tables indicate the percentage relationships of income and expense items in the statements of income and the percentage changes in those items for such years.
Income & Expense Items as Income & Percentage a Percentage Of Revenues Expense Items Increase/Decrease From Operations For The Years Ended July 31 1998 1997 1996 1997 to 1996 to 1995 to 1998 1997 1996 100.0% 100.0% 100.0% Sales & (33.6%) (41.6%) (8.0%) other income 126.0%* 84.2%* 67.2* Cost of (0.5) (27.9) (32.9) products sold 207.4 182.9 49.2 Selling, (24.6) (117.0) 3.4 general & administrat ive 3.0 7.4 6.8 Interest (72.9) (38.0) (51.8)
336.5 274.4 123.2 Total costs (18.5) 29.9 (23.0) & expenses (236.5) (174.4) (23.2) Income (9.9) (338.5) (56.5) (loss) before taxes - .9 - Income (98.0) 494.2 (100.0) taxes (credits) (236.5)%(175.3)%(23.2)% Loss before (10.4)% (339.0)% (16.5)% extraordinary item
* Includes write-offs for obsolete or excess inventory which were $410,759, $28,101, and $50,281 in 1998, 1997,and 1996 respectively.
Results of Operations
1998 Compared to 1997
Total revenue decreased $376,970 or 33% from $1,123,391 to $746,420 in 1998. This decrease was attributable, in part, to delays in the release of tone protection orders from the Bonneville Power Authority and other utilities customers which the Company attributes to budget constraints and the delay in the release of its new advanced PTR1500 tone protection system. The Company shipped its PTR1500 prototype to the General Electric Company (GE) in May 1998 for extensive electrical and environmental tests. As a result of these tests, the Company has agreed to and is presently redesigning some modules to accommodate modifications requested by GE to expand the product's range. The Company plans to ship the expanded prototypes in late 1998 and production models by the end of the third quarter ending April 30, 1999.
1998 Compared to 1997 (Continued)
Gross Margins, exclusive of inventory adjustments for the years ended July 31, 1998 and 1997 totaled $216,462 and $206,011 representing 29% and 18% of revenues. Gross margins for 1998 were higher than 1997 due to efficiencies in lower operating costs.
Selling, General and Administrative expenses decreased from $2,054,630 in 1997 to $1,548,446 in 1998 representing a decrease of 24.6% or $506,184. This decrease is attributable to less shares of common stock being issued as compensation.
Interest expense totaled $22,447 for the year ended July 31, 1998 compared to $82,932 for the year ended July 31, 1997. This decrease was a result of the debt repayment from proceeds of the Company's Public Offering.
As a result of the foregoing, the Company reported a net loss of $1,765,390 or $0.54 per share. This compares to a net loss of $3,810,736 or $1.24 per share for the same period last year.
1997 Compared to 1996
Total revenue decreased $801,076 or 42% from $1,924,466 to $1,123,391 in 1997. This decrease was attributable to delays in the release of tone protection orders from the Bonneville Power Administration and other customers. The Company attributes these delays to the budget constraints for various utilities and to the pending release of the new advanced tone protection device, the PTR-1500. The Company essentially completed the prototypes during the first fiscal quarter ended October 31, 1997. The Company plans to ship prototypes to GE during November 1997.
Gross Margins, inclusive of inventory adjustments for the years ended July 31, 1997 and 1996 totaled $177,910 & $632,185 representing 15.8% and 32.9% of revenues. Gross margins for 1997 were lower than 1996 due to the lower utilization of the factory in fiscal 1997 over 1996. Selling, General and Administrative expenses increased from $946,954 in 1996 to $2,054,630 in 1997 representing an increase of 117%. This increase is the result of the Company issuing 359,500 shares of Common Stock to eight employees, incurring an additional $1,313,750 in salary expense.
Interest expense totaled $82,932 for the year ended July 31, 1997 compared to $133,652 for the year ended July 31, 1996. This decrease was a result of lower outstanding loan balances resulting from the paydown of the credit facility during the year.
As a result of the foregoing, the Company reported a net loss before extraordinary item of $1,969,736 or $1.24 per share. This compares to a net loss before extraordinary item of $448,622 or $.43 per share for the same period last year.
1996 Compared To 1995
Revenues for the year ended July 31, 1996 decreased to $1,924,466 from $2,090,933 for the twelve months of the prior year, representing a decrease of 8.0%. Revenues declined as a result of a decline in sales in the military sector. The Company completed a large sale of switches to the military in Fiscal 1995 and did not have a comparable sale for Fiscal 1996.
Gross margins for the year totaled $632,184 and $163,194, respectively, representing 32.9 % and 7.8%, respectively, of revenues. Gross margins were higher in 1996 due to the obsolete inventory write-off in 1995. Without the inventory write-off the 1996 and 1995 gross margin would have been 35.5% and 39.3%, respectively. The gross margin for 1996 was lower than 1995 without the inventory write-off due to the fact that higher than normal discounts were offered and taken on two major sales.
Selling, general and administrative expenses increased from $916,016 in 1995 to $946,954 in 1996, representing an increase of 3.4%. These expenses increased as a result of an expansion of the employment base and an increase in advertising and promotion costs.
Interest expense totaled $133,652 for the year ended July 31, 1996 as compared to $277,440 in interest expense for the year ended July 31, 1995. The Company reached a debt restructuring agreement with the Bank during 1995 that resulted in having no interest expense for the quarter ended April 30, 1996.
As a result of the foregoing, the Company reported a net income of $291,754, or $.28 per share. The 1996 net profit was inclusive of a debt compromise of $740,376, net of a tax benefit of $492,352. This compares to a net loss of $537,290 or $.12 per share for the same period last year (after retroactive effect to a 1 for 100 reverse split on August 16, 1995 and after extraordinary item in 1996).
As of July 31, 1996 the Registrant's backlog of orders was approximately $3.4 million, representing a mix of military and commercial telecommunication products. The Company anticipates its commercial shipments to grow as a percentage of total sales for the foreseeable future.
