Notes to Consolidated Financial Statements

October 31, 1998

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF OPERATIONS

Megadata designs and manufactures specialized computer equipment with applications in the aviation and communication industries. Its product line includes: PASSUR (Passive Secondary Surveilance Radar) systems which monitor air traffic in real time: SA9600 Wireless Radio Moderns: MURS, ALCX and RESNET airline reservation access systems; as well as customized hardware and software which enable the Company's products to fit its customers' specific requirements.

BASIS OF PRESENTATION

At October 31, 1998, the Company's current liabilities exceeded current assets by approximately $483,000 and reported a net loss of approximately $880,000, which includes restructuring related charges of $170,000 and an inventory write-down of $196,000. Management will address this working capital deficiency and operating losses by reducing operating expenses as outlined in its restructuring plan (see Note 8), by utilizing cash proceeds from the proposed sale of the building for working capital purposes and, if required, by obtaining external financing.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Megadata Corporation (the Company) and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

INVENTORIES

Inventories are stated at the lower of cost (first-in, first-out method) or market.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are recorded at cost. Depreciation is computed on the straight-line method over the estimated useful lives of the asset.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

IMPAIRMENT OF LONG-LIVED ASSETS

The Company follows the provisions of Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This standard establishes the accounting for the impairment of long-lived assets, certain identifiable intangibles and the excess of cost over net assets acquired, related to those assets to be held and used in operations, whereby impairment losses are required to be recorded when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS No. 121 also addresses the accounting for long-lived assets and certain identifiable intangibles that are expected to be disposed of.

REVENUE RECOGNITION POLICY

The Company recognizes revenue when products are shipped. Service revenues are recognized on a straight-line basis over the service contract period.

INCOME TAXES

The Company and its subsidiaries file a consolidated Federal income tax return. The Company uses the liability method in accounting for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." 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.

RESEARCH AND DEVELOPMENT COSTS

Research and development costs are charged to operations as incurred.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

NET LOSS/INCOME PER COMMON SHARE INFORMATION

In 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share." SFAS No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented and, where appropriate, restated to conform to the SFAS No. 128 requirements.

Net loss per common share was computed using the weighted average number of common shares outstanding during the period. Conversion of the common equivalent shares was not assumed since the result would have been antidilutive.

EMPLOYEE STOCK OPTIONS

The Company has a stock option program which is more fully described in Note 12. The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion ("APB Opinion") No. 25, "Accounting for Stock Issued to Employees." Under the Company's stock option program, options are granted with an exercise price equal to the market price of the underlying common stock of the Company on the date of grant. Accordingly, no compensation expense is recognized in connection with the grant of stock options.

In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation." The new standard defines a fair value method of accounting for the issuance of stock options and other equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. Pursuant to SFAS No. 123, companies are encouraged, but are not required, to adopt the fair value method of accounting for employee stock-based transactions. Companies are also permitted to continue to account for such transactions under APB Opinion No. 25, but are required to disclose in the financial statement footnotes, pro forma net
(loss) income and per share amounts as if the Company had applied the new method of accounting for all grants made beginning with 1995. SFAS No. 123 also requires increased disclosures for stock-based compensation arrangements.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

RECENTLY ISSUED ACCOUNTING STANDARDS

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which is effective for years beginning after December 15, 1997. SFAS No. 131 established standards for the way the public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services, geographical areas, and major customers. Since SFAS No. 131 is not required to be applied to interim financial statements in the initial year of adoption, the Company is not required to disclosure segment information in accordance with SFAS No. 131 until the fiscal year ending October 31, 1999, if applicable. In the Company's first quarter of fiscal 2000 report, and in subsequent quarters, it would present the interim disclosures required by SFAS No. 131 for both fiscal 2000 and 1999, if applicable. Management does not expect that adoption of SFAS No. 131 will have a significant impact on the Company's determination that it operates in one business segment.

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 amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

RECLASSIFICATION

Certain items within the 1997 and 1996 financial statements have been reclassified to conform to the 1998 presentation.

