-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, H+47P3LEL95VCh0OwX1h5+U+X4V4dtct5PG9gUtbpQOsY5f3E65L9brV4Gur2dzw 0xmQj79LWrtsdNj2AhFhUQ== 0000950124-98-002634.txt : 19980508 0000950124-98-002634.hdr.sgml : 19980508 ACCESSION NUMBER: 0000950124-98-002634 CONFORMED SUBMISSION TYPE: S-4/A PUBLIC DOCUMENT COUNT: 9 FILED AS OF DATE: 19980507 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: DAEDALUS ENTERPRISES INC CENTRAL INDEX KEY: 0000026537 STANDARD INDUSTRIAL CLASSIFICATION: MEASURING & CONTROLLING DEVICES, NEC [3829] IRS NUMBER: 381873250 STATE OF INCORPORATION: DE FISCAL YEAR END: 0731 FILING VALUES: FORM TYPE: S-4/A SEC ACT: SEC FILE NUMBER: 333-47333 FILM NUMBER: 98612412 BUSINESS ADDRESS: STREET 1: 300 PARKLAND PLAZA STREET 2: P O BOX 1869 CITY: ANN ARBOR STATE: MI ZIP: 48106 BUSINESS PHONE: 3137695649 MAIL ADDRESS: STREET 1: PO BOX 1869 CITY: ANN ARBOR STATE: MI ZIP: 48106 S-4/A 1 S-4/A 1 As filed with the Securities and Exchange Commission on May 7, 1998 Registration No. 333-47333 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------- AMENDMENT NO. 2 TO FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ---------------------- DAEDALUS ENTERPRISES, INC. (Exact name of Registrant as specified in its charter) Delaware 3812 38-1873250 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation or organization) Classification Code Number) Identification No.) 300 Parkland Plaza Ann Arbor, Michigan 48103 (313) 769-5649 (Address, including zip code, and telephone number, including area code, of registrants' principal executive offices) ---------------------- Thomas R. Ory 300 Parkland Plaza Ann Arbor, Michigan 48103 (313) 769-5649 (Name, Address, including zip code, and telephone number, including area code, of agent for service) ---------------------- copies to: Mark A. Metz Mark J. Wishner Dykema Gossett PLLC Michaels, Wishner & Bonner, P.C. 400 Renaissance Center 1140 Connecticut Avenue, N.W. Detroit, Michigan 48243 Washington, D.C. 20036 ---------------------- Approximate date of commencement of proposed sale to public: At the effective time of the merger of a wholly-owned subsidiary of Daedalus Enterprises, Inc. with and into S. T. Research Corporation as described in the enclosed Joint Proxy Statement/Prospectus. If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box: [ ] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] ____________________ If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] ____________________ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. ================================================================================ 2 [DEI Logo] May 8, 1998 Dear Stockholders: You are cordially invited to attend the Annual Meeting of Stockholders of Daedalus Enterprises, Inc. ("DEI"), which will be held on May 28, 1998 at DEI's principal office, 300 Parkland Plaza, Ann Arbor, Michigan, commencing at 9:00 a.m., local time. At this important meeting you will be asked to consider and vote to approve an amendment to DEI's certificate of incorporation (the "Charter Amendment") to change DEI's name to "Sensys Technologies Inc." and increase the number of authorized shares of DEI common stock, par value $.01 per share ("DEI Common Stock"), to 5,000,000 pursuant to the Agreement and Plan of Merger, dated as of December 23, 1997 (the "Merger Agreement"), by and among DEI, DEI Merger Sub, Inc., a wholly owned subsidiary of DEI ("Merger Sub"), and S. T. Research Corporation ("STR"). Upon consummation of the transactions contemplated by the Merger Agreement, Merger Sub will be merged with and into STR, STR will become a wholly owned subsidiary of DEI (the "Merger") and the stockholders of STR (other than stockholders of STR who perfect their dissenters' rights in the manner described in the enclosed Joint Proxy Statement/Prospectus) will receive 2.58 shares of DEI Common Stock for each outstanding share of STR common stock (expected to total approximately 3.4 million shares), which will represent approximately 86.5% of the outstanding shares of DEI Common Stock immediately following the Merger. Based on the average of the bid and ask prices of DEI Common Stock of $3.19 on November 11, 1997 (the date on which the Merger was announced), the aggregate consideration paid to STR stockholders would have a market value of approximately $8.23 per share and would total approximately $28.2 million (subject to change based on market price fluctuations of DEI Common Stock at the closing of the Merger). Immediately following the Merger, persons who currently serve as directors or executive officers of DEI or STR will beneficially own approximately 56.7% of the outstanding shares of DEI Common Stock. DEI stockholders do not have dissenters' rights in connection with the Merger. You will also be asked to consider and vote upon the election of directors to the DEI Board of Directors and an amendment to DEI's Long-Term Incentive Plan to increase the number of shares issuable under the Plan and to increase the limit on the number of shares that may be subject to options granted to any salaried employee in any three consecutive fiscal years. Although approval of the Merger by DEI's stockholders is not required under applicable law, the consummation of the Merger is conditioned on approval of the Charter Amendment by the DEI stockholders. A vote against the Charter Amendment will have the effect of a vote against the Merger. If the Merger Agreement is terminated, the amendment to the certificate of incorporation and the amendment to the Long-Term Incentive Plan will not become effective. Approval of the amendment to the Long-Term Incentive Plan is not a condition to consummation of the Merger. The accompanying Joint Proxy Statement/Prospectus provides details of the proposed Merger and information related to the matters to be acted upon at the Annual Meeting. You are urged to read the Joint Proxy Statement/Prospectus carefully. YOUR BOARD OF DIRECTORS HAS APPROVED THE MERGER AS BEING FAIR TO, AND IN THE BEST INTERESTS OF DEI AND ITS STOCKHOLDERS. IN ORDER TO ENABLE THE MERGER TO OCCUR, THE BOARD UNANIMOUSLY RECOMMENDS A VOTE FOR APPROVAL OF THE AMENDMENT TO THE CERTIFICATE OF INCORPORATION. IN ADDITION, THE BOARD RECOMMENDS A VOTE FOR APPROVAL OF THE DIRECTORS NOMINATED FOR ELECTION TO THE BOARD OF DIRECTORS AND THE AMENDMENT TO THE LONG-TERM INCENTIVE PLAN. It is important that your shares be represented at the Annual Meeting whether or not you are personally able to attend. In order to ensure that you will be represented, we encourage you to complete and return the enclosed proxy card promptly, even if you currently plan to attend the Annual Meeting. If you are a record owner, attend the Annual Meeting and vote in person, your vote will supersede your proxy. Sincerely, Thomas R. Ory President and Chief Executive Officer 3 DAEDALUS ENTERPRISES, INC. NOTICE OF ANNUAL MEETING OF STOCKHOLDERS TO BE HELD MAY 28, 1998 To the Stockholders of Daedalus Enterprises, Inc. NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders of Daedalus Enterprises, Inc., a Delaware corporation ("DEI"), will be held on May 28, 1998 at DEI's principal office, 300 Parkland Plaza, Ann Arbor, Michigan, commencing at 9:00 a.m., local time, for the following purposes: (1) to consider and vote upon a proposal to amend and restate DEI's certificate of incorporation (the "Charter Amendment") to change DEI's name to "Sensys Technologies Inc." and increase the number of authorized shares of DEI common stock, par value $.01 per share (the "DEI Common Stock"), to 5,000,000 pursuant to the Agreement and Plan of Merger, dated as of December 23, 1997 (the "Merger Agreement"), by and among DEI, DEI Merger Sub, Inc., a wholly owned subsidiary of DEI ("Merger Sub"), and S. T. Research Corporation ("STR"), pursuant to which, among other things; (a) Merger Sub will be merged with and into STR (the "Merger"), and (b) each share of STR common stock outstanding immediately prior to the consummation of the Merger (other than shares held by stockholders of STR who perfect their dissenters' rights in the manner described in the enclosed Joint Proxy Statement/Prospectus), will be converted into the right to receive 2.58 shares of DEI Common Stock; (2) to elect a board of directors; (3) to approve an amendment to DEI's Long-Term Incentive Plan to increase the number of shares issuable under the Plan and to increase the limit on the number of shares that may be subject to options granted to any salaried employee in any three consecutive fiscal years; and (4) to transact such other business as may properly come before the meeting or any adjournment thereof; Only holders of record of DEI Common Stock at the close of business on April 20, 1998 are entitled to notice of, and to vote at, the Annual Meeting or any adjournments thereof. The matters to be voted upon at the Meeting are more completely described in the accompanying Joint Proxy Statement/Prospectus and the Annexes thereto. Although approval of the Merger by DEI's stockholders is not required under applicable law, the consummation of the Merger is conditioned on approval of the Charter Amendment by the DEI stockholders. A vote against the Charter Amendment will have the effect of a vote against the Merger. Approval of the amendment to the Long-Term Incentive Plan is not a condition to consummation of the Merger. The Joint Proxy Statement/Prospectus and the Annexes thereto from a part of this Notice. All stockholders, whether or not they expect to attend the meeting in person, are requested to complete, sign, date and return the enclosed form of proxy in the accompanying envelope (which requires no additional postage if mailed in the United States). Your proxy will be revocable by filing with the Secretary a written revocation or a proxy bearing a later date at any time prior to the time it is voted, or by attending the meeting and voting there. YOUR VOTE IS IMPORTANT. PLEASE COMPLETE, DATE AND SIGN THE ENCLOSED PROXY AND RETURN IT PROMPTLY IN THE ENCLOSED RETURN ENVELOPE. RETURNING THE ENCLOSED PROXY WILL NOT AFFECT YOUR RIGHT TO VOTE IN PERSON OR ATTEND THE ANNUAL MEETING. THE BOARD OF DIRECTORS OF DEI UNANIMOUSLY RECOMMENDS THAT THE HOLDERS OF DEI COMMON STOCK VOTE FOR APPROVAL OF EACH OF THE MATTERS LISTED ABOVE AND FOR THE ELECTION OF EACH OF THE DIRECTORS NOMINATED. By order of the Board of Directors, Lloyd A. Semple, Secretary Ann Arbor, Michigan May 8, 1998 4 [STR Logo] May 8, 1998 Dear Stockholders: A Special Meeting of Stockholders of S. T. Research Corporation ("STR") will be held at the principal offices of STR at 8419 Terminal Road, Newington, Virginia on May 28, 1998 at 9:00 a.m., local time. At this important meeting, you will be asked to consider, and vote to approve the Agreement and Plan of Merger, dated as of December 23, 1997 (the "Merger Agreement"), by and among Daedalus Enterprises, Inc., a Delaware corporation ("DEI"), DEI Merger Sub, Inc., a Virginia corporation and a wholly owned subsidiary of DEI ("Merger Sub") and STR, pursuant to which Merger Sub will be merged with and into STR (the "Merger"). Upon consummation of the Merger, STR will be the surviving corporation, the separate existence of Merger Sub will cease and STR will become a wholly owned subsidiary of DEI. Each share of STR common stock ("STR Common Stock") outstanding immediately prior to the consummation of the Merger (other than shares held by stockholders of STR who perfect their dissenters' rights in the manner described in the enclosed Joint Proxy Statement/Prospectus), will be converted into the right to receive 2.58 shares of DEI common stock, $.01 par value ("DEI Common Stock") (or a total of approximately 3.4 million shares). Immediately following the Merger, STR stockholders will own approximately 86.5% of the outstanding shares of DEI Common Stock. Based on the average of the bid and ask prices of DEI Common Stock of $3.19 on November 11, 1997 (the date on which the Merger was announced), the aggregate consideration received by STR stockholders would have a market value of approximately $8.23 per share and would total approximately $28.2 million (subject to change based on market price fluctuations of DEI Common Stock at the closing of the Merger). The Merger has been structured as a tax-free transaction for federal income tax purposes, although any cash received in lieu of a fractional share of DEI Common Stock will be taxable income to the recipient. Immediately following the Merger, persons who currently serve as directors or executive officers of DEI or STR will beneficially own approximately 56.7% of the outstanding shares of DEI Common Stock. YOUR BOARD OF DIRECTORS BELIEVES THAT THE MERGER IS ADVISABLE AND IN THE BEST INTERESTS OF STR AND ITS STOCKHOLDERS AND, BY UNANIMOUS VOTE, HAS RECOMMENDED THAT THE STOCKHOLDERS OF STR VOTE FOR APPROVAL OF THE MERGER. In the material accompanying this letter, you will find a Notice of Special Meeting of Stockholders, a Joint Proxy Statement/Prospectus relating to the actions to be taken by STR stockholders at the Special Meeting, and a proxy. The Joint Proxy Statement/Prospectus more fully describes the Merger and includes information about STR and DEI and the reasons for the Merger. All stockholders are cordially invited to attend the Special Meeting in person. However, whether or not you plan to attend the Special Meeting, please complete, sign, date and return your proxy in the enclosed envelope. If you attend the Special Meeting, you may withdraw your proxy and vote in person if you wish. It is important that your shares be represented and voted at the Special Meeting. Sincerely, S. R. Perrino, President 5 S. T. RESEARCH CORPORATION NOTICE OF SPECIAL MEETING OF STOCKHOLDERS TO BE HELD May 28, 1998 To the Stockholders of S. T. Research Corporation: A Special Meeting of Stockholders of S. T. Research Corporation ("STR") will be held on May 28, 1998 at 9:00 a.m. at the principal offices of STR at 8419 Terminal Road, Newington, Virginia, to approve an Agreement and Plan of Merger between STR, Daedalus Enterprises, Inc., a Delaware corporation ("DEI"), and DEI Merger Sub, Inc., a Virginia corporation and wholly owned subsidiary of DEI ("Merger Sub"), dated as of December 23, 1997 (the "Merger Agreement"), pursuant to which, among other things, (i) Merger Sub will be merged with and into STR and STR will