LIQUIDITY AND CAPITAL RESOURCES
Working capital at July 31, 1998 was $4,192,541 compared to $2,456,121 at year ended July 31, 1997. The improvement in the working capital is primarily attributable to higher cash reserves and lower debt due to the Company's Public Offering.
Accounts receivable have decreased from $109,571 at year-end July 31, 1997 to $44,477 at July 31, 1998. This decrease of $65,094 is the result of lower average sales for fiscal 1998 versus 1997.
The Company plans to meet its cash requirements for the next twelve months through existing cash balances and cash generated from operations . In addition, the Company believes that it can obtain financing from institutional investors secured by its assets, if necessary.
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.
Y2K Issues
The company has contracted a Y2K solution provider to review its mainframe computer system for Y2K issues and to upgrade the computer system to be Y2K compliant. The Company anticipates that the upgrade will be completed by fiscal year end July 31, 1999. The Company is also in the process of contacting all of its major suppliers to request representations that their systems are or will be Y2K compliant. The Company is in the process of determining the impact, if any, that third parties who are not Y2K compliant may have on its operations.
	Management estimates that the cost of its Y2K compliance program will be $5,000; In the event that this upgrade will not be ready, the Company has a contingency plan that is not Y2K reliant.
	The Company's entire product line is not date sensitive and the Company presently believes that there are no potential product-related implications that may result from Y2K issues.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of Conolog Corporation, together
with notes and the Independent Auditors Report, are set forth immediately following Item 14 of this Form 10-K.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
MANAGEMENT
Directors and Executive Officers
The following table sets forth certain information regarding the officers and directors of the Company as of July 31, 1998.
NAME AGE POSITION
Robert S. Benou 64 President and Director
Arpad J. Havasy 62 Executive Vice President, Secretary, Treasurer and Director
Louis S. Massad 61 Director
Marc R. Benou 31 Vice President, Assistant Secretary and Director
Edward J. Rielly 31 Director
Thomas Fogg 63 Vice President-Engineering
Robert S. Benou has served as President and a Director of the Company since 1968. Mr. Benou is responsible for military products, new product development and supervision of sales and marketing. 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.
Arpad J. Havasy has served as the Company's Executive Vice President and Director since 1968. Mr. Havasy is a graduate of Electromos E's Gepeszeti Technikum (Hungary) and the University of Budapest. In addition, Mr. Havasy has attended courses at both Rutgers University and the American Management Association. Mr. Havasy is on total disability.
Louis S. Massad has been a Director of the Company since April 1995. Mr. Massad has been Vice President, Chief Financial Officer and Director of Computer Power Inc. since 1986. Mr. Massad holds a BS and MS degree from Cairo University (Egypt) and an MBA from Long Island University, New York.
Marc R. Benou joined the Company in 1991 and is responsible for material, purchasing and inventory control. In March 1995, he was elected Vice President, Assistant Secretary and a Director. Mr. Benou attended Lehigh and High Point University and holds a BS degree in Psychology and a BS in Business Administration and Management. Marc R. Benou is the son of Robert S. Benou, the Company's President.
Thomas R. Fogg joined the Company in 1976 as Chief Engineer responsible for analog and guidance projects. Since 1986, when he became Vice President-Engineering, he led the design team in the development of the Company's commercial products. Mr. Fogg holds a BSEE degree from Lafayette College and a MSEE degree from Rutgers University. Mr. Fogg is a fellow of the Institute of Electrical and Electronic Engineers and has published articles on delay equalization and the use of crystal resonators.
Edward J. Rielly has been a Director of the Corporation since January 1998. Mr. Rielly is an Application Developer with Chubb & Son. 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.
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.
Section 16 (a) Beneficial Ownership Reporting Requirements There were no delinquent or untimely filers during the fiscal year.
Item 11.
Item 11. EXECUTIVE COMPENSATION
Executive Compensation
The following table sets forth the cash compensation (consisting entirely of salary) paid (or accrued for) by the Company to its President, the only executive officer whose aggregate remuneration exceeded $100,000 in each of the three Company's fiscal years ended July 31, 1998, 1997 and 1996:
Summary Compensation Table
Annual Compensation Long Term Compensation
Name and Other Annual Principal Fiscal Compensation Position Year-End Salary Bonus (1) Awards Payouts
1998 $170,000 0 0 0 Robert Benou, President 1997 $150,000 0 0 0
1996 $150,000 0 0 0
_________________
Incentive Stock Option Plan
On May 15, 1995, the Board of Directors of the Company adopted and on August 14, 1995, the shareholders approved the Conolog Corporation 1995/1996 Stock Option Plan ( the "Option Plan"). The Option Plan is designed to permit the Company to grant either incentive stock options under Section 422A of the Internal Revenue Code (the "Code") or nonqualified stock options. Under the Option Plan, a Stock Option Committee (the "Option Committee") of the Board is authorized to grant options to purchase up to 200,000 shares of stock to key employees, officers, directors and consultants of the Company. The Option Committee administers the Option Plan and designates the optionee's, the type of options to be granted (i.e., nonqualified or incentive stock options), the number of shares subject to the options, and the terms and conditions of each option. The terms and conditions include the exercise price, date of grant, and date of exercise of each option. An employee may, at the discretion of the Option Committee, be permitted to exercise an option and make payment by giving a personal note.
Incentive stock options may only be granted to employees of the Company and not to directors or consultants who are not so employed. The exercise price for incentive stock options must be at least one hundred percent (100%) of the fair market value of the Common Stock as determined by the Option Committee on the date of grant. All incentive stock options under the Option Plan must be granted within ten (10) years from the date of adoption of the Option Plan and each option must be exercised, if at all, within ten (10) years of the date of grant. In no event may any employee be given incentive stock options whereby more than $100,000 of options become exercisable for the first time in a single calendar year. All incentive stock options must be exercised by an option within three (3) months after termination of the optionee's employment, unless such termination is as a result of death, disability or retirement. In the event an optionee's employment is terminated as a result of death or disability, such optionee or his designated beneficiary shall be entitled to exercise any and all options for a period of twelve (12) months after such termination. If an optionee's employment is terminated as a result of retirement, the optionee shall be entitled to exercise his options for a period of twenty four (24) months following such termination.