                                                       OCTOBER 31
                                                  1998             1997
                                            ----------------- ----------------

Prepaid real estate taxes                      $  32,206         $  28,073
Prepaid insurance                                 22,215            18,478
Other current assets                               4,510            41,010
                                            ================= ================
                                               $  58,931         $  87,561
                                            ================= ================

3. INVENTORIES

Inventories are summarized as follows:

                                                       OCTOBER 31
                                                  1998             1997
                                            ----------------- ----------------

Parts and raw materials                        $   69,071        $  103,251
Work-in-process                                    74,632           282,352
Finished goods                                    123,213            63,172
                                            ================= ================
                                               $  266,916        $  448,775
                                            ================= ================

                                     ESTIMATED
                                       USEFUL                  OCTOBER 31
                                       LIVES              1998             1997
                                  ----------------- ----------------- ----------------

Land                                                  $    200,000      $    200,000
Building                             31.5 years          1,780,000         1,793,805
Building improvements                 3-5 years             66,670            65,420
Factory equipment                    5-10 years          2,279,846         2,241,645
Furniture, fixtures
 and improvements                    5-10 years            113,158           113,158
Automobile                            3-5 years                  -            31,395
                                                    ----------------- ----------------
                                                         4,439,674         4,445,423
Less accumulated depreciation                            3,056,925         3,026,532
                                                    ================= ================
                                                      $  1,382,745      $  1,418,891
                                                    ================= ================

4. PROPERTY, PLANT AND EQUIPMENT (CONTINUED)

The Company recorded depreciation and amortization expense on the assets included in property, plant and equipment of $68,103, $63,335 and $63,268 for the years ended October 31, 1998, 1997 and 1996, respectively.

                                                          OCTOBER 31
                                                     1998             1997
                                               ----------------- ---------------

Accrued payroll, payroll taxes and benefits      $    50,904       $    51,673
Accrued professional fees                             34,000            18,000
Accrued restructuring charge                         167,485                 -
Other accrued liabilities                            102,050            50,802
                                               ================= ===============
                                                 $   354,439       $   120,475
                                               ================= ===============

6. NOTES PAYABLE--RELATED PARTY

During the period between September 18, 1996 and June 6, 1997 the Company signed agreements with a private investor (the "Investor") that provided for three loans of $100,000 each, of which $200,000 was received in 1996 and $100,000 was received in 1997. The three notes bore interest at a rate of 9% per annum, and were payable by July 30, 1997. In addition, stock warrants were awarded for the purchase of up to 1,400,000 common shares. On June 6, 1997, the Investor and his affiliate purchased 700,000 shares for the amount of $500,000, paid by $400,000 in cash and cancellation of the first $100,000 note.

On October 31, 1997, the Investor and two other directors purchased 200,000 shares for the amount of $150,000. The purchase of these shares validated a stock purchase warrant, that gives the investor and his affiliates the right to purchase 500,000 shares at $1.25 per share. This warrant expires October 31, 2001, and is exercisable during the year preceding expiration. On July 30, 1997, the remaining notes totalling $200,000 were amended and restated by a new note bearing interest at 9% per annum, with quarterly payments of $25,000 plus accrued interest due on the last business day of each calendar quarter, commencing December, 1997, with any remaining balance being due July 30, 1999. The note is secured by the Company's assets excluding its building.

6. NOTES PAYABLE--RELATED PARTY (CONTINUED)

During 1997, the Investor was elected a director of the Company and Chairman of the Board and on October 2, 1998 the Investor was elected to the additional post of President and Chief Executive Officer.

In November 1998, and on January 11,1999, the Investor issued promissory notes aggregating $300,000 which are payable quarterly, maturing at various dates from June 30, 2000 through June 30, 2001. As of January 11, 1999, the total notes payable due to the Investor totalled $475,000.

7. DEFERRED INCOME

Deferred income represents advances received on maintenance agreements and deposits from customers for equipment that will be shipped in the next fiscal year.

8. RESTRUCTURING RELATED CHARGES

In October 1998, the Company announced a Restructuring Plan in which it will focus its attention primarily on its PASSUR line of passive radar systems. As part of this restructuring, the Company will move its corporate headquarters and national sales office to Greenwich, Connecticut. The Company has offered for sale its building in Bohemia, New York and will move its manufacturing and research and development facility to a more modern location in the same area.

The Restructuring Charges include exit costs of $93,000 related to the building, severance costs of $53,000, asset write-downs of $24,000 relating to assets to be sold or abandoned, and inventory write-downs of $196,000 associated with the elimination of certain nonstrategic inventory and product lines (which costs are included in costs of sales).

9. INSTALLMENT NOTES PAYABLE

Notes due on financing of insurance premiums and equipment purchases bearing interest at 8.25% and 12.5% per annum, with the final payments due November, 2000 and August 2001, respectively.

October 31:
   1999                                                  $    58,382
   2000                                                       64,017
   2001                                                      498,637
                                                       =================
Total                                                    $   621,036
                                                       =================

                                              YEAR ENDED OCTOBER 31
                                     1998             1997             1996
                                ---------------- ---------------- --------------
Current:
   States and local                $  8,389         $  1,023         $  2,376
                                ================ ================ ==============
Total                              $  8,389         $  1,023         $  2,376
                                ================ ================ ==============

At October 31, 1998, the Company has available a federal net operating loss carryforward of approximately $5,300,000 for income tax purposes to offset future taxable income and which will expire in various years from 2006 through 2018. The Company has $25,000 of general business tax credit carryforwards available which expire in various years through 2008. The Company has provided a full valuation allowance on the net deferred tax asset which primarily consists of the net operating loss carryforwards and tax credit available.

12. STOCK OPTIONS

The Company's 1982 and 1988 stock option plans provide for the granting of stock options for up to 100,000 shares of the Company's common stock for each plan. The 1982 plan provides that only 40,000 options can be granted during any one fiscal year. The 1988 plan provides that no individual can receive in excess of $100,000, as determined by the fair market value of options during any calendar year. Under both plans, the option price per share is the fair market value at date of grant, except on the issuance of non-qualified options pursuant to the 1988 plan in which the option price is not less than 85% of the fair market value of the shares. Options granted may be exercised up to a maximum of ten years from the date of grant; however, individuals who own more than 10% of the Company's common stock must exercise their options within five years of the date of the grant and these options are exercisable at 110% of the fair market value of the shares. As of October 31, 1998 no further options are available for grant under the 1982 and 1988 stock option plans.

The Company has elected to comply with APB Opinion No. 25, and related interpretations in accounting for its employee stock options because the alternate fair value accounting provided for under SFAS No. 123, "Accounting for Stock-Based Compensation" requires use of option valuation models which were not developed for use in valuing employee stock options. Under APB Opinion No. 25, no compensation expense is recognized in connection with the grant of stock options under the stock option plans.

In accordance with SFAS No. 123, pro forma information regarding net (loss) and
(loss) per common share has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these stock options was estimated at the date of grant, using a Black Scholes option pricing model with the following weighted average assumptions for 1998, 1997 and 1996, respectively; risk-free interest rates of 5.0%, no dividend yields on the Common Stock, volatility factors of the expected market price of the Company's Common Stock of 1.029 and the weighted average expected life of the options is approximately 8 years.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. In management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options due to changes in subjective input assumptions which may materially affect the fair value estimate, and because the Company's employee stock options have characteristics significantly different from those of traded options.

12. STOCK OPTIONS (CONTINUED)

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information is as follows:

Pro forma net (loss)                                 ($  902,000)
                                                   ==================
Pro forma net (loss) per common share--basic and
   diluted                                           $     (.36)
                                                   ==================

Information with respect to options during the years ended December 31, 1998, 1997 and 1996 under SFAS No. 123 is as follows:

                                           1998                         1997                        1996
                                                WEIGHTED                     WEIGHTED                    WEIGHTED
                                                 AVERAGE                     AVERAGE                     AVERAGE
                                                EXERCISE                     EXERCISE                    EXERCISE
                                  OPTIONS         PRICE        OPTIONS        PRICE        OPTIONS        PRICE
------------------------------- ------------- -------------- ------------- ------------- ------------- -------------

Options outstanding--beginning
   of year                           25,000       $ 1.35        25,000         $1.35        55,000         $1.73
Options granted:                                                                                 -
Incentive options                    60,000          .38             -          -                -
Options canceled and expired        (32,500)       (1.13)            -          -          (30,000)        (2.04)
                                ------------- -------------- ------------- ------------- ------------- -------------
Options outstanding--
   end of year                       52,500         $.38        25,000         $1.35        25,000         $1.35
                                ============= ============== ============= ============= ============= =============
Options exercisable at
   end of year                       52,500       $  .38        25,000         $1.35        25,000         $1.35
                                              ==============               =============               =============
                                =============                =============               =============
Weighted average fair value
   per share of options
   granted during the year             $.35
                                =============

Exercise prices for stock options outstanding and for options exercisable as of October 31, 1998 were as follows:

                           NUMBER               RANGE OF
      NUMBER             OF OPTIONS             EXERCISE
    OF OPTIONS          EXERCISABLE              PRICES
------------------- --------------------- ---------------------

        52,500              52,500             $   .38
=================== ===================== =====================

12. STOCK OPTIONS (CONTINUED)

The weighted average remaining contractual life of the above-described stock options is 8 years.

Shares of common stock reserved for future issuance as of October 31, 1998 are as follows:

Stock options                                      52,500
Warrants issued                                   500,000
                                            ==================
                                                  552,500
                                            ==================

13. MAJOR CUSTOMERS

During the fiscal year ended October 31, 1998, three customers accounted for approximately 28%, 14% and 10% of revenues. During the fiscal year ended October 31, 1997, three customers accounted for approximately 27%, 22% and 14% of revenues. During the fiscal year ended October 31, 1996, one customer accounted for approximately 25% of revenues. The Company had export sales of approximately $93,000, $173,000 and $234,000 in fiscal 1998, 1997 and 1996, respectively.

14. RELATED PARTY TRANSACTIONS

The Company had contracted with Data Probe, Inc., which is majority owned by the Company's former president, to provide certain research and development and sales support services through July, 1996. The Company has incurred approximately $60,442 for the year ended October 31, 1996 in consideration for the aforementioned services.

For the years ended October 31, 1998 and 1997, the Company reimbursed Datatab, Inc., a subsidiary of Data Probe, Inc., $47,683 and $65,763, respectively, for services rendered by an employee of Datatab, Inc. for the Company.

On January 16, 1996, the Company signed a promissory note to an officer for a $30,000 loan, which was secured by certain test equipment. The note bore interest at 10% per annum, and was paid in full on July 16, 1997. Total interest payments for the year ended October 31, 1996 were $2,265. In addition, net loans of $6,883 were made by another officer which had no provision for interest and were paid on demand.

14. RELATED PARTY TRANSACTIONS (CONTINUED)

In addition, during 1998 the Company reimbursed Field Point Capital Management Company, an entity affiliated with the Investor/President, for services rendered in the amount of $31,500.

The Company is leasing space from Field Point Capital Management Company, a company 100% owned by the Company's President. From October 2, 1998 through January 31, 1999 the Company paid rental of $4,000 to Field Point Capital Management Company. Effective February 1, 1999, the Company will pay Field Point Capital Management Company $2,000 per month rent.

15. ROYALTY AGREEMENT

During March of 1997, the Company entered into a license agreement whereby the Company was granted the exclusive right and license worldwide to manufacture and sell PASSUR and ATMS systems for use with airline dispatch arrangements and in other aircraft flight tracking. The Company was also granted an exclusive license to sell PASSUR systems for noise applications in the United States. The company shall pay a royalty based on the number of PASSUR systems sold, subject to a minimum annual royalty of $50,000. This license agreement is in effect until the date of expiration of the last PASSUR patent to expire.

16. YEAR 2000 (UNAUDITED)

The Company has diligently studied the impact of the Year 2000 on the hardware and software it sells as well as its own internal systems.

The Company's top technical and development personnel have carefully reviewed the Company's PASSUR hardware product line and related software and are satisfied that they are Year 2000 compliant.

A review of Year 2000 compliance for the other products sold by the Company, radio modems and protocol converters, is continuing and should be completed by the middle of 1999.

A thorough review of the Company's internal systems is continuing. The Company is also working with suppliers and service providers with whom it does business to determine their Year 2000 compliance and to minimize any impact their noncompliance (if any) would have on the Company. These studies are also scheduled for completion by the middle of 1999.

16. YEAR 2000 (UNAUDITED) (CONTINUED)

To date, the Company has not found any area where a Year 2000 compliance problem with either its internal systems or outside providers could have a material adverse impact on any part of the Company's business operations.