be the surviving corporation (the "Merger"); (ii) the separate existence of Merger Sub will cease; and (iii) each outstanding share of STR common stock ("STR Common Stock") (other than shares held by stockholders of STR who perfect their dissenters' rights in the manner described in the enclosed Joint Proxy Statement/Prospectus) will be converted into 2.58 shares of DEI common stock. The Board of STR has fixed the close of business on April 20, 1998 as the record date for determination of the holders of STR Common Stock entitled to vote at the Special Meeting. Approval of the Merger requires the affirmative vote of the holders of at least two-thirds of the outstanding shares of STR Common Stock at the close of business on the record date. YOUR BOARD OF DIRECTORS BELIEVES THAT THE MERGER IS ADVISABLE AND IN THE BEST INTERESTS OF STR AND ITS STOCKHOLDERS AND, BY UNANIMOUS VOTE OF THE DIRECTORS, HAS RECOMMENDED THAT THE STOCKHOLDERS OF STR VOTE FOR THE APPROVAL OF THE MERGER. The Merger and related matters are more fully described in the Merger Agreement attached to the accompanying Joint Proxy Statement/Prospectus. All stockholders are cordially invited to attend the Special Meeting in person. However, whether or not you plan to attend the Special Meeting, please complete, sign, date and return your proxy in the enclosed envelope. If you attend the Special Meeting, you may withdraw your proxy and vote in person if you wish. It is important that your shares be represented and voted at the Special Meeting. By order of the Board of Directors Robert R. Bower, Secretary 6 DAEDALUS ENTERPRISES, INC. AND S.T. RESEARCH CORPORATION JOINT PROXY STATEMENT DAEDALUS ENTERPRISES, INC. PROSPECTUS This Joint Proxy Statement/Prospectus is being furnished to holders of shares of common stock of Daedalus Enterprises, Inc., a Delaware corporation ("DEI"), in connection with the solicitation of proxies by the Board of Directors of DEI for use at the annual meeting of stockholders of DEI to be held on May 28, 1998 at DEI's principal offices, 300 Parkland Plaza, Ann Arbor, Michigan, commencing at 9:00 a.m., local time, and at any adjournments or postponements thereof (the "DEI Annual Meeting"). At the DEI Annual Meeting, stockholders of record of DEI, as of the close of business on April 20, 1998, will consider and vote upon (i) a proposal to amend and restate DEI's certificate of incorporation (the "Charter Amendment") to increase the number of authorized shares of DEI common stock, $.01 par value ("DEI Common Stock"), and change the name of DEI to "Sensys Technologies Inc." pursuant to an Agreement and Plan of Merger, dated as of December 23, 1997, among DEI, DEI Merger Sub, Inc., a Virginia corporation and a wholly owned subsidiary of DEI ("Merger Sub"), and S.T. Research Corporation, a Virginia corporation ("STR") (the "Merger Agreement"); (ii) the election of directors; and (iii) the approval of an amendment to DEI's Long-Term Incentive Plan. The approval of the Charter Amendment is required to consummate the merger under the Merger Agreement. This Joint Proxy Statement/Prospectus is also being furnished to holders of shares of common stock of STR in connection with the solicitation of proxies by the Board of Directors of STR for use at the special meeting of stockholders of STR to be held on May 28, 1998 at STR's headquarters, located at 8419 Terminal Road, Newington, Virginia, commencing at 9:00 a.m., local time, and at any adjournments or postponements thereof (the "STR Special Meeting"). At the STR Special Meeting, stockholders of record of common stock, $.10 par value per share ("STR Common Stock"), as of the close of business on April 20, 1998, will consider and vote upon the approval and adoption of the Merger Agreement and the transactions contemplated thereby. Pursuant to the Merger Agreement, Merger Sub will be merged with and into STR and STR will be the surviving corporation (the "Merger"). Upon consummation of the Merger, each outstanding share of STR Common Stock (other than shares held by stockholders of STR who perfect their dissenters' rights in the manner described in this Joint Proxy Statement/Prospectus) will be converted into the right to receive 2.58 fully paid and nonassessable shares of DEI Common Stock. No fractional shares will be issued in connection with the Merger. Assuming no STR stockholder exercises dissenters' rights, immediately following the Merger, STR stockholders will hold approximately 86.5% of the outstanding shares of DEI Common Stock. See "The Merger Agreement -- Conversion and Exchange of STR Common Stock." The Boards of Directors of DEI and STR know of no business that will be presented for consideration at the meetings of stockholders of DEI and STR, respectively, other than the matters described in this Joint Proxy Statement/Prospectus. If any other matters are presented at either of such meetings, the proxies will be voted in accordance with the best judgment of the proxy holders. This Joint Proxy Statement/Prospectus also constitutes a prospectus of DEI with respect to up to 3,420,527 shares of DEI Common Stock to be issued in the Merger in exchange for outstanding shares of STR Common Stock. All information contained in this Joint Proxy Statement/Prospectus relating to DEI has been supplied by DEI and all information relating to STR has been supplied by STR. THE OFFERING OF DEI COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" COMMENCING ON PAGE 14. This Joint Proxy Statement/Prospectus is first being mailed to stockholders of DEI and stockholders of STR on or about May 12, 1998. THE SECURITIES TO WHICH THIS JOINT PROXY STATEMENT/PROSPECTUS RELATES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS JOINT PROXY STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THE DATE OF THIS JOINT PROXY STATEMENT/PROSPECTUS IS _________, 1998. 7 AVAILABLE INFORMATION DEI is subject to the information requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). The reports, proxy statements and other information filed by DEI with the Commission may be inspected and copied at the public reference facilities maintained by the Commission at 450 Fifth Street NW, Judiciary Plaza, Washington, D.C. 20549, and at the Commission's Regional Offices located at 7 World Trade Center, 13th Floor, New York, New York 10048 and Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661, at prescribed rates. In addition, the Commission maintains a Website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants (such as DEI) that file electronically with the Commission. Whether or not the Merger is consummated, DEI will continue to be required to file periodic reports, proxy statements and other information with the Commission pursuant to the Exchange Act. DEI has filed with the Commission a Registration Statement on Form S-4 (together with any amendments thereto, the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the securities to be issued to STR stockholders pursuant to the Merger Agreement. This Joint Proxy Statement/Prospectus does not contain all the information set forth in the Registration Statement. The Registration Statement may be obtained from the Commission's principal office in Washington, D.C. Statements contained in this Joint Proxy Statement/Prospectus or in any document incorporated by reference in this Joint Proxy Statement/Prospectus as to the contents of any contract or other document referred to herein or therein are not necessarily complete, and in each instance reference is made to the copy of such contract or other document filed or incorporated by reference as an exhibit to the Registration Statement or such other document, each such statement being qualified in all respects by such reference. THIS JOINT PROXY STATEMENT/PROSPECTUS MAY INCLUDE OR INCORPORATE BY REFERENCE INFORMATION FROM DOCUMENTS WHICH ARE NOT PRESENTED HEREIN OR DELIVERED HEREWITH. THESE DOCUMENTS ARE AVAILABLE UPON WRITTEN OR ORAL REQUEST, WITHOUT CHARGE, IN THE CASE OF DOCUMENTS RELATING TO DEI, DIRECTED TO DAEDALUS ENTERPRISES, INC., 300 PARKLAND PLAZA, ANN ARBOR, MICHIGAN 48103 (TELEPHONE NUMBER 313-769-5649), ATTENTION: TREASURER; OR IN THE CASE OF DOCUMENTS RELATING TO STR, DIRECTED TO S. T. RESEARCH CORPORATION, 8419 TERMINAL ROAD, NEWINGTON, VIRGINIA 22122-1430 (TELEPHONE NUMBER: 703-550-7000). IN ORDER TO ENSURE TIMELY DELIVERY OF THE DOCUMENTS, ANY REQUEST SHOULD BE MADE NO LATER THAN FIVE BUSINESS DAYS PRIOR TO THE DEI ANNUAL MEETING OR THE STR SPECIAL MEETING, AS APPLICABLE. NO PERSONS HAVE BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED IN THIS JOINT PROXY STATEMENT/PROSPECTUS IN CONNECTION WITH THE SOLICITATIONS OF PROXIES OR THE OFFERING OF SECURITIES MADE HEREBY AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY DEI, STR OR ANY OTHER PERSON. THIS JOINT PROXY STATEMENT/PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO BUY OR SELL, OR A SOLICITATION OF AN OFFER TO BUY OR SELL, ANY SECURITIES, OR THE SOLICITATION OF A PROXY, IN ANY JURISDICTION TO OR FROM ANY PERSON TO WHOM IT IS NOT LAWFUL TO MAKE ANY SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS JOINT PROXY STATEMENT/PROSPECTUS NOR ANY DISTRIBUTION OF SECURITIES MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE AN IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF DEI OR STR SINCE THE 2 8 DATE HEREOF OR THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE. TABLE OF CONTENTS Page ---- Available Information......................................................................................... 2 Table of Contents............................................................................................. 3 Summary....................................................................................................... 4 Cautionary Statement Regarding Forward-Looking Statements................................................... 14 Risk Factors.................................................................................................. 14 Introduction.................................................................................................. 20 The Merger and Related Matters................................................................................ 23 The Merger Agreement.......................................................................................... 34 The Employment Agreements..................................................................................... 38 The Voting Agreement.......................................................................................... 39 Unaudited Pro Forma Combined Financial Statements............................................................. 39 Proposal to Amend the DEI Certificate of Incorporation........................................................ 46 Proposal to Amend the DEI Long-Term Incentive Plan............................................................ 47 Information about DEI......................................................................................... 51 Election of DEI Directors..................................................................................... 64 Principal Stockholders of DEI and Security Ownership of DEI Management........................................ 68 Information About STR......................................................................................... 70 Principal Stockholders of STR and Security Ownership of STR Management........................................ 83 Information About Merger Sub.................................................................................. 84 Description of DEI Capital Stock.............................................................................. 84 Comparison of Rights of STR Stockholders with Rights of DEI Stockholders...................................... 85 Legal Matters................................................................................................. 88 Experts....................................................................................................... 88 Accountants' Representatives.................................................................................. 88 Stockholder Proposals for DEI's 1998 Annual Meeting........................................................... 88 Index to Financial Statements................................................................................. 89 Annex A Agreement and Plan of Merger.......................................................................... A-1 Annex B Opinion of Roney & Co................................................................................. B-1 Annex C Full Text of Sections 13.1-729 through 13.1-741....................................................... C-1 Annex D Form of Amended and Restated Certificate of Incorporation of DEI...................................... D-1 Annex E Opinion of Corporate Finance of Washington, Inc....................................................... E-1