Nonqualified stock options under the Option Plan are generally subject to the same rules as discussed above. Nonqualified stock options may, however, also be granted to directors and consultants, whether or not such individuals are employees of the Company. 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.
No incentive stock options or non-qualified options have been granted.
EMPLOYMENT AGREEMENTS
The Company has entered into a 5-year employment agreement commencing June 1, 1997 and ending May 31, 2002, with Robert Benou. Under his employment agreement, Mr. Benou will receive an annual base salary of $150,000 for the first year of employment with an increase of $20,000 beginning November 1997 and every profitable year thereafter. 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 employee may be terminated by the Company for cause. The company intends to maintain a $1 million life insurance policy on the life of Robert Benou.
The Company has entered into a 5-year employment agreement commencing June 1, 1997 and ending May 31, 2002, with Marc Benou. Under his employment agreement, Mr. Benou will receive an annual base salary of $55,000 for the first year of employment with an increase of $6,000 beginning June 1998 and every year thereafter.
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 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 terminated upon death or disability of the employee and employee may be terminated by the Company for cause.
On March 12, 1998, the Company entered into a five year employment with Dina Stellwagen to serve as Corporate Development Manager. Base salary is $50,000 per annum with annual increases of $4,000. The agreement calls for the Corporate Development Manager to receive a quarterly bonus of 5,000 shares of Common Stock that have not been registered and eligible for sale under Rule 144 code. The employment agreement also entitles her to the use of an automobile and to reimburse her for all ordinary and necessary business expenses. Eligibility for all employee benefit plans, such as life, health, pension, profit sharing and other plans is provided under the agreement, however, the Company is not obligated to establish or maintain any of the afore- mentioned executive plans. Upon termination without cause, the agree- ment provides for severance compensation equal to 2.99 times the average annual compensation.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of outstanding shares of Common Stock of the Company as of the date hereof by any person who, to the knowledge of the Company, owns beneficially more than 5% of the outstanding Common Stock, by all directors of the Company, and by the directors and officers of the Company as a group.
Name and Amount and Address of Nature of After Beneficial Owner(1) Beneficial Ownership Offering
Robert S. Benou 220,000 5.8%
Arpad J. Havasy 55,000 1.5%
Marc R. Benou 45,000 	 1.2%
Louis Massad 5,000 .1%
Edward J. Rielly 500 		 .0% All Directors and Officers as a Group (5 persons) 325,500 8.6%
(1) The address for these individuals is c/o Conolog Corporation, 5 Columbia Road, Somerville, New Jersey 08876.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CERTAIN TRANSACTIONS On August 16, 1995, the Company effected a 1-for-100 reverse stock split of its Common Stock on all shares of Common Stock outstanding as of that date.
On August 16, 1995, holders of 19,360 shares of the Company's Series B Preferred Stock (Robert Benou and Arpad J. Havasy, officers and directors of the Company) converted their shares of Series B Preferred Stock into 387,200 shares of Common Stock (3,872 post-split shares).
On August 16, 1995, $381,533 of the $420,179 of accrued dividends on the Series B Preferred Stock at December 31, 1994 were converted into 76,306 shares of Common Stock and the remaining dividends due to such holders (Messrs. Benou and Havasy) were waived.
On August 16, 1995, accrued salaries of $309,109 owed by the Company to Mr. Benou were converted into 61,822 shares of Common Stock Payment of the Company's liabilities to the Bank under the Credit Facility were guaranteed by Mr. Benou to the extent of $965,000 and Mr. Havasy to the extent of $492,000. Their respective guarantees were secured by a pledge to the Bank of all Common Stock and Series B Preferred Stock owned by each of them. As a result of the August 1995 Offering, the Bank released the guarantees.
Article Eighth of the Company's Certificate of Incorporation provides that the Company shall, to the full extent permitted by Section 145 of the Delaware General Corporation Law, as amended from time to time, indemnify all persons whom it may indemnify pursuant thereto.
Section 145 of the General Corporation Law of the State of Delaware authorizes a corporation to provide indemnification to a director, officer, employee or agent of the corporation, including attorneys' fees, judgments, fines and amounts paid in settlement, actually and reasonably incurred by him in connection with such action, suit or proceeding, if such party acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful as determined in accordance with the statute, and except that with respect to any action which results in a judgment against the person and in favor of the corporation the corporation may not indemnify unless a court determines that the person is fairly and reasonably entitled to the indemnification. Section 145 further provides that indemnification shall be provided if the party in question is successful on the merits.
Insofar as indemnification for liabilities arising under the Securities Act of 1933 (the "Act") may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. If a claim for indemnification against such liabilities (other than the payment by the Company of expenses incurred or paid by a director, officer or controlling person in connection with the securities being registered) the Company will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.
The Company has adopted a policy that transactions with affiliated entities or persons will be on terms no less favorable than could be obtained from unrelated parties and that all transactions between the Company and its officers, directors, principal shareholders and affiliates will be approved by a majority of the Company's Board of Directors.
FORWARD LOOKING STATEMENTS
The foregoing contains certain forward looking statements. Due to the uncertainties associated with doing business with governmental entities and the release of backlog orders and competition in a business characterized by rapid technologic changes and advances, actual results may differ materially from any such forward looking statements.
PART IV
Item 14.
Item 14. EXHIBITS AND REPORTS ON FORM 8-K
(a)Financial Statements
Balance Sheets as of July 31, 1998 and 1997 -3 Statements of Operations for the years ended July 31, 1998 and 1997 						
Statements of Stockholders' Equity for the years ended July 31, 1998 , 1997 and 1996 -6 Statements of Cash Flows for the years ended July 31, 1998 and 1997 -8 Notes to Financial Statements to-17
Index of Exhibits
Item 16. Exhibits - None.
Exhibit No. Description of Exhibit
1(a)* Form of Underwriting Agreement
1(b)* Form of Selected Dealer Agreement
1(c)* Form of Agreement Among Underwriters
3(a) Certificate of Incorporation - incorporated by reference to the Registrant's Exhibit 3.01 to Registration Statement on Form S-1 (File No. 2-31302).
(b) Certificate of Amendment of Certificate of Incorporation - incorporated by reference to Exhibit 3.02 to the Registrant's Registration Statement on Form S-1 (File No. 2- 31302).
(c) Certificate of Amendment of Certificate of Incorporation incorporated by reference to Exhibit 4 to the Registrant's Current Report on Form 8-K for July 1971.
(d) 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." - incorporated by reference to Exhibit 3.03(a) to the Registrant's Registration Statement on Form S-1 (File No. 2-31302).
(e) 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. - incorporated by reference to Exhibit 3.04 to the Registrant's Registration Statement on Form S-1 (File No. 2-31302).
(f) 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. - incorporated by reference to Exhibit 1 to the Registrant's Current Report on Form 8-K for November 1972.
(g) Certificate of Ownership and Merger respecting merger of Conolog Corporation into the Registrant and the changing of the Registrant's name from "DSI Systems, Inc." to "Conolog Corporation" - incorporated by reference to Exhibit 3 to the Registrant's Current Report on Form 8-K for June 1975.
(h) 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(a)* Specimen Certificate for shares of Common Stock
(b)* Specimen Certificate for Class A Warrant
(c)* Form of Warrant Agreement
(d)* Form of Representative's Unit Purchase Option
(e)* Form of Financial Consulting Agreement
10.1 Credit Facility documents between Manufacturers Hanover Trust Company and the Registrant pursuant to which Registrant obtained a Credit Facility for $4,000,000 - incorporated by reference to Exhibit 6A-D to the Registrant's Current Report on Form 8-K dated April 5, 1989.
10.2 * Conolog Corporation 1995/1996 Stock Option Plan.
10.3 *** Option and Purchase, Sale and Assignment Agreement, dated as of September 12, 1996 by and between The Chase Manhattan Bank and CNL Holdings, Inc.
10.4 *** Irrevocably Proxy dated as of September 12, 1996 by and between CNL Holdings, Inc. and Conolog Corporation.
10.5 *** Agreement dated September 12, 1996 by and between CNL Holdings, Inc. and Conolog Corporation.
10.5 (A)** Amendment No. 1 dated January 31, 1997 to Conolog Corporation Allonge.
10.6 Agreement with General Electric Company dated April 1, 1997 incorporated by reference to the Company s Form 10-Q for the quarter ended April 30, 1997.
10.7**** Employment Agreement dated June 1, 1997 between Robert Benou and Conolog Corporation
10.8**** Employment Agreement dated June 1, 1997 between Marc Benou and Conolog Corporation
10.9***** Employment Agreement dated March 1, 1998 between Dina Stellwagen and Conolog Corporation ___________________
* Incorporated by reference to the Registrant's Registration Statement on Form S-1 (33-92424).
** Filed by Amendment to the Registrant's Registration Statement file on Form S-1 (File No. 0-8184) as filed on October 16, 1996.
*** Incorporated by reference to the Registrant's Registration Statement file on Form S-1 (File No 0-8174) as filed on October 16, 1996
**** Incorporated by reference to the Registrant's Registration Statement on Form S-1 (File No. 0-8174) as filed on September 12,
(b) Reports on Form 8-K None
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 	Conolog Corporation 	By: October 29, 1998	/s/ Robert S. Benou 	President, Chief Executive 	Officer and Chairman of the Board
In accordance with the Exchange Act, this report has been signed below by the following persons, on behalf of the registrant and in the capacities and on the dates indicated.
October 29, 1998 	/s/Robert S. Benou 	President, Chief Executive Officer 	and Chairman of the Board
October 29, 1998	/s/Arpad J. Havasy 	Executive Vice President, Secretary, 	Treasurer and Director
October 29, 1998	/s/Marc R. Benou 	Vice President, Assistant Secretary and Director
October 29, 1998	/s/Louis S. Massad 	Director
				 Annual Report on Form 10-K
				Item 8, Item 14 (a)(1) and (2)
			 Financial Statements
			 Year Ended July 31, 1998
		 	 Conolog Corporation
				Somerville, New Jersey 08876
				Form 10-K Item 14(a)(1) and (2) Index to the Financial Statements 		 Conolog Corporation 		 July 31, 1998
The following financial statements of the registrant are included in
Item 14:
Balance Sheets - July 31, 1998 and 1997 ......................... -3
Statements of Operations - Years Ended July 31, 1998, 1997 and 1996 .............................................
Statements of Stockholders' Equity (Deficiency) - Years Ended July 31, 1998, 1997 and 1996 ......................... -6
Statements of Cash Flows - Years Ended July 31, 1998, 1997 and 1996 .. . . ....................................... -8
Notes to Financial Statements ....................................-17
			Independent Auditors' Report To the Board of Directors Conolog Corporation
We have audited the accompanying balance sheets of Conolog Corporation as of July 31, 1998 and 1997 and the related statements of operations, stockholders' equity (deficiency) and cash flows for each of the three years in the period ended July 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. 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 financial statements referred to above present fairly, in all material respects, the financial position of Conolog Corporation at July 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended July 31, 1998 in conformity with generally accepted accounting principles.
/s/Rosenberg Rich Baker Berman & Company Bridgewater, New Jersey October 9, 1998
	 	 Conolog Corporation Balance Sheets
July 31, 1998 1997 --------- --------- ASSETS
Current Assets Cash and equivalents $ 1,108,581 $ 503,217 Accounts receivable - less allowances of $6,000 in 1998 and 1997 44,477 109,571 Inventories Finished goods 905,939 1,705,782 Work-in-process 1,205,450 498,070 Materials and supplies 1,098,879 969,940 ---------- ---------- 3,210,268 3,173,792
Other current assets 36,347 44,085
Deferred offering costs - 113,813
---------- ---------- 4,399,673 3,944,478
Property, Plant and Equipment Land and improvements 34,524 34,524 Building and improvements 700,461 663,630 Machinery and equipment 1,328,218 1,291,838 Furniture and fixtures 341,607 336,001 ---------- ---------- 2,404,810 2,325,993 Less allowance for depreciation and amortization 1,994,822 1,938,188 ---------- ---------- 409,988 387,805 Other assets 9,803 7,469 ---------- ---------- TOTAL ASSETS $ 4,819,464 $ 4,339,752 ========== ==========
See notes to financial statements
July 31, 1998 1997 -------- -------- LIABILITIES
Current Liabilities Notes payable - other $ - $ 916,235 Accounts payable 60,845 188,510 Accrued payroll 30,950 15,645 Accrued interest - 17,374 Bridge loan - 200,000 Other accrued expenses 115,337 146,791 Current maturities of - 3,802 capitalized lease obligations --------- ----------- Total Current Liabilities $ 207,132 $ 1,488,357 						 ---------- ----------- Stockholders' Equity
Preferred Stock, par value $.50; Series A; 4% cumulative;162,000 shares authorized; 155,000 shares issued and outstanding 77,500 77,500 Preferred Stock, par value $.50; Series B; $.90 cumulative; 50,000 shares authorized, 1197 shares issued and outstanding 597 597 Common Stock, par value $1.00; 20,000,000 shares authorized; issued 3,724,773 shares in 1998 and 2,803,473 in 1997, including 8,776 shares held in Treasury 3,724,773 2,803,473 Contributed Capital 9,643,215 7,034,008 Retained Earnings (Deficit) (8,702,019) (6,932,449) Treasury Shares at Cost (131,734) (131,734) ----------- ----------- Total Stockholders' Equity 4,612,332 2,851,395 ---------- ----------- Total Liabilities and Stockholders' Equity $ 4,819,464 $ 4,339,752 ========== ==========
See notes to the financial statements
				Conolog Corporation 			 Statements of Operations
July 31, 1998 1997 1996 ------------ ------------ ------------ Sales and other income		 $ 746,420 $ 1,123,390 $ 1,924,466 					 ------------ ------------ ------------ Costs and Expenses: Cost of products sold	 529,958 917,379	1,242,001 Selling, general and administrative		 1,548,446 2,054,630	 946,954 Interest 22,447 82,932 133,652 Write-off obsolete or excess inventories		 410,759 28,101	 50,281 ------------ ------------ ------------ 2,511,610 3,083,042 2,372,888 				 ------------ ------------ ------------ Loss Before Income Taxes and Extraordinary Items (1,765,190) (1,959,652) (448,422)
Income taxes 		 200 10,084	 200 ------------ ------------ ------------ Net Loss before Extraordinary Items (1,765,390) (1,969,736) (448,622)
Extraordinary Items - (1,841,000) 740,376 ------------ ------------ ------------ Net Income (Loss) $(1,765,390) $(3,810,736) $ 291,754 ============ ============ ============ (Loss) from Continuing Operations Per Share $ (.54) $ (1.24) $ (.43)
(Loss) Net Income Per Share - Basic (loss) earnings per share 	 $ (.54) $ (2.41) $ .28 - Diluted (loss) earning per share $ (.54) $ (2.41) $ .25
See notes to the financial statements 			
Conolog Corporation Statement of Stockholders' Equity (Deficiency) 					
Series A Series B Preferred Preferred Common Contributed Stock Stock Stock Capital
Balance @ July 31, 1995 $ 77,500 $ 10,661 $ 52,239 $ 1,453,773
Public stock offering - (10,064) 982,947 3,448,642 Net income for the year - - - - Dividends - - - (390,211) -------- -------- --------- ----------- Balance @ July 31, 1996 77,500 597 1,035,186 4,512,204
Debt to equity conversion - - 1,408,787 1,563,377 Additional shares issued to employees		 - - 359,500 954,250 Net loss for the year - - - - Dividends				 - - - 4,177 -------- -------- --------- ---------- Balance @ July 31, 1997 77,500 597 2,803,473 7,034,008
Public stock offering - - 725,300 2,045,777 Additional shares issued to employees - - 55,000 80,100 Additional shares issued to consultant - - 141,000 429,150 Debt to equity conversion - - - 50,000 Net loss for the year - - - - Dividends - - - 4,180 --------- -------- --------- --------- Balance @ July 31, 1998 $ 77,500 $ 597 $ 3,724,773 $9,643,215 ========= ========= =========== ==========
Conolog Corporation Statement of Stockholders' Equity (Deficiency)
					
	Total Retained Stockholders' Earnings Treasury Equity 	(Deficit) Stock (Deficiency) 			 		------------- ----------- -------------- Balance @ July 31, 1995 		$ (3,402,914) $ (131,734) $ (1,940,475) Public stock offering - - 4,421,525 Net income for the year 	 291,754 - 291,754 Dividends (6,376) - (396,587) 			------------- ---------- ------------ Balance @ July 31, 1996 		 (3,117,536) (131,734) 2,376,217
Debt to equity conversion 	 - - 2,972,164 Additional shares issued to employees - - 1,313,750 Net loss for the year (3,810,736) - (3,810,736) Dividends (4,177) - - 		 ------------ ---------- ------------ Balance @ July 31, 1997 		 (6,932,449) (131,734) 2,851,395 Public stock offering - - 2,771,077 Additional shares issued to employees - - 121,500 Additional shares issued to consultant - - 570,150 Debt to Equity Conversion - - 50,000 Net Loss for the year (1,765,390) - (1,751,790) Dividends 	 (4,180) - - 					 ------------ --------- ----------- Balance @ July 31,		 $(8,702,019) $(131,734) $4,612,332 1998 ============ ========== ==========
See notes to the financial statements
Conolog Corporation				 Statements of Cash Flows 								 July 31, 1998 1997 1996 ----------- ---------- ------------ Cash Flows From Operating Activities Net (Loss)Income $(1,765,390) $(3,810,736) $ 291,754 Adjustments to Reconcile Net (Loss) Income to Net Cash Used by Operating Activities Debt retirement cost	 - 1,841,000 - Common stock base compensation 135,100 1,313,750 - Common stock for consulting fees 570,150 - - Deferred income taxes - - 492,352 Depreciation and amortization 56,634 57,781 64,994 Gain on disposition of equipment - - (3,420) Provision for losses on accounts receivable - (8,000) 9,000 (Increase)Decrease in Operating Assets Accounts receivable 65,094 202,449 (141,479) Inventories (36,476) (236,012) (339,653) Other current assets 7,738 (568) (17,834) Increase(Decrease) in Operating Liabilities Accounts payable (127,665) (92,119) (7,001) Accrued expenses and other liabilities (33,523) 78,241 (1,066,379) ---------- ---------- ----------- Net Cash Used by Operating Activities (1,128,338) (654,214) (717,666) ----------- --------- ---------- Cash Flows From Investing Activities Purchase of property, plant and equipment (78,817) (11,680) (43,163) Proceeds from sale of equipment - - 18,666 ---------- --------- --------- Net Cash Used in Investing Activities (78,817) (11,680) (24,497) ---------- -------- -------- Cash Flows From Financing Activities Deferred offering costs 113,813 (113,813) 86,154 Increase from public stock offering 2,771,077 - 4,421,525 (Repayments)proceeds from borrowings (916,235) 916,235 - Increase (Decrease) in bridge loan (150,000) 200,000 (200,000) Repayments of long-term borrowings (3,802) (34,453) (2,836,008) (Increase)reductions in other assets (2,334) 22,929 (20,580) Dividends paid - - (396,587) Increase (Decrease) in due to officers - - (161,705) --------- ----------- ---------- Net Cash Provided by Financing Activities 1,812,519 990,898 892,799 ---------- ----------- ---------- Net Increase in Cash and Equivalents 605,364 325,004 150,636 Cash and Equivalents at Beginning of Period 503,217 178,213 27,577 ----------- ---------- --------- Cash and Equivalents at End of Period $1,108,581 $ 503,217 $ 178,213 ========= ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid(received) during the year for:
Interest $ 39,821 $ 77,349 $ 772,773 Taxes $ (9,520) $ 10,084 $ 125
SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES On January 21, 1998, the Company satisfied a $50,000 Bridge Loan with the conversion of the loan to 1.2 million Class A Warrants.
See notes to the financial statements
				Conolog Corporation 			Notes to the Financial Statements
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Organization
The principal business activity of Conolog Corporation (the "Company") is the design, manufacturing and distribution of small electronic and electromagnetic components and subassemblies for use in telephone, radio and microwave transmission 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 and various branches of the military.
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.
Inventories Inventories are stated principally at average cost which is not in excess of market.
Property, Plant and Equipment Property, plant and equipment are carried at cost, less allowances for depreciation and amortization. Depreciation and amortization are computed by the straight-line method over the estimated useful lives of the assets.
Revenue Recognition Sales are recognized when the products are shipped. Sales under certain fixed-price-type contracts, where progress payments are received, are recognized when work is performed, under the percentage-of-completion method, in accordance with Statement of Position 81-1, Accounting for Performance of Construction Type and Certain Production-Type contracts.
Advertising Costs Advertising costs are charges to operations when incurred.
Income Taxes Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the bases of assets and liabilities for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. deferred taxes also are recognized for operating losses that are available to offset future federal and state income taxes.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued
Income (Loss) Per Share of Common Stock Income (loss) per share of common stock is computed by dividing net earnings (loss) (after dividends on preferred shares) by the weighted average number of shares of Common Stock outstanding during the year. The number of shares used in the computations were 3,251,150, 1,581,218 and 1,041,978 for 1998, 1997 and 1996, respectively. The effect of assuming the exchange of the warrants, Series A Preferred Stock and Series B Preferred Stock in 1997 and 1996 would be anti- dilutive.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CONCENTRATIONS OF BUSINESS AND CREDIT RISK
At times throughout the year, the Company may maintain certain bank accounts in excess of FDIC insured limits.
The Company provides credit in the normal course of business. The Company performs ongoing credit evaluations of its customers and maintains allowances for doubtful accounts based on factors surrounding the credit risk of specific customers, historical trends, and other information.
NOTES PAYABLE - OTHER
CNL Holdings, Inc. loaned the Company $916,235. The notes were due during the fiscal year July 31, 1998 and bore interest at the rate of 4% per annum. The loans were payable in cash or Series C Preferred Stock, at the Company's option at $5.00 per share. Interest was payable in Common Stock up to a maximum of 40,000 shares per annum. On January 21, 1998, the Company paid CNL Holdings, Inc. $916,235 plus accrued interest of $25,421 in cash. This effectively eliminated all debts and liens with CNL Holdings, Inc.
BRIDGE LOAN
The Company received $200,000 in net proceeds from several investors in a private placement. Each investor received two (2) Promissory Notes. Promissory Notes (the "First Note") totaling $150,000 was due and payable on the earlier of January 31, 1999 or the closing of the Company's next public offering. The Second Convertible Note (the "Second Note"), totaling $50,000 plus accrued interest was payable on the earlier of January 31, 1999 or the closing of the Company's next public offering, or convertible at the time the next Registration Statement was declared effective by the Securities and Exchange Commission and at the option of the selling security holders into a total of 1.2 million Class A Warrants. Each Class A Warrant contained in the Second Note is identical to the Company's currently out- standing Class A Warrants. On January 21, 1998, at the closing of the Company's public offering, $150,000 plus accrued interest of $13,306 was paid in cash in full settle- ment of the First Note. The Second Note was satisfied with the 1.2 million Class A Warrants issued on January 21, 1998.
LEASES
The Company leases various equipment under operating leases. The future minimum rental payments under the operating leases that have initial or remaining lease terms in excess of one year as of July 31, 1998 are as follows:
Year Ended July 31, 1999 $ 4,808 2000 4,808	 -------	 $ 9,616 	 ======= Total rental expense for all operating leases of the Company amounted to approximately $7,659, $10,353 and $11,447 during the years ended July 31, 1998, 1997 and 1996.
INCOME TAXES
The income tax provision is comprised of the following:
July 31 1998 1997 1996 						 -------- --------- ----------- Current Income Taxes Federal - 9,884 - State 200 200 200 --------- --------- ---------- $ 200 $ 10,084 $ 200 ========= ========= ==========
INCOME TAXES, Continued A reconciliation between taxes computed at the federal statutory rate and the effective tax rate follows:
						 July 31,
						1998		1997		1996 						----		----		---- Federal statutory tax rate (34.0)%	(34.0)%	(34.0)% Valuation Allowance on Net Operating Loss Carryover	 34.0 34.0 34.0 Permanent and other differences - .5 - 						-----		-----		----- 						 - %	 0.5 %	 - % 						=====		=====		=====
Deferred taxes are recognized for temporary differences between the bases of assets and liabilities for financial statement and income tax purposes.
The temporary differences causing deferred tax benefits are primarily due to net operating loss carry forwards.
At July 1, 1998, the Company has net operating loss carry forwards for federal and state income tax purposes of approximately $4,710,000 and $3,863,000, respectively, which are available to offset future Federal and State taxable income, if any. The federal and state net operating loss carry forwards expire as follows:
						Federal	State 	2001				 $	 - $	 706,241 	2002					 - 	 897,997 	2004					 -	 542,540 	2005					 -	1,716,222 	2008				 	253,276	 - 	2009				 1,232,010		 - 	2010					957,538		 - 	2012					550,752		 - 	2013				 1,716,424		 - 					 ---------- ----------- 					 $ 4,710,000 $ 3,863,000 					 =========== =========== At July 31, 1998 the Company has available unused general business credits that may provide future tax benefits and expire as follows:
					 Amount 2000				$ 12,100 2001				 26,300 2002				 64,900 					--------- 					$ 103,300	 					=========
INCOME TAXES, Continued
The Company's deferred tax asset is comprised of the following temporary differences:
						Federal		State 						-------		----- 	Net operating losses and tax credit carry forwards		$ 1,704,562		$ 231,768 Less: valuation allowance	 (1,704,562)	 (231,768) 						------------	----------- 		Net Deferred Tax Assets	$ -		$	 - 						============	===========
The net change in the valuation allowance increased by approximately 	$607,000.
PROFIT SHARING PLAN
The Company sponsors a qualified profit sharing plan that covers substantially all full time employees. Contribution to the plan are discretionary and determined annually by management.
The Plan also provides an employee savings provision (401(k) plan whereby eligible participating employees may elect to contribute up to 15% of their compensation to an investment trust. The Company contributes $2 for every $1 of the participant's elective contribution, up to 6% of the participant's compensation.
The total expense for the above plan amounted to $52,721, $28,531, and $29,603 for the years ended July 31, 1998, 1997 and 1996 respectively.
CAPITAL STOCK
The Series A Preferred Stock provides 4% ($.02 per share) cumulative dividends, which may be exchanged for one share of Common Stock upon surrender of the Preferred Stock and payment of $1,200 per share. The Company may redeem the Series A Preferred Stock at $.50 per share plus accrued and unpaid dividends.
The Series B Preferred Stock provides cumulative dividends of $.90 per share which were $29,017 in arrears at July 31, 1998. In addition, each five shares of Series B Preferred Stock is convertible into 1 share of Common Stock. The Company may redeem the Series B Preferred Stock at $15 per share plus accrued and unpaid dividends.
The Company has reserved 155,392 shares of Common Stock for Series A and B Preferred Stock.
WARRANTS The Company issued common stock purchase warrants separately and as part of the previous offerings as follows:
						Exercise	Original	Extended	 				Number of	Price Per	Expiration	Expiration Date of Grant	Shares	Share		Date		Date ------------- --------- ---------- ---------- ----------- 	08/16/95		1,135,750	$6.00		08/16/98	08/16/2002 	01/21/98		2,901,200	$6.00		08/30/2002	 - 	01/21/98		1,200,000	$5.25		01/21/2001	 -		
MAJOR CUSTOMERS
The following summarized sales to major customers (each 10% or more of net sales) by the Company.
Sales to Major Number of Percentage Year Ended Customers Customers of Total ---------- --------- --------- ----------- 1998 $ 205,868 1 28 1997 625,134 3 57 1996 401,840 1 21
COMMITMENTS AND CONTINGENCIES
Employment Agreements 	On June 1, 1997 the Company entered into an employment agreement with Robert Benou to serve as the Company's President for a period of five years. Base salary under the agreement is $150,000 per 	annum with annual increases of $20,000 beginning November 1997 	and every profitable year thereafter. The agreement also calls 	for an annual bonus equal to 6% of the Company's income before 	income taxes as stated in its annual Form 10-K. Employee benefit 	plans, such as life, health, pension and other plans are provided 	under the agreement. The Company will also provide reimbursement 	of ordinary and necessary business expenses and a monthly car 	allowance. A noncompetion/nonsolicitation restriction applies 	for one year after termination of employment. Upon termination 	without cause, the agreement provides for severance compensation 	equal to 2.99 times the average annual compensation.
COMMITMENTS AND CONTINGENCIES (Continued)
Employment Agreements (Continued)
	The Vice President of the Company entered into an employment 	agreement on June 1, 1997. The agreement is for a period of 	five years expiring May 31, 2002. Pursuant to the terms of the 	agreement, the officer is to receive a base salary of $55,000 	for the period June 1, 1997 through May 31, 1998 and an increase 	of $6,000 per annum for each twelve month period thereafter. The 	agreement also calls for an annual bonus equal to 3% of the 	Company's income before taxes as stated in its annual Form 10-K. 	The Vice President is entitled to participate in all general 	pension, profit-sharing, life, medical, disability and other 	insurance and executive benefit plans at any time in effect for 	executives of the Company, however, the Company is not obligated 	to establish or maintain any of the aforementioned executive 	benefit plans. The Company will also provide an automobile for 	the use of the Vice President and reimburse him for all ordinary and necessary business expenses. A noncompetition/nonsolicitation 	restriction applies six months after termination of employment. 	Upon termination without cause the agreement provides for severance compensation equal to 2.99 times the average compensation paid by the Company. 	 	On March 1, 1998, the Company entered into an employment agreement 	with a Company executive to serve as a Corporate Development Manager 	for a period of five years. Base salary under the agreement is $50,000 	per annum with annual increases of $4,000. The agreement calls for 	the Corporate Development Manager to receive a quarterly bonus of 	5,000 shares of Conolog Corporation stock that have not been 	registered and eligible for sale under Rule 144 code. Eligibility 	for all general pension, profit-sharing, life, medical disability 	and other insurance and executive benefit plans is provided under 	the agreement, however, the Company is not obligated to establish	 	or maintain any of the aforementioned executive plans. The Company 	will also provide an automobile for the use of the Corporate 	Development Manager and reimburse her for all ordinary and necessary 	business expenses. Upon termination without cause, the agreement 	provides for severance compensation equal to 2.99 times the average 	annual compensation.
Consulting Agreements 	In February of 1998 the Company entered into a management and 	financial consulting agreement with Warren Schreiber ("Schreiber"}, 	whereby Schreiber would act as a consultant to the Company. In 	consideration of such services, Schreiber was granted 75,000 shares 	of common stock of the Company upon commencement of the contract. 	Additionally, for the duration of the agreement, Schreiber is to 	receive 25,000 shares of the Company's common stock on the last 	day of March, June, September and December of each year. Under 	the agreement, termination may occur by either party with or 	without cause at any time upon 60 days prior written notice.
Stock Option Plan 	On May 15, 1995, the Board of Directors of the Company adopted and 	on August 14, 1995, the shareholders approved the Conolog Corporation 	1995/1996 Stock Option Plan (the "Option Plan"). The Option Plan is 	designed to permit the Company to grant either incentive stock options 	under Section 422A of the Internal Revenue Code (the "Code") or 	nonqualified stock options. Under the Option Plan, the Board is 	authorized to grant options to purchase up to 200,000 shares of 	stock to key employees, officers, directors and consultants of the 	Company.
	Incentive stock options may only be granted to employees of the 	Company and not to directors or consultants who are not so employed. 	The exercise price for incentive stock options must be at least 	one hundred percent (100%) of the fair market value of the common 	stock as determined on the date of the grant. All incentive stock 	options under the Option Plan must be granted within ten (10) years 	from the date of adoption of the Option Plan and each option must 	be exercised, if at all, within ten (10) years of the date of the 	grant. In no event may any employee be given incentive stock options 	whereby more than $100,000 of options become exercisable for the 	first time in a single calendar year. All incentive stock options 	must be exercised by an optionee within three(3) months after termination 	of the optionee's employment, unless such termination is a result of 	death, disability or retirement. In the event of an optionee's 	employment is terminated as a result of death or disability, such 	optionee or his designated beneficiary shall be entitled to exercise 	any and all options for a period of twelve (12) months after such 	a termination. If an optionee's employment is terminated as a result 	of retirement, the optionee shall be entitled to exercise his options 	for a period of twenty four (24) months following such termination.
	Nonqualified stock options under the Option Plan are generally subject 	to the same rules as discussed above. Nonqualified stock options 	may, however, also be granted to directors and consultants, whether 	or not such individuals are employees of the Company. The exercise 	price for nonqualified stock options may be granted at less than 	eighty-five percent (85%) of the fair market value of the shares on 	the date of grant. 	 	No incentive stock options or nonqualified options have been granted.
COMMON STOCK ISSUED TO EMPLOYEES
	In February 1998 the Company issued 45,000 shares of the Company's 	common stock, as additional remuneration to certain employees.
	Compensation expense was recorded at the average fair value of the 	stock at the time of issuance, $121,500 ($2.70 per share).
	In accordance with the employment agreement between the Company and 	one of their executives the Company issued 10,000 shares of common 	stock during fiscal year ended July 31, 1998. Compensation expense 	was recorded at the average fair value of the stock at the time of 	issuance, $13,600 ($1.36 per share)
COMMON STOCK ISSUED TO EMPLOYEES (Continued)
	In July 1997 the Company issued 359,500 shares of common stock to 	several employees. Compensation expense was recorded at the average 	fair value of the stock at the time of issuance, $1,313,750 ($3.66 	per share).
FAIR VALUE OF FINANCIAL INSTRUMENTS
	The carrying amounts of cash, accounts receivable, other current assets, 	accounts payable and accrued expenses approximates fair value because 	of the short maturity of these instruments.
Limitations
	Fair value estimates are made at a specific point in time, based on 	relevant market information and information about the financial instru- 	ment. These estimates are subjective in nature and involve uncertain- ties and matters of significant judgment and therefore cannot be 	determined with precision. Changes in assumptions could significantly 	affect the estimates.
EXTRAORDINARY ITEM
On August 16, 1995 the Company's Bank debt was restructured resulting in debt forgiveness of $1,232,728. This created a deferred tax asset at July 31, 1996 of $492,352. When the debt forgiveness occurred, the Company wrote off its deferred tax asset against the forgiveness of debt, resulting in extraordinary income of $740,376.
During the year ended July 31, 1997, the Bank converted 1,400,000 shares of Common Stock it was holding using a value negotiated between Conolog and the Bank. The difference between the fair value and the negotiated value was $1.315 and was considered to be contributed capital and an extraordinary expense called Debt Retirement Cost. The total value placed upon this transaction was $1,841,000 (1,400,000 x $1.315).
The cost of debt retirement of $1,841,000, which occurred in 1997, is considered an extraordinary item with no tax effect due to the non-deductibility of this expense.
SUBSEQUENT EVENTS Sales of Real Estate 	 In September 1998 the Company completed the sale of its land and building resulting in approximately $725,000 net proceeds to the Company. The transaction also provides for a three year rent-free lease to the Company of approximately 38% of the total space of the building.
Acquisition of Atlas Design, Inc. 	 	In September1998, the Company acquired the assets of Atlas Design, 	Inc. Atlas Design, Inc. provides short and long term qualified 	engineering and technical services as well as human resource consulting.