3 9 SUMMARY The following is a summary of certain information contained elsewhere in this Joint Proxy Statement/Prospectus. Reference is made to, and this summary is qualified in its entirety by, the more detailed information contained elsewhere in this Joint Proxy Statement/Prospectus and in the Annexes hereto and the documents referred to herein. Stockholders are urged to read this Joint Proxy Statement/Prospectus and the Annexes hereto in their entirety. BUSINESS OF DEI AND MERGER SUB DEI manufacturers products for, and performs development projects in, the field broadly described as "remote sensing." Remote sensing is the detection or measurement of various physical parameters of an object or system without making direct contact with the observed object. DEI's customers use these remote sensing products to detect and measure either the emitted or reflected radiation of objects or systems. The principal products manufactured by DEI are airborne imaging systems. DEI's customers install these systems in aircraft and use them to acquire radiation data from objects on the earth's surface and in the atmosphere. This data is then processed into a useful form by data handling and data processing equipment which, in some cases, is also manufactured by DEI. A principal application of DEI's remote sensing products has been the measurement of environmental parameters in support of pollution control programs and environmental impact studies. Merger Sub is a recently formed Virginia corporation which was organized for the sole purpose of effecting the Merger. DEI's and Merger Sub's principal executive offices are located at 300 Parkland Plaza, Ann Arbor, Michigan 48103 (telephone: 313-769-5649). See "Information About DEI" and "Information About Merger Sub." BUSINESS OF STR STR designs, develops, manufacturers and markets intelligence sensory and electronic reconnaissance systems for defense and commercial markets. Various agencies of the U. S. Government are the principal customers for these systems. STR's principal executive offices are located at 8419 Terminal Road, Newington, Virginia 22122-1430 (telephone: 703-550-7000). See "Information About STR." THE MERGER DEI, Merger Sub and STR have entered into the Merger Agreement pursuant to which Merger Sub will be merged with and into STR. Immediately following the Merger, DEI will remain in existence as a Delaware corporation and STR will be a wholly owned subsidiary of DEI. Each share of STR Common Stock (other than shares held by stockholders of STR who perfect their dissenters' rights in the manner described in this Joint Proxy Statement/Prospectus) which is issued and outstanding at the Effective Time (as defined below) of the Merger, will be converted into the right to receive 2.58 shares of DEI Common Stock. Based on the 1,325,786 shares of STR Common Stock outstanding at January 31, 1998 and assuming no STR stockholders perfect their dissenters' rights, approximately 3,420,527 shares of DEI Common Stock will be issued in the Merger, representing approximately 86.5% of the outstanding shares of DEI Common Stock immediately following the Merger. See "The Merger and Related Matters." 4 10 TIME, PLACE AND DATE OF ANNUAL MEETING OF STOCKHOLDERS OF DEI The annual meeting of the stockholders of DEI (the "DEI Annual Meeting") will be held on May 28, 1998 at 9:00 a.m., local time, at DEI's principal offices. Only holders of record of DEI Common Stock at the close of business on April 20, 1998 (the "DEI Record Date") will be entitled to notice of, and to vote at, the DEI Annual Meeting. At such date, there were 534,574 shares of DEI Common Stock outstanding and entitled to vote. The purpose of the DEI Annual Meeting is to consider and approve (a) the Charter Amendment, a copy of which is attached to this Joint Proxy Statement/Prospectus as Annex D; (b) the election of directors; (c) Long-Term Incentive Plan amendment; and (d) the transaction of such other business as may properly come before the DEI Annual Meeting or any adjournments thereof. See "Introduction." TIME, PLACE AND DATE OF SPECIAL MEETING OF STOCKHOLDERS OF STR The special meeting of the stockholders of STR (the "STR Special Meeting") will be held on May 28, 1998 at 9:00 a.m., local time, at STR's principal offices. Only holders of record of STR Common Stock at the close of business on April 20, 1998 (the "STR Record Date"), will be entitled to notice of, and to vote at, the STR Special Meeting. At such date, there were 1,325,786 shares of STR Common Stock outstanding and entitled to vote. The purpose of the STR Special Meeting is to consider and approve the Merger Agreement and the Merger. See "Introduction." DEI VOTE REQUIRED; QUORUM The approval of the Charter Amendment requires the affirmative vote of the holders of a majority of the shares of DEI Common Stock outstanding. Because the number of shares of DEI Common Stock to be issued in the Merger exceeds the number of shares which are currently authorized for issuance under DEI's certificate of incorporation, approval by the DEI stockholders of the Charter Amendment is a condition to the consummation of the Merger. A vote against the Charter Amendment will have the effect of a vote against the Merger. The election of the directors requires the approval of a plurality of the votes cast at the Annual Meeting. Approval of the Long-Term Incentive Plan amendment requires the affirmative vote of the holders of a majority of the shares of DEI Common Stock voting on the matter. For purposes of determining the number of votes cast with respect to the election of directors, only those cast "for" are included. Abstentions and withheld votes are counted only for purposes of determining whether a quorum is present at the Annual Meeting and broker non-votes are not counted. Abstentions and broker non-votes will have the effect of a vote against the Charter Amendment but will have no effect on the vote on the Long-Term Incentive Plan amendment. As of January 31, 1998, the executive officers and directors of DEI beneficially own approximately 16.6% of the outstanding shares of DEI Common Stock. Such persons have advised DEI that they intend to vote all of the shares over which they hold voting power in favor of the foregoing proposals and certain of such persons are contractually bound to do so. See "The Voting Agreement." A majority of the issued and outstanding shares of DEI Common Stock entitled to vote, represented in person or by proxy, shall constitute a quorum at the DEI Annual Meeting. See "Introduction -- DEI Record Date; Voting Quorum." STR VOTE REQUIRED; QUORUM The affirmative vote of at least two-thirds of the outstanding shares of STR Common Stock is required to approve the Merger Agreement and Merger. Abstentions will have the effect of a vote against the Merger Agreement and the Merger. As of January 31, 1998, the principal stockholders, executive officers and directors of STR beneficially own approximately 62.5% of STR Common Stock and have informed STR that all such shares over which they hold voting power will be voted for approval of the Merger and certain of such persons are contractually bound to do so. See "The Voting Agreement." A majority of the issued and outstanding shares of STR Common Stock entitled to vote, represented in person or by proxy, shall constitute a quorum at the STR Special Meeting. See "Introduction -- STR Record Date; Voting Quorum." 5 11 CERTAIN EFFECTS OF THE MERGER The Merger will become effective when Articles of Merger are filed with the Virginia State Corporation Commission ("Effective Time"). At the Effective Time, each issued and outstanding share of STR Common Stock (other than shares held by stockholders of STR who perfect their dissenters' rights in the manner described in this Joint Proxy Statement/Prospectus) will be converted into the right to receive 2.58 newly issued shares of DEI Common Stock (the "Exchange Ratio"). STR stockholders will receive cash in lieu of any fractional share to which they are otherwise entitled. Promptly after the Effective Time, DEI will forward a letter of transmittal to stockholders of STR containing detailed instructions for the surrender of certificates representing STR Common Stock. The Merger will result in a change of control of DEI due to the issuance of an additional 3.4 million shares of DEI Common Stock to STR's stockholders and the appointment of STR's directors to fill a majority of the positions on DEI's Board of Directors. See "The Merger and Related Matters -- Certain Effects of the Merger" and "The Merger Agreement." DILUTION As of the DEI Record Date, there were 534,574 shares of DEI Common Stock outstanding. As of the STR Record Date, there were 1,325,786 shares of STR Common Stock outstanding. It is anticipated that approximately 3,420,527 shares of DEI Common Stock will be issued in the Merger. The following table illustrates the dilution of voting interests resulting from the Merger based on the tables included under "Principal Stockholders of DEI and Security Ownership of DEI Management" and "Principal Stockholders of STR and Security Ownership of STR Management."
Before the Merger ------------------------------------------------ After the Merger DEI Common Stock STR Common Stock --------------------------- Number of Shares(1)% Number of Shares(1)% Number of Shares(1)% -------------------------------------------------------------------------------- DEI Directors and Executive officers as a Group 88,866 16.6 4,000(4) 0.3 99,186(4) 2.5 All other DEI stockholders 443,208 82.9 - (3) - (3) 443,208 11.2 STR Directors and Executive Officers as a Group 2,500(2) 0.5 829,220(2) 62.5 2,141,887(2) 54.2 All other STR stockholders - (3) - (3) 492,566 37.2 1,270,820 32.1 ------- ----- --------- ----- --------- ----- 534,574 100.0 1,325,786 100.0 3,955,101 100.0 ======= ===== ========= ===== ========= =====
- -------------- (1) Does not include shares which may be acquired upon exercise of outstanding stock options. There are currently 108,975 outstanding options to purchase DEI Common Stock and 34,000 outstanding options to purchase STR Common Stock. Immediately following the Merger there will be a total of 196,695 outstanding options which, if fully exercised, would represent 4.5% of the then outstanding DEI Common Stock. (2) To avoid double counting, does not include the 5,876 shares of STR Common Stock owned by Dr. Sanders, a director of STR and a director of DEI, which will convert into 15,160 shares of DEI Common Stock pursuant to the Merger. (3) Cross-ownership is assumed to be zero unless otherwise disclosed in the table. (4) To avoid double counting, does not include the 26,250 shares of DEI Common Stock owned by Dr. Sanders, who is a director of STR and a director of DEI. 6 12 RECOMMENDATION OF THE DEI BOARD THE BOARD OF DIRECTORS OF DEI BELIEVES THAT THE MERGER IS IN THE BEST INTERESTS OF DEI AND ITS STOCKHOLDERS, HAS APPROVED THE MERGER AGREEMENT AND UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS OF DEI VOTE FOR APPROVAL OF THE CHARTER AMENDMENT, THE LONG-TERM INCENTIVE PLAN AMENDMENT AND THE ELECTION OF EACH OF THE DIRECTOR-NOMINEES. In making this determination, the Board of Directors of DEI has considered the factors described under the caption, "The Merger and Related Matters -- DEI's Reasons for the Merger; Recommendation of DEI's Board of Directors; Fairness to DEI's Stockholders." In connection with such recommendation, stockholders should consider the matters discussed in "The Merger and Related Matters -- Conflicts of Interest." OPINION OF DEI'S FINANCIAL ADVISOR On December 23, 1997, Roney and Co. ("Roney"), DEI's financial advisor in connection with the transactions contemplated by the Merger Agreement, gave an opinion to the Board of Directors of DEI that the terms of the Merger are fair to the stockholders of DEI from a financial point of view. See "The Merger and Related Matters -- Opinion of DEI's Financial Advisor." The full text of the written opinion of Roney, which contains information as to the assumptions made, matters considered and the scope of and limitations on the review undertaken by Roney, is set forth as Annex B to this Joint Proxy Statement/Prospectus and should be read in its entirety. See "The Merger and Related Matters -- Opinion of DEI's Financial Advisor." RECOMMENDATION OF THE STR BOARD THE BOARD OF DIRECTORS OF STR BELIEVES THAT THE TERMS OF THE MERGER ARE FAIR TO AND IN THE BEST INTERESTS OF STR AND ITS STOCKHOLDERS, HAS APPROVED THE MERGER AGREEMENT AND UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS OF STR VOTE FOR APPROVAL OF THE MERGER AGREEMENT AND THE MERGER. In making this determination, the Board of Directors of STR has considered the factors described under the caption, "The Merger and Related Matters -- STR's Reasons for the Merger; Recommendation of STR's Board of Directors; Fairness to STR's Stockholders." In connection with such recommendation, stockholders should consider the matters discussed in "The Merger and Related Matters -- Conflicts of Interest." OPINION OF STR'S FINANCIAL ADVISOR On December 23, 1997, Corporate Finance of Washington, Inc. ("Corporate Finance"), STR's financial advisor in connection with the transactions contemplated by the Merger Agreement, gave an opinion to the Board of Directors of STR that the terms of the Merger are fair to the stockholders of STR from a financial point of view. See "The Merger and Related Matters -- Opinion of STR's Financial Advisor." The full text of the written opinion of Corporate Finance which contains information as to the matters considered, and the scope and limitations of the review undertaken by Corporate Finance, is set forth as Annex E to this Joint Proxy Statement/Prospectus and should be read in its entirety. See "The Merger and Related Matters -- Opinion of STR's Financial Advisor." PRIVATE PLACEMENT The shares of STR Common Stock being converted include 582,000 shares which STR issued at $6.50 per share in a private placement completed on January 30, 1998. Based upon the average of the bid and ask price of DEI Common Stock on November 11, 1997 (the date on which the Merger was announced), these shares, along with all of the other shares of STR Common Stock, had an equivalent value of approximately $8.23 per share. The private placement occurred after the respective Boards of Directors had approved the Merger and had received the opinions of their financial advisors. CONDITIONS TO THE MERGER; TERMINATION OF THE MERGER AGREEMENT The obligations of DEI and STR are subject to the satisfaction of certain conditions, including obtaining the approval of the STR stockholders of the Merger Agreement and the approval of the DEI stockholders of the Charter Amendment. See "The Merger Agreement -- Conditions to Consummation of the Merger." The Board of Directors of either STR or DEI has the right to waive certain conditions precedent to the consummation of the Merger other than those conditions which are a legal necessity for the Merger to occur such as STR stockholder approval of the Merger or DEI stockholder approval of the Charter Amendment. In the event either Board waives any condition, each company intends to resolicit shareholder approval unless in the opinion of such company's Board, the delay associated with the resolicitation process is likely to have a material adverse effect on the business or financial condition of such company. 7 13 The Merger Agreement may be terminated at any time prior to the Effective Time, whether before or after approval by the stockholders of DEI or STR, by either DEI or STR if the Merger has not been consummated by May 31, 1998 and prior to such time upon the occurrence of certain events. If the Merger is not completed under certain circumstances, DEI or STR may be entitled to have its expenses paid by the other. See "The Merger Agreement -- Termination; Amendment; Waiver." CONFLICTS OF INTEREST In considering the recommendation of STR's Board of Directors with respect to the Merger and the Merger Agreement and the recommendation of DEI's Board of Directors with respect to the Charter Amendment, stockholders should be aware that certain members of STR's Board of Directors and DEI's Board of Directors have interests in the Merger that are in addition to and potentially in conflict with the interests of stockholders of STR and DEI generally. The Boards of Directors of STR and DEI were aware of these interests and considered them, among other matters, in approving the Merger Agreement. As a condition to the parties' obligations to consummate the Merger, Thomas Ory, the President, Chief Executive Officer and a Director of DEI, and Charles Stanich, the Vice President - Research and Development, Chief Operating Officer and a Director of DEI, have entered into employment agreements with DEI which will become effective upon consummation of the Merger. See "The Employment Agreements." John D. Sanders is the Chairman of DEI's Board of Directors and is also a member of STR's Board of Directors. Dr. Sanders also acted as a consultant to DEI to assist management in seeking potential financing transactions and identifying joint venture and merger partners. Dr. Sanders received a fee of $1,500 per month from DEI from January 1997 to December 1997 but will not receive any fee which is contingent on consummation of the Merger. See "The Merger and Related Matters -- Background of the Merger." Certain directors and principal stockholders of STR have indicated they will vote to approve the Merger. These same persons will be nominated or appointed to serve on DEI's Board of Directors. Effective upon consummation of the Merger, DEI will increase the size of its Board of Directors to seven and S. R. Perrino, James Busey, Charles Bernard and S. Kent Rockwell will be appointed as directors of DEI. Charles Stanich and William Panschar will resign from the DEI Board upon consummation of the Merger. See "Election of DEI Directors -- Possible Changes and Appointments to DEI'S Board of Directors and Executive Officers." In addition, in connection with the Merger, Thomas Ory, Charles Stanich, John Sanders and Philip Power (the "DEI VA Stockholders"), S. R. Perrino, John Sanders, Robert Bower and Donald Reiser (the "STR VA Stockholders"), and DEI have entered into a Voting Agreement, dated as of December 23, 1997 (the "Voting Agreement"). The Voting Agreement provides that if the Merger Agreement has not been terminated in accordance with its terms, (i) the DEI VA Stockholders will vote their shares of DEI Common Stock for the approval of the Charter Amendment and the DEI Long-Term Incentive Plan at the DEI Annual Meeting and will not sell their shares of DEI Common Stock prior to the earlier of the Effective Time, the termination of the Merger Agreement or July 1, 1998; and (ii) the STR VA Stockholders will vote their shares of STR Common Stock for approval of the Merger Agreement at the STR Special Meeting and will not sell their shares of STR Common Stock prior to the earlier of the Effective Time, the termination of the Merger Agreement or July 1, 1998. DEI has agreed to reconstitute its Board of Directors and to nominate certain persons for two years after the Merger. See "The Voting Agreement." At the Effective Time, outstanding options to purchase STR Common Stock will be converted into options to purchase the same number of shares of DEI Common Stock as the holders of such options would have been entitled to receive pursuant to the Merger had such holders exercised such options in full immediately prior to the consummation of the Merger (without taking into account whether such option was in fact exercisable at such time). See "The Merger and Related Matters -- Conflicts of Interest." 8 14 DEI COMMON STOCK DEI Common Stock is the only authorized and issued class of capital stock of DEI. Each share of DEI Common Stock is entitled to one vote and cumulative voting is not permitted. See "Description of DEI Capital Stock -- DEI Capital Stock." FEDERAL INCOME TAX CONSEQUENCES Based upon the opinion of Michaels, Wishner & Bonner P.C., counsel to STR, the Merger will be a tax-free reorganization for federal income tax purposes within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code"), assuming certain non-statutory requirements with respect to continuity of business enterprise and interest are met subsequent to the Merger. If such requirements are met, the holders of STR Common Stock who exchange STR Common Stock for DEI Common Stock in the Merger will recognize no gain or loss upon the exchange of shares of STR Common Stock for shares of DEI Common Stock, except that any realized gain or loss will be recognized with respect to the receipt of cash exchanged for fractional shares. See "The Merger and Related Matters -- Federal Income Tax Consequences." The opinion of Michaels, Wishner & Bonner, P.C. is attached as an exhibit to the Registration Statement. The rendering of such opinion is not a condition to consummation of the Merger. ACCOUNTING TREATMENT The Merger will be treated as a reverse acquisition purchase by STR of DEI for financial reporting purposes. See "The Merger and Related Matters - -- Accounting Treatment." COMPARISON OF STOCKHOLDER RIGHTS Since STR is organized under the Virginia Stock Corporation Act ("VSCA") and DEI is organized under the Delaware General Corporation Law ("DGCL"), certain differences between the rights of holders of STR Common Stock and the rights of holders of DEI Common Stock arise from various provisions of the corporate laws of those states as well as from various differences in the provisions of the respective charters and bylaws of STR and DEI. Such differences include differences with respect to the ability of directors to declare dividends, the protection available against unsolicited takeovers, the general standards of conduct of directors, the rights of dissenting stockholders to seek an appraisal of their shares in connection with certain corporate transactions, the ability of stockholders to act without a meeting, the voidability of certain conflict of interest transactions, the permissibility and limitations regarding indemnification by a corporation of its directors and officers, and the limitations on liability of directors and officers to the corporation and to the stockholders. See "Comparison of Rights of STR Stockholders with Rights of DEI Stockholders." APPRAISAL/DISSENTERS' RIGHTS Holders of DEI Common Stock are not entitled to appraisal rights under the DGCL in connection with the Merger because DEI is not a constituent corporation in the Merger. DEI Common Stock is currently thinly traded. See "Risk Factors -- No Active Market For the DEI Common Stock." Holders of STR Common Stock are entitled to dissenters' rights under the VSCA in connection with the Merger. Certain provisions of the VSCA regarding dissenters' rights are reproduced in full as Annex C. Failure to follow any of the statutory procedures may result in a termination or waiver of dissenters' rights. See "The Merger and Related Matters -- Dissenters' Rights." APPROVALS DEI and STR are not aware of any federal or state regulatory requirements or approvals which must be complied with or obtained in order to consummate the Merger. The Merger is subject to the approval of DEI's and 9 15 STR's principal lenders. DEI's lender has indicated its intention to allow the current mortgage to remain in effect. STR intends to use funds available under its line of credit to satisfy DEI's line of credit borrowings. STR's lender has given its consent to the Merger. AMENDMENT OF THE DEI CERTIFICATE OF INCORPORATION At the DEI Annual Meeting, the stockholders of DEI will be requested to approve the Charter Amendment, which will increase the number of authorized shares of DEI Common Stock from 2,000,000 to 5,000,000 shares and to change DEI's name to "Sensys Technologies Inc." The primary purpose of the increase in the number of shares is to authorize the shares of DEI Common Stock being issued to STR stockholders upon consummation of the Merger. Stockholder approval of the Charter Amendment is a condition to consummation of the Merger. The affirmative vote of the holders of a majority of the outstanding shares of DEI Common Stock is required for the approval of the Charter Amendment. The Charter Amendment will not become effective unless the Merger is consummated. See "Proposal to Amend the DEI Certificate of Incorporation." ELECTION OF DIRECTORS AND AMENDMENT OF DEI'S LONG-TERM INCENTIVE PLAN Stockholders of DEI will also be asked, at the Annual Meeting, to vote on the election of directors to DEI's Board of Directors and to approve an amendment to DEI's Long-Term Incentive Plan. See "Election of Directors" and "Proposal to Amend the DEI Long-Term Incentive Plan." RISK FACTORS In deciding how to vote their shares at the STR Special Meeting and DEI Annual Meeting, the following factors relating to DEI and STR, among others, should be considered by holders of STR Common Stock and DEI Common Stock: (i) DEI's substantial dependence on its line of credit and DEI's going concern considerations; (ii) STR's substantial dependence on its line of credit; (iii) DEI's urgent need for additional capital; (iv) potential unprofitability and variability of DEI's operating results; (v) the potential inability to integrate DEI and STR; (vi) DEI's and STR's substantial dependence on government funding and government contracts; (vii) DEI's significant revenues from international customers; (viii) intense competition; (ix) STR's substantial dependence on major suppliers; (x) potential inability to implement DEI's growth plan; (xi) DEI's and STR's dependence on key management; (xii) the potential inability of DEI and STR to attract and retain qualified personnel; (xiii) the lack of an active market for the DEI Common Stock; (xiv) the fixed exchange ratio; (xv) the potential failure of future acquisitions; and (xvi) conflicts of interest. See "Risk Factors." DEI MARKET PRICES DEI Common Stock is traded over the counter. The information presented in the table below represents the average of the high and low sale prices quoted by the National Quotation Bureau, Inc. for DEI Common Stock on December 22, 1997, the last full trading day prior to the public announcement that the Merger Agreement had been executed, and on May 8, 1998, the last full trading day for which quotations were available at the time of the printing of this Joint Proxy Statement/Prospectus, as well as the "equivalent per share price" of STR Common Stock on such dates. There is no public trading market for STR Common Stock. The "equivalent per share price" of STR Common Stock at each specified date represents the average of the high and low sale prices quoted by the National Quotation Bureau, Inc. for DEI Common Stock at such specified date multiplied by the Exchange Ratio. DEI Common STR Equivalent Stock Price Per Share Price ----------- --------------- December 22, 1997 $3.00 $7.74 May 8, 1998 10 16 For information relating to market prices of DEI Common Stock during the current fiscal year and the past two fiscal years, see "Information About DEI -- Market Price and Dividend Information." Because the market price of DEI Common Stock is subject to fluctuation, the value of the consideration that holders of STR Common Stock will receive in the Merger may increase or decrease prior to consummation of the Merger. STOCKHOLDERS ARE URGED TO OBTAIN CURRENT QUOTATIONS FOR DEI COMMON STOCK. SELECTED FINANCIAL INFORMATION The following selected consolidated financial data for DEI as of and for each of the five years ended July 31, 1997, and the selected financial data for STR as of and for each of the five years ended September 30, 1997, are derived from the audited financial statements of DEI and STR, respectively. The selected consolidated financial data of DEI as of and for the six months ended January 31, 1998 and 1997 and the selected financial data of STR as of and for the three months ended December 31, 1997 and 1996 are derived from unaudited financial statements of DEI and STR, respectively. The unaudited financial statements of DEI and STR included all adjustments, consisting solely of normal recurring accruals, which the management of DEI and STR, respectively, considered necessary for a fair presentation of the financial position and the results of operations for such periods. Operating results for the three months ended January 31, 1998 and 1997 for DEI and for the three months ended December 31, 1997 and 1996 for STR are not necessarily indicative of the results that may be expected for future periods. The data should be read in conjunction with the DEI and STR financial statements, related notes and other financial information included in this Joint Proxy Statement/Prospectus. DEI SELECTED CONSOLIDATED FINANCIAL DATA
For the six months ended January 31, For the year ended July 31, ------------------------ ------------------------------------------------- 1998 1997 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- ---- (in thousands except for per share data) RESULTS OF OPERATIONS DATA Total revenues $ 852 $1,511 $3,001 $2,090 $3,624 $2,453 $6,305 Net income (loss)(1) (306) (18) (64) (967) (362) (631) 454 Net income (loss) per share-basic(2) (0.57) (0.03) (0.12) (1.85) (0.70) (1.24) 0.78 Net income (loss) per share-diluted(2) (0.57) (0.03) (0.12) (1.85) (0.70) (1.24) 0.78 Dividends per share -- -- -- -- 0.17 0.15 0.13 BALANCE SHEET DATA (as of end of period) Total assets $2,197 $2,070 $2,070 $2,769 $3,930 $4,041 $4,762 Working capital (88) 268 268 213 801 1,562 2,144 Long-term debt -- -- -- -- -- 278 314 Stockholders' equity 1,106 1,411 1,411 1,473 2,390 2,830 3,516
(1) Effective August 1, 1993, DEI changed from completed component to cost incurred as a percentage of the total estimated cost as the method for determining percentage completion for revenue recognition on standard product contracts. The cumulative effect of this accounting change reduced the loss by $22, or $.04 per share, for fiscal 1994. (2) Net income per share has been computed in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share." 11 17 STR SELECTED FINANCIAL DATA
For the three months ended December 31, For the year ended September 30, -------------------------- ------------------------------------------------------- 1997 1996 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- ---- (dollars in thousands except for per share data) RESULTS OF OPERATIONS DATA Total revenues $ 5,837 $5,606 $23,953 $21,655 $16,652 $10,601 $12,198 Net income before cumulative effect of a change in accounting principle(1) (69) (18) 120 327 317 63 54 Net income (69) (18) 120 327 317 63 264 Net income per share-basic(2) (0.09) (0.02) 0.17 0.45 0.44 0.09 0.39 Net income per share-diluted(2) (0.09) (0.02) 0.16 0.42 0.42 0.09 0.39 BALANCE SHEET DATA (as of end of period) Current assets $10,299 $7,111 $ 9,812 $ 7,267 $ 4,898 $ 4,068 $ 4,825 Total assets 11,259 8,158 10,804 8,145 5,642 4,376 5,213 Current liabilities 8,782 5,698 8,254 5,635 3,398 2,635 3,571 Working capital 1,517 1,413 1,558 1,632 1,500 1,433 1,254 Long-term obligations 9 61 14 90 151 15 19 Redeemable preferred stock -- -- -- -- -- -- 105 Stockholders' equity(3) 2,467 2,398 2,536 2,420 2,093 1,726 1,623
(1) Effective October 1, 1992, STR adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." The cumulative effect of this accounting change increased net income by approximately $210 or $0.31 per share. (2) Net income per share has been computed in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share." (3) STR has not declared any dividends during the periods presented. On January 30, 1998, STR issued 582,000 shares of its common stock for cash of $6.50 per share for aggregate proceeds of $3,783. UNAUDITED PRO FORMA SELECTED COMBINED FINANCIAL DATA The following sets forth certain selected financial information of DEI and STR on an unaudited pro forma basis after giving effect to the Merger on a Areverse acquisition purchase" basis (as if STR had acquired DEI) and to the private placement of 582,000 shares of STR Common Stock on January 30, 1998 (Stock Issuance). The unaudited pro forma selected combined results of operations data include the results of operations of DEI and STR for the respective periods presented and gives effect to pro forma adjustments as if the Merger and the Stock Issuance had occurred at the beginning of the period. The unaudited pro forma selected combined balance sheet data includes the historical balance sheet data of DEI and STR as of December 31, 1997 and gives effect to the pro forma adjustments as if the Merger and Stock Issuance had occurred on that date. This data should be read in conjunction with the Unaudited Pro Forma Combined Financial Statements, the Selected Financial Information, the Comparative Per Share Data and the separate historical financial statements of DEI and STR and the notes thereto included elsewhere in this Joint Proxy Statement/Prospectus. The unaudited pro forma combined financial data are not necessarily indicative of the operating results or financial position that would have been achieved had the Merger been consummated at the beginning of the periods presented and should not be construed as representative of future operations. 12 18
Three months ended Fiscal year ended December 31, September 30, 1997 1997 ------------------ ------------------- (in thousands except for per share data) RESULTS OF OPERATIONS DATA Total revenues $6,321 $26,955 Net income (loss) (70) 313 Net income (loss) per share-basic (0.02) 0.08 Net income (loss) per share-diluted (0.02) 0.08 Dividends per share -- -- BALANCE SHEET DATA December 31, (as of end of period) 1997 ------------ Total assets $13,939 Working capital 5,472 Long-term obligations 9 Stockholders' equity 8,138
COMPARATIVE PER SHARE DATA The following table sets forth certain historical per share data of DEI and STR and combined per share data on an unaudited pro forma basis after giving effect to the Merger on a "reverse acquisition purchase" basis (as if STR has acquired DEI). This data should be read in conjunction with the Selected Financial Information, the Unaudited Pro Forma Combined Financial Statements and the separate historical financial statements and the notes thereto of DEI and of STR included elsewhere in this Joint Proxy Statement/Prospectus. The unaudited pro forma combined financial data are not necessarily indicative of the operating results or financial position that would have been achieved had the Merger been consummated at the beginning of the periods presented and should not be construed as representative of future operations.
As of and for the As of and for the six months ended fiscal year ended January 31, 1998 July 31, 1997 ------------------- ------------------ Historical - DEI Net loss per share-basic $(0.57) $(0.12) Net loss per share-diluted (0.57) (0.12) Book value per share 2.46 2.64 Cash dividends per share -- -- As of and for the As of and for the three months ended fiscal year ended December 31, 1997 September 30, 1997 ------------------- ------------------ Historical - STR Net income (loss) per share-basic $(0.09) $0.17 Net income (loss) per share-diluted (0.09) 0.16 Book value per share 3.41 3.50 Cash dividends per share -- --
13 19 Pro forma combined - DEI and STR Net income (loss) per share-basic (0.02) 0.08 Net income (loss) per share-diluted (0.02) 0.08 Book value per share 2.08 2.10 Cash dividends per share -- -- Equivalent pro forma - STR Net income (loss) per share-basic (0.05) 0.21 Net income (loss) per share-diluted (0.05) 0.21 Book value per share 5.37 5.42 Cash dividends per share -- --
(1) Equivalent pro forma per share amounts are calculated by multiplying the pro forma combined per share data amounts by the exchange ratio of 2.58 shares of DEI Common Stock for each share of STR Common Stock. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS The discussion in this Joint Proxy Statement/Prospectus contains forward-looking statements that are based on certain assumptions and involve risks and uncertainties. Actual future results may vary materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Risk Factors," "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations," "Information About STR -- Management's Discussion and Analysis of Financial Condition and Results of Operations," "Information About DEI -- Business," and "Information About STR -- Business," as well as those discussed elsewhere in this Joint Proxy Statement/Prospectus. Statements contained in this Joint Proxy Statement/Prospectus regarding DEI that are not historical facts are forward-looking statements that are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. DEI and STR do not undertake any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. RISK FACTORS In deciding how to vote their shares at the DEI Annual Meeting and the STR Special Meeting, respectively, holders of shares of DEI Common Stock and shares of STR Common Stock should carefully consider all of the information contained in this Joint Proxy Statement/Prospectus and, in particular, the following factors. DEI'S SUBSTANTIAL DEPENDENCE ON ITS LINE OF CREDIT AND GOING CONCERN CONSIDERATIONS DEI incurred losses of $631,000, $362,000, $967,000, $64,000 and $306,000 during fiscal 1994, 1995, 1996 and 1997 and in the first six months of fiscal 1998, respectively. Due to these losses, DEI has experienced severe liquidity problems and has depended primarily on its bank line of credit to maintain operations. The bank line of credit is due on demand and is secured by substantially all of DEI's assets, including real estate. Borrowing availability under the line of credit is subject to a formula. As of October 31, 1997, the formula was $950,000 based on the value of the real estate, with the remaining available borrowings based on 50% of the value of certain receivables specified in the line credit agreement. As of October 31, 1997, total remaining availability was approximately $581,000 based on the formula. At that date, DEI had an outstanding balance of $310,000 under the line of credit with an additional $59,000 of the line reserved for a standby letter of credit. DEI's mortgage indebtedness is cross-collateralized and cross-defaulted with the line of credit. See "Summary -- Selected Financial Information" and "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations." There can be no assurance that the lending bank will continue to permit DEI to borrow and will not demand payment at a time at which DEI is unable to repay or refinance such indebtedness. If the lending bank believes that the 14 20 prospect of payment of DEI's indebtedness under the line of credit is impaired, the lending bank is permitted under the agreement governing the line of credit to declare such indebtedness due and payable or to limit DEI's ability to borrow additional funds thereunder. Although the Merger is expected to have a positive impact on DEI's consolidated results of operations and liquidity and substantially reduce its dependence on its line of credit, there can be no assurance that DEI will be profitable following the Merger or that it will generate cash flow at a rate sufficient to operate the business. If the Merger is consummated, the borrowing capacity under STR's line of credit is expected to be sufficient to support the operations of both DEI and STR, although there can be no assurance to that effect. See "Information About STR -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." DEI's financial statements have been prepared on the basis that DEI will continue operating as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. DEI's ability to continue as a going concern is dependent upon several factors, including DEI's ability to generate sufficient cash flow to meet its obligations on a timely basis. DEI's financial statements were audited by its independent certified public accountants, whose report includes an explanatory paragraph stating that the financial statements have been prepared assuming DEI will continue as a going concern and that DEI has incurred losses from operations that raise substantial doubt about its ability to continue as a going concern. If the Merger is not consummated, DEI will need additional financing to fund expected operating losses and other working capital needs. See "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations" and DEI's Financial Statements included in this Joint Proxy Statement/Prospectus. STR'S SUBSTANTIAL DEPENDENCE ON ITS LINE OF CREDIT Until STR completed a $3,783,000 private placement in January 1998, STR historically depended upon its line of credit from its bank and extended payment terms from its vendors to operate its business. The proceeds from the private placement were used to pay down the line of credit. At March 31, 1998, STR was able to borrow up to $2.8 million pursuant to the borrowing base provisions of its $4.5 million line of credit and had outstanding borrowings of $125,000 thereunder. If STR's operating performance does not improve or if DEI and STR cannot be effectively integrated, STR will again become reliant on its line of credit. The withdrawal of this line of credit could have a material adverse effect on STR's business. See "Information About STR -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." DEI'S URGENT NEED FOR ADDITIONAL CAPITAL DEI had working capital of approximately $172,000 at October 31, 1997. In order to provide additional working capital and retire current debt, DEI is attempting to sell its building and lease back a portion of the facility from the new owner. There can be no assurance that the building can be sold at a price acceptable to DEI or that an acceptable lease-back agreement can be negotiated. If DEI must relocate, management believes that a suitable facility can be found and that DEI's business will not be materially disrupted. The building is listed for sale with a real estate agency and DEI expects to continue efforts to sell its building whether or not the Merger is consummated. The building was first listed for sale in February 1996 at an asking price of $2.2 million and is currently listed at a price of $1.95 million. An offer to lease the building for two years with an option to buy at a price of $1.8 million is currently pending and is being considered by DEI. See "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." The sale of the building is expected to result in the termination of DEI's existing line of credit. Management believes that a new line of credit supported by receivables, irrevocable letters of credit and other assets of DEI can be negotiated with the current bank lender or a substitute bank which will be adequate to support DEI's working capital needs provided that DEI's backlog increases significantly over the current level. In the absence of a significant increase in DEI's backlog, it is unlikely that DEI would have sufficient operating cash flow to induce a bank to establish a new line of credit. There can be no assurance that DEI will be able to acquire a replacement line of credit at all or that the level of borrowing permitted under any replacement line of credit will be adequate for DEI's working capital needs if the Merger is not consummated or on a consolidated basis with STR if the Merger is consummated. Absent a new line 15 21 of credit, STR believes the current borrowing capacity available under its lines of credit would be sufficient for both companies, although there can be no assurance to that effect. The failure to obtain an adequate line of credit may have a material adverse effect on DEI's financial condition and results of operations. See "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." If the Merger is not consummated, DEI will continue to pursue additional equity financing through discussions with potential investors possessing related technological and/or marketing capabilities. DEI will also continue to operate supported by its line of credit, but the lending bank has indicated that it may limit the amount which DEI is permitted to borrow under the line of credit in the absence of continued improvement in DEI's business prospects or progress toward the acquisition of a significant amount of equity capital. If the Merger is not consummated and DEI is unable to borrow amounts necessary to fund its operations, its financial position would be materially and adversely affected and DEI may have no choice but to cease operations if other sources of capital are not available. See "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." POTENTIAL UNPROFITABILITY AND VARIABILITY OF OPERATING RESULTS STR's historical profit margins have been very low and DEI has operated at a loss over the past several fiscal years. Unless the combined companies are able to achieve the cost efficiencies and increased revenues anticipated as a result of the Merger, the combined companies may not be able to operate at a profit. Although STR's management believes that the January 1998 infusion of equity will significantly reduce interest expense and will provide for an improved operating environment with other reduced costs, there can be no assurance that the anticipated cost efficiencies and revenue increases will occur. See "Information About STR -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." DEI's results of operations are affected by certain factors which can cause its results of operations to vary significantly from period to period and have led to losses in recent periods. DEI currently receives the majority of its revenue from a small number of relatively large contracts. Standard product contracts are generally of higher dollar value than customer-funded product development contracts, with each contract representing a substantial portion of total revenue each year. Therefore, the timing of the receipt of a standard product sales contract as well as the related manufacturing endeavor can have a material impact on a quarter-to-quarter or year-to-year comparison of DEI's results of operations. DEI experienced delays in the receipt of certain U.S. Government contracts in fiscal 1996 and has failed to receive expected contracts due to funding constraints resulting from pressures to balance the federal budget and delays in congressional budget approval. DEI also failed to receive certain contracts from Asian customers due to the well-publicized adverse economic conditions in Asia and the resulting funding constraints, which contracts DEI expected to be awarded in late 1997 or early 1998. These delays and failures to receive contracts have had, and continue to have, a material adverse effect on DEI's revenue base. The small number of customers and large percentage of total revenues in a given year represented by any particular customer also contribute to the variability in DEI's operating results. For example, during fiscal 1997, out of 18 total customers, two U.S. Government agencies (the National Aeronautics and Space Administration and the U.S. Department of Agriculture) accounted for $1,625,000 or 54% of DEI's revenue and the Royal Thai Air Force accounted for $1,144,000 or 38% of DEI's revenue. During fiscal 1996, four agencies of the U.S. Government (the National Aeronautics and Space Administration, the U.S. Department of Agriculture, the U.S. Department of the Air Force and Bechtel Nevada) accounted for $618,000 or 30% of revenue, Asia Air Survey Co., Ltd. accounted for $562,000 or 27% of revenue and the Instituto de Meteorologia of Portugal accounted for $436,000 or 21% of revenue. As a result of these factors and others, there can be no assurance that DEI will be profitable in the future on a quarterly or annual basis, whether or not the Merger is consummated. If operating results are below the expectations of public market analysts and investors as expected, or in the event that adverse conditions prevail or are perceived to prevail generally or with respect to DEI's business, the price of the DEI Common Stock may be materially adversely affected. DEI's ability to continue operations if the Merger is not consummated depends upon the receipt of additional significant orders in fiscal 1998 and the success of DEI's growth strategy. See "Summary -- Selected Financial Information," "Information About DEI -- Business -- Growth Plan" and "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations." 16 22 POTENTIAL INABILITY TO INTEGRATE DEI AND STR Achieving the anticipated benefits of the Merger will depend in part upon whether the integration of the businesses of DEI and STR can be achieved in an efficient and effective manner. The combination of the two businesses will require, among other things, partial integration of the companies' respective marketing and research and development efforts. Furthermore, the combined companies will have a new board of directors consisting of certain members of the current DEI and STR boards of directors and will have a new management team combining managers from DEI and STR. There can be no assurance that integration of the companies and their management will be accomplished successfully. Failure to effectively accomplish the integration of the two companies could have a material adverse effect on the combined companies' results of operations and financial condition. See "The Merger and Related Matters -- STR's Reasons for the Merger; Recommendation of STR's Board of Directors; Fairness to STR's Stockholders." SUBSTANTIAL DEPENDENCE ON GOVERNMENT FUNDING AND GOVERNMENT CONTRACTS A substantial portion of DEI's revenue is generated from the U.S. Government or from customers who depend, at least in part, upon government appropriations for funding to purchase DEI's products. Because many of its customers are involved in programs aimed at improving man's impact on the environment, the ability or willingness of such customers to purchase DEI's products are often subject to political, economic and social factors outside the control of the customers and DEI. As a result of these factors, certain sales of DEI's products may not occur despite excellent sales efforts, competitive pricing and the customer's willingness to purchase. See "Information About DEI - -- Business -- Customers." STR's historical market (accounting for approximately 95% of its total revenue during fiscal 1996 and 1997) has been U.S. Government contracts, primarily prime contracts. See "Information About STR -- General Description of Business -- Marketing and Customers." The award of such contracts is dependent on government funding and there is currently a downward trend in funding for defense and intelligence programs. In fiscal 1997, 45% of STR's total revenue was derived from contracts with the United States Navy and 23% of total revenue was derived from contracts with agencies related to the intelligence community. The Navy Sea Systems Command accounted for 31.1% of STR's revenue in 1997 and 57.8% in 1996. One customer in the intelligence community accounted for 10.8% of STR's revenue in 1997. All other customers individually accounted for less than 10% of STR's revenue during 1997 and 1996. Although the markets in which STR participates are expected to grow, there can be no assurance that the U.S. Government funding will continue to be available to purchase STR's products or that the U.S. Government will wish to continue doing business with STR. The loss of all or a material part of STR's revenues from the U.S. Government could have a material adverse effect on STR's results of operation and financial position. There are several risks inherent in doing business with agencies of the U. S. Government. The major risk is that U.S. government agencies are essentially one customer and their funding comes from the budget approved by Congress which is influenced by various political and economic factors outside the control of any particular agency with which DEI or STR is doing business. In addition, government contracts generally provide that the agency has the right to cancel a contract at its convenience. Contracts with U.S. Government agencies can provide for reimbursement of costs plus a fee. Costs under such contracts (including overhead and general and administrative expenses) are generally subject to audit and adjustment by negotiation between DEI and STR, as the case may be, and U.S. government representatives. DEI has not been involved in a reimbursable contract during any of the periods for which financial statements are included in this Joint Proxy Statement/Prospectus, but has been awarded fixed fee contracts which are not subject to audit. From time to time, STR enters into contracts which are subject to audit. See "Information About STR -- General Description of Business -- Marketing and Customers." 17 23 SIGNIFICANT REVENUES DERIVED FROM INTERNATIONAL CUSTOMERS A significant portion of DEI's revenues are derived from the international market. See "Information About DEI -- Business -- Customers." Deriving revenues from the international market involves certain risks in addition to those involved in doing business with domestic customers. For example, foreign customers may be adversely affected by a more volatile economy or political system that may prevent them from making payment in a timely manner or at all. In addition, contracts with foreign governmental agencies may be delayed by the need for U.S. Governmental or foreign administrative approvals which are in addition to those which would be obtained in connection with a domestic contract. The current economic crisis in several Asian countries has delayed several programs that DEI expected to be awarded in fiscal 1998. Foreign contracts also subject DEI and STR to additional U. S. Government regulation requiring export licensing which could result in difficulties making delivery and receiving final payment. Foreign contracts could also result in the risk of currency fluctuation. To mitigate foreign currency transaction losses, DEI denominates international contracts in U.S. dollars and secures large standard product contracts with irrevocable letters of credit. DEI may continue to derive a significant portion of its revenues from the international market whether or not the Merger is consummated due to its marketing efforts and the perceived demand for its products, although international revenues are expected to be a much smaller percentage of total revenues if the Merger is consummated. INTENSE COMPETITION There are several competitors that compete with individual products produced by DEI. During the past few years, one of these competitors has begun offering to build products that compete with more of DEI's standard remote sensing systems. In addition, many companies selling similar instruments for military purposes are now beginning to pursue non-military customers as governments worldwide continue to reduce military spending. There can be no assurance that such competition will not, in the future, have a material adverse effect on DEI's financial condition and results of operations. See "Information About DEI -- Business -- Competition." In addition, if DEI implements its growth plan, competition in the new areas of business addressed by the growth plan will be different than that faced by DEI in its core business and competitors will be more numerous since there are many more companies offering products and services in each of these areas of new business. Competition will include conventional aerial survey firms using film cameras and commercial remote sensing satellite data. There can be no assurance that DEI will be able to compete successfully in each of these market areas. See "Information About DEI -- Business -- Growth Plan." STR relies upon state of the art technological solutions to obtain its contracts, many of which are sole source contracts. There is substantial competition in both the domestic and foreign threat warning and communications intercept business. The size and reputation of these competitors can give them a significant advantage in competing for contracts. STR can maintain its competitive position only if its products remain highly regarded. Other companies may develop innovative products which the market regards as superior to those of STR. If this occurs, STR's market position could erode. See "Information About STR -- General Description of Business -- Competition." STR'S DEPENDENCE ON MAJOR SUPPLIERS STR relies upon certain sources to supply several component parts which are used in the STR manufacturing process. Certain subassemblies utilized in the Company's products are manufactured by >specialty' vendors to STR specifications upon receipt of purchase orders issued by STR, which include standard commercial terms. While these subassemblies can be manufactured by others, and STR has not encountered difficulties in obtaining such subassemblies in the past, there would be a significant schedule impact while the new company purchased material, developed its manufacturing capability, and qualified its products. Such items are Digital Frequency Discriminators manufactured by MA-Com, Division of AMP, Inc., Successive Detection Log Video Amplifiers manufactured by Veritech Microwave, Inc., and Yig notch filters manufactured by Stellex Microwave Systems. The necessity to change any of these sources could have a material adverse effect on STR's results of operation and financial position. 18 24 POTENTIAL INABILITY TO IMPLEMENT DEI'S GROWTH PLAN In 1995, DEI developed a growth plan to reduce fluctuations in its revenue and earnings which involves the use and sale of airborne digital cameras developed by DEI and performing domestic environmental surveys with DEI's airborne multispectral scanners. The successful implementation of DEI's growth plan involves a number of risks, including, without limitation, the potential inability to compete with larger and more numerous competitors, the potential inability to alter its sales and marketing strategies as necessary to participate in these new markets and the potential continued lack of available financing. As a result of these risks, there can be no assurance that the growth plan can be successfully implemented. DEI's inability to implement its growth plan could have a material adverse effect on its results of operations and financial position. See "Information About DEI -- Business -- Growth Plan." DEPENDENCE ON KEY MANAGEMENT The operations of DEI have been largely dependent on the skills, experience and efforts of its senior management and especially its President and Chief Executive Officer, Thomas Ory and its Vice President and Chief Operating Officer, Charles Stanich. See "Information About DEI -- Business -- Executive Officers of DEI." The loss of the services of Mr. Ory or Mr. Stanich could have a material adverse effect on DEI's business and prospects. DEI has entered into employment agreements with Mr. Ory and Mr. Stanich which will become effective at the Effective Time. See "The Employment Agreements." The operations of STR have been largely dependent on the skills, experience and efforts of senior management and especially its President and Chief Executive Officer, S. R. Perrino and its Senior Vice President, Donald Reiser. See "Information About STR -- Management." The loss of the services of Mr. Perrino and Mr. Reiser could have a material adverse effect on STR's business and prospects. POTENTIAL INABILITY TO ATTRACT AND RETAIN QUALIFIED PERSONNEL The success of STR and DEI depends in large part upon their ability to attract, develop, motivate and retain qualified employees. Many of these employees are required in the information technology field. Today, especially in the geographic areas in which STR and DEI are located, employees with information technology backgrounds are in great demand and likely to remain so for the foreseeable future. There can be no assurance that STR and DEI will be able to continue to attract and retain a sufficient number of qualified personnel in the future. The inability of STR and DEI to hire sufficient qualified personnel could have a material adverse effect on their business, financial condition and results of operations. Engineers and key technical employees of DEI and STR are bound by confidentiality agreements to protect the companies from loss of trade secrets and know-how in the event such persons leave the employ of DEI or STR. NO ACTIVE MARKET FOR THE DEI COMMON STOCK The DEI Common Stock does not qualify for listing on Nasdaq nor is the DEI Common Stock listed on any stock exchange. As a result, there is currently no active trading market for the DEI Common Stock. Following the Merger, the DEI Common Stock is expected to qualify for listing on the Nasdaq SmallCap Market and DEI intends to seek authorization to list the DEI Common Stock thereon. The listing requirements for the Nasdaq SmallCap Market are as follows: the applicant must have (a) either (i) net tangible assets in excess of $4 million, (ii) a $50 million market capitalization or (iii) net income of $750,000 in the latest fiscal year or in two of the last three fiscal years, (b) at least one million shares of public float, (c) at least $5 million market value of the public float, (d) at least a $4 minimum bid price, (e) at least three market makers, (f) at least 300 shareholders each holding at least 100 shares, (g) an operating history of at least one year and (h) must satisfy certain corporate governance requirements, which include having at least two independent directors and having an audit committee, a majority of whose members are independent directors. DEI believes that it will satisfy all of these requirements immediately following consummation of the Merger. Even if Nasdaq accepts DEI's application for the SmallCap Market, there can be no assurance that an active public trading market for the DEI Common Stock will develop following the Merger. Accordingly, STR stockholders who receive DEI Common Stock in the Merger may experience substantial difficulty selling such securities and the price of such securities may be subject to volatility. 19 25 FIXED EXCHANGE RATIO Under the terms of the Merger Agreement, each share of STR Common Stock issued and outstanding at the Effective Time (other than shares held by stockholders of STR who perfect their dissenters' rights) will be converted into the right to receive 2.58 shares of DEI Common Stock. See "The Merger Agreement - -- Conversion and Exchange of STR Common Stock." The Merger Agreement does not contain any provisions for adjustment of the Exchange Ratio based on fluctuations in the market price of shares of DEI Common Stock. Accordingly, the value of the shares of DEI Common Stock to be received by the STR stockholders upon completion of the Merger may differ from the value of the shares of DEI Common Stock on December 23, 1997, the date on which the Merger Agreement was executed (when the average of the quoted bid and asked prices was approximately $3 7/16 per share). There can be no assurance that the market price of shares of DEI Common Stock on and after the Effective Time will not be lower than such price. The shares of STR Common Stock being converted include 582,000 shares, which STR issued at $6.50 per share in a private placement completed on January 30, 1998. Based upon the average of the bid and ask price of DEI Common Stock on November 11, 1997 (the date on which the Merger was announced), these shares, along with all of the other shares of STR Common Stock, had an equivalent value of approximately $8.23 per share. The private placement occurred after the respective Boards of Directors had approved the Merger and had received the opinions of their financial advisors. See "Risk Factors -- No Active Market for the DEI Shares" and "Information about DEI -- Market Price and Dividend Information." POTENTIAL WAIVER OF CONDITIONS TO MERGER The Board of Directors of either STR or DEI has the right to waive certain conditions precedent to the consummation of the Merger other than those conditions which are a legal necessity for the Merger to occur such as STR stockholder approval of the Merger or DEI stockholder approval of the Charter Amendment. In the event either Board waives any condition, each company intends to resolicit shareholder approval unless in the opinion of such company's Board, the delay associated with the resolicitation process is likely to have a material adverse effect on the business or financial condition of such company. POTENTIAL FAILURE OF FUTURE ACQUISITIONS Following the Merger, DEI and STR intend to increase the size of their consolidated business in part through acquisitions. Acquisitions can fail to achieve their objectives as a result of a number of factors, including (a) the time and expense involved with integrating operations of those acquisitions for which integration is required, (b) the devotion of senior management time to the acquisition process as opposed to other operations, (c) the financial risks associated with any acquisition including the inability to achieve projected financial results and (d) the dilutive impact which shareholders may sustain if shares of DEI Common Stock are issued as consideration for the acquisition. No assurance can be provided that such acquisitions will occur or that, if they do occur, the acquisitions will be successful. CONFLICTS OF INTEREST Certain members of DEI's management and STR's board of directors have interests in the Merger that are in addition to and potentially in conflict with the interests of stockholders of DEI and STR generally. Messrs. Ory and Stanich have become parties to employment agreements with DEI, which are contingent on the consummation of the Merger, and Messrs. Perrino, Rockwell, Busey and Bernard will become directors of DEI. Dr. Sanders is currently a member of the DEI board of directors and the STR board of directors. The boards of directors of DEI and STR were aware of these interests and considered them, among other things, in approving the Merger Agreement and the transactions contemplated thereby. See "The Merger and Related Matters -- Background of the Merger" and "-- Conflicts of Interest." INTRODUCTION This Joint Proxy Statement/Prospectus is furnished to stockholders of DEI in connection with the solicitation of proxies by the Board of Directors of DEI for use at the DEI Annual Meeting to be held at 9:00 a.m. local time, on May 28, 1998 at DEI's headquarters located at 300 Parkland Plaza, Ann Arbor, Michigan 48103, for the purpose of considering and voting upon (a) the approval of the Charter Amendment to increase the number of authorized shares of DEI Common Stock and change the name of DEI to "Sensys Technologies Inc." as required by the Merger Agreement; (b) the election of directors; and (c) the approval of an amendment to DEI's Long-Term Incentive Plan. It is also furnished to stockholders of STR in connection with the solicitation of proxies by the Board of Directors of STR for use at the STR Special Meeting to be held at 9:00 a.m. local time, on May 28, 1998 at STR's headquarters located at 8419 Terminal Road, Newington, Virginia 22122-1430, for the purpose of considering and voting upon a proposal to approve the Merger Agreement and the Merger. This Joint Proxy Statement/Prospectus also constitutes the Prospectus of DEI with respect to up to approximately 3,420,527 shares of DEI Common Stock to be issued in connection with the Merger. 20 26 Pursuant to the Merger Agreement, among other things, Merger Sub, a wholly owned subsidiary of DEI, will be merged with and into STR, which will be the surviving corporation. The separate existence of Merger Sub will cease. Each share of STR Common Stock (other than shares held by stockholders of STR who perfect their dissenters' rights in the manner described in this Joint Proxy Statement/Prospectus) which is issued and outstanding at the Effective Time of the Merger, will be converted into the right to receive 2.58 shares of DEI Common Stock. A copy of the Merger Agreement is attached hereto as Annex A. Based on the 1,325,786 shares of STR Common Stock outstanding at January 31, 1998 and assuming no STR stockholders perfect their dissenters' rights, approximately 3,420,527 shares of DEI Common Stock will be issued in the Merger. This Joint Proxy Statement/Prospectus contains certain information set forth more fully in Annexes A through E, and is qualified in its entirety by reference to such documents. In deciding how to vote on the proposals included herein, each stockholder of DEI and STR should carefully read all of these documents. DEI RECORD DATE; VOTING QUORUM The Board of Directors of DEI has fixed the close of business on April 20, 1998 for determination of holders of DEI Common Stock entitled to notice of, and to vote at, the DEI Annual Meeting. On the DEI Record Date, 534,574 shares of DEI Common Stock were issued and outstanding and entitled to vote. Each share of DEI Common Stock is entitled to one vote on all matters that properly come before the DEI Annual Meeting. The presence, in person or by proxy, of a majority of the issued and outstanding shares of DEI Common Stock entitled to vote constitutes a quorum at the DEI Annual Meeting. On January 31, 1998, 88,866 of the outstanding shares of DEI Common Stock (16.6% of the DEI Common Stock outstanding) were beneficially owned by the directors and executive officers of DEI. All such persons have indicated to DEI that they intend to vote all shares of DEI Common Stock over which they have voting power in favor of the Charter Amendment, the election of each of the director-nominees and the Long-Term Incentive Plan amendment, and certain of such persons are contractually bound to do so. See "The Voting Agreement." STR RECORD DATE; VOTING QUORUM The Board of Directors of STR has fixed the close of business on April 20, 1998 for determination of holders of STR Common Stock entitled to notice of, and to vote at, the STR Special Meeting. On the STR Record Date, 1,325,786 shares of STR Common Stock were issued and outstanding and entitled to vote. Each share of STR Common Stock is entitled to one vote on all matters that properly come before the STR Special Meeting. The presence, in person or by proxy, of a majority of the issued and outstanding shares of STR Common Stock entitled to vote constitutes a quorum at the STR Special Meeting. On January 31, 1998, 829,220 shares of STR Common Stock (62.5% of the STR Common Stock outstanding) were beneficially owned by the directors, executive officers and principal stockholders of STR. All such persons have indicated to STR that they intend to vote all shares of STR Common Stock over which they have voting power in favor of the Merger Agreement and certain of such persons are contractually bound to do so. See "The Voting Agreement." DEI PROXIES; VOTE REQUIRED Stockholders of DEI are requested to complete, sign, date and return promptly the enclosed proxy in the postage paid envelope provided for this purpose in order to assure that their shares are voted. Shares of DEI Common Stock represented by proxies received by DEI prior to or at the DEI Annual Meeting will be voted in accordance with the instructions contained thereon. SHARES OF DEI COMMON STOCK REPRESENTED BY PROXIES FOR WHICH NO INSTRUCTION IS GIVEN WILL BE VOTED FOR THE CHARTER AMENDMENT, FOR THE ELECTION OF EACH OF THE DIRECTOR-NOMINEES AND FOR THE LONG-TERM INCENTIVE PLAN AMENDMENT. 21 27 The approval of the Charter Amendment requires the affirmative vote of the holders of a majority of the shares of DEI Common Stock outstanding. Because the number of shares of DEI Common Stock to be issued in the Merger exceeds the number of shares which are currently authorized for issuance under DEI's certificate of incorporation, approval by the DEI stockholders of the Charter Amendment has been made a condition to the consummation of the Merger. A VOTE AGAINST THE CHARTER AMENDMENT WILL HAVE THE EFFECT OF A VOTE AGAINST THE MERGER. The election of directors requires a plurality of the votes cast at the Annual Meeting. Approval of the Long-Term Incentive Plan amendment requires the affirmative vote of the holders of a majority of the shares of DEI Common Stock voted on such matter. For purposes of determining the number of votes cast with respect to the election of directors, only those cast Afor" are included. Abstentions and withheld votes are counted only for purposes of determining whether a quorum is present at the Annual Meeting and broker non-votes are not counted. Abstentions and broker non-votes will have the effect of a vote against approval of the Charter Amendment but will have no effect on the vote on the Long-Term Incentive Plan amendment. A proxy may be revoked at any time prior to the exercise of the authority granted thereunder. Revocation may be accomplished by the granting of a later proxy with respect to the same shares or by written notice to the Secretary of DEI at any time prior to the vote at the DEI Annual Meeting. Mere attendance at the DEI Annual Meeting will not in itself revoke a proxy. The DEI Board of Directors knows of no matters to be presented at the Annual Meeting other than those described in this Joint Proxy Statement/Prospectus. If other matters are properly brought before the DEI Annual Meeting, it is the intention of the persons named in the proxies to vote the shares to which such proxies relate in accordance with their best judgment. DEI will bear the cost of the solicitation of proxies from its stockholders. In addition to solicitation by mail, directors, officers and employees of DEI, who will receive no compensation other than their regular salaries or fees, may solicit proxies by telephone, telegram or otherwise. Brokerage firms, fiduciaries and other custodians who forward soliciting material to the beneficial owners of shares of DEI Common Stock held of record by them will be reimbursed for their reasonable expenses incurred in forwarding such material. DEI'S BOARD OF DIRECTORS BELIEVES THAT THE MERGER IS IN THE BEST INTERESTS OF DEI AND ITS STOCKHOLDERS, HAS APPROVED THE MERGER AGREEMENT, THE CHARTER AMENDMENT AND THE LONG-TERM INCENTIVE PLAN AMENDMENT, AND UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS OF DEI VOTE FOR THE CHARTER AMENDMENT, FOR THE LONG-TERM INCENTIVE PLAN AMENDMENT AND FOR THE ELECTION OF EACH OF THE DIRECTOR-NOMINEES. STR PROXIES; VOTE REQUIRED Stockholders of STR are requested to complete, sign, date and return promptly the enclosed proxy in the postage paid envelope provided for this purpose in order to assure that their shares are voted. Shares of STR Common Stock represented by proxies received by STR prior to or at the STR Special Meeting will be voted in accordance with the instructions contained thereon. SHARES OF STR COMMON STOCK REPRESENTED BY PROXIES FOR WHICH NO INSTRUCTION IS GIVEN WILL BE VOTED FOR APPROVAL OF THE MERGER AGREEMENT AND THE MERGER. The affirmative vote of at least two-thirds of the outstanding shares of STR Common Stock is required to approve the Merger Agreement and Merger. An abstention will have the effect of a vote against the Merger Agreement. The STR Board of Directors knows of no matters to be presented at the STR Special Meeting other than those described in this Joint Proxy Statement/Prospectus. If other matters are properly brought before the STR Special Meeting, it is the intention of the persons named in the proxies to vote the shares to which such proxies relate in accordance with their best judgment. 22 28 STR will bear the cost of solicitation of proxies from its stockholders. In addition to solicitation by mail, officers and employees of STR, who will receive no compensation other than their regular salaries, may solicit proxies in person, by telephone or otherwise. A proxy may be revoked at any time prior to the exercise of the authority granted thereunder. Revocation may be accomplished by the granting of a later proxy with respect to the same shares or by written notice to the Secretary of STR at any time prior to the vote at the STR Special Meeting. Mere attendance at the STR Special Meeting will not in itself revoke a proxy. STR'S BOARD OF DIRECTORS BELIEVES THAT THE TERMS OF THE MERGER AGREEMENT ARE FAIR TO AND IN THE BEST INTERESTS OF STR AND ITS STOCKHOLDERS, HAS APPROVED THE MERGER AGREEMENT AND UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS OF STR VOTE FOR APPROVAL OF THE MERGER AGREEMENT AND THE MERGER. SPECIAL INSTRUCTIONS TO PARTICIPANTS IN STR'S EMPLOYEE STOCK OWNERSHIP PLAN Under the S.T. Research Corporation 401(k)/Employee Stock Ownership Plan (the "STR ESOP"), participants in the STR ESOP have the right to vote the shares of STR Common Stock allocated to their stock accounts on major corporate events such as mergers. Therefore, participants will have the opportunity to vote the shares of STR Common Stock they beneficially hold in the STR ESOP in connection with the Merger, provided that they comply with the applicable procedures described below. The STR ESOP's trustees ("Trustees") will mail to each participant a Confidential Participant Voting Instruction Form. Participants can vote their STR ESOP shares by properly completing this form and returning the form to Blue Ridge ESOP Associates, Inc., the company which assists STR in the administration of the STR ESOP. A proxy form will not be effective to vote shares of STR Common Stock allocated to a participant's STR ESOP account. Blue Ridge ESOP Associates, Inc. will tabulate all forms and advise the Trustees of the manner in which all STR ESOP shares covered by the voting instruction forms should be voted. The Trustees will not vote any shares on behalf of an STR ESOP participant from whom a voting instruction form has not been received. If the Merger is approved, all of STR Common Stock shares held in the STR ESOP will be converted into shares of DEI Common Stock. DISSENTERS' RIGHTS Stockholders of DEI Common Stock are not entitled to appraisal rights under the DGCL in connection with the Merger because DEI is not a constituent corporation in the Merger. DEI, as sole stockholder of Merger Sub, has approved the Merger pursuant to applicable law. Stockholders of STR who do not vote in favor of the Merger are entitled to dissenters' rights under the VSCA in connection with the Merger in accordance with the procedures prescribed by the VSCA. Certain provisions of the VSCA regarding dissenters' rights are reproduced in full as Annex C. The failure of a dissenting stockholder of STR to follow the appropriate procedures may result in the termination or waiver of such rights. See "The Merger and Related Matters -- Dissenters' Rights." THE MERGER AND RELATED MATTERS BACKGROUND OF THE MERGER The terms of the Merger Agreement are the result of arm's-length negotiations between representatives of DEI and STR. The following is a brief discussion of the background of the negotiations between DEI and STR. 23 29 For nearly two years prior to signing the Merger Agreement, DEI's management had unsuccessfully sought additional equity financing through discussions with potential investors possessing related technological or marketing capabilities to permit DEI to pursue its growth plan. The additional equity was also intended to address the liquidity problems resulting from its recent operating losses. In September 1996, STR developed a strategic plan pursuant to which STR intended to substantially increase revenues and raise additional equity capital. The plan contemplated achieving 50% of its revenue growth through acquisitions of companies with complementary technologies. Consistent with this plan, in January 1997, STR purchased the assets and assumed certain liabilities of a division of Computer Sciences Corporation, including certain complementary technologies to STR. Discussions between DEI and STR regarding a possible business combination began in early October 1996 with a series of telephone conversations initiated by STR and the exchange of basic financial information between Thomas Ory, President and Chief Executive Officer of DEI, and S. R. Perrino, President and Chief Executive Officer of STR, and Robert Bower, Chief Financial Officer of STR. STR contacted DEI because STR sought acquisition candidates with similar or complementary technology, customers or markets. As a result of these initial contacts, Mr. Perrino and Mr. Bower visited DEI on October 28, 1996. During this visit, Messrs. Perrino and Bower met with Thomas Ory and Charles Stanich, Vice President and Chief Operating Officer of DEI, signed a nondisclosure agreement and exchanged information about the respective capabilities, customers, products and financial status of DEI and STR. Several areas of mutual business interest were identified, including the integration of multiple sensors on various platforms to better support the companies' existing business base and expand their market area, and the companies' complementary marketing expertise and technologies, but no specific plans for a business combination or other transaction resulted from the meeting. In December 1996, as a means of intensifying its search for a strategic business partner to infuse equity capital, the DEI Board approved a consulting arrangement with John D. Sanders, the Chairman of DEI's Board of Directors, pursuant to which Dr. Sanders would be paid a monthly fee, beginning in January 1997, to assist DEI's management in seeking potential financing transactions and identifying joint venture or merger partners. See "Election of DEI Directors -- Nominees" for a description of Dr. Sanders' business experience. STR's discussions with DEI ceased because of STR's discussions with several other companies in late 1996 and early 1997. STR made acquisition proposals to three companies, each of which was rejected by the proposed target for various reasons. In one case, the target desired to reorganize to better posture itself prior to any merger or acquisition. In another case, the owner was able to obtain needed financing and did not want to give up control of his business, and in the third instance there was a disagreement relating to the displacement of the chief executive officer and relocation of the executive offices. In June 1997, Dr. Sanders, who is also a member of STR's Board of Directors, suggested to the STR Board that DEI should be re-evaluated as a potential merger candidate in view of STR's internal growth and expanded customer base, which had expanded its opportunities to utilize the technologies possessed by DEI, and the demise of the other potential acquisitions discussed above. After further discussion and evaluation of DEI by STR, in early August 1997, Dr. Sanders notified Mr. Ory that STR's management was interested in discussing a possible merger and outlined proposed terms based upon discussions with STR management, including a proposed exchange ratio of 3 to 1 and the conversion of the existing senior officer severance agreements into employment agreements. On August 21, 1997, Dr. Sanders met with DEI management to discuss the tentative proposal in more detail and to provide additional information about STR's reasons for seeking a merger, including DEI's complementary customers and complementary technologies and the expressed interest of STR customers in DEI's airborne sensor technology. Mr. Ory and Mr. Stanich visited STR on August 27, 1997 to further discuss a possible merger, negotiate certain terms and conditions, and to inspect STR's facilities and capabilities. On September 9, 1997, Mr. Perrino and Mr. Bower met with Mr. Ory and Mr. Stanich at DEI for further discussion and negotiation of the proposed merger. On September 15, 1997, Mr. Ory sent a letter to the DEI directors which outlined the proposed merger discussions and included details on STR's financial performance and business 24 30 description. Discussions continued through September and October 1997, during which time DEI and STR reviewed business projections for both corporations as well as technical synergistic capabilities that could be exploited utilizing the capabilities of the two companies. For example, DEI has recognized capabilities in infrared systems which could be used for the detection of land mines. STR has been providing complementary systems for radar detection and the customer base of the combined companies could easily be expanded by offering a single system integrating DEI's infrared capabilities and STR's radar detection capabilities. Discussions consisted of present and anticipated customers, current product capabilities of the individual companies and potential new products as a result of the integration of the technology and markets of the two companies. Discussions also occurred regarding organizational structure, how the companies could work together to best pursue the market areas, and the relative values of the individual companies and combined company. STR was also conducting due diligence on DEI during this period, and the Acquisition Committee of STR's Board, comprised of S. Kent Rockwell and Dr. Sanders, was kept fully apprised of the results of the due diligence. On October 20, 1997, STR's Board of Directors met and instructed management to continue to pursue the merger with DEI. DEI's Board of Directors met informally on October 23 and formally on October 24, 1997 for detailed consideration of the proposed merger. The DEI Board instructed DEI management to continue discussions with STR, to conduct due diligence and to engage an independent financial advisor to perform a fairness analysis of the proposed merger on behalf of DEI stockholders. On October 31, 1997, Mr. Ory, Mr. Stanich and Philip Power, a director of DEI, visited STR for further discussions about post-merger operations and to conduct preliminary due diligence on STR operations. In early November, DEI and STR reached an agreement in principle on the terms of the Merger and issued a press release announcing such agreement on November 11, 1997. The Merger was structured as a reverse acquisition in order to allow DEI to survive as a publicly traded company. Due diligence and negotiations of the terms of the definitive Merger Agreement, Employment Agreements and Voting Agreement, primarily through the exchange of draft agreements, continued throughout November and December by STR, DEI and their representatives, with the respective Boards of Directors of DEI and STR being kept apprised of the progress of the negotiations through informal communications from management. The parties reached agreement on the terms of the definitive agreements (including the Exchange Ratio and the proposed name change of DEI) in mid-December 1997. Because of the losses incurred since 1994 by DEI, STR's initial offer of an exchange ratio of 3:1 was based on the appraised value of STR Common Stock of $8.07 and STR's perception of the realizable asset value of the DEI Common Stock of approximately $1.5 million. Management of STR and DEI then engaged in a number of discussions with respect to the value of STR Common Stock, which centered on the appropriate multiples and discount percentage for a non-public company, and the value of DEI Common Stock, which centered on the value of DEI's real estate, tax loss carryforwards, inventory and other fixed assets. The parties eventually agreed that the relative values of the two companies yielded an exchange ratio of 2.58:1, but agreed to renegotiate the Exchange Ratio if DEI was awarded either of two multi-million dollar contracts prior to the signing of the Merger Agreement. Such contracts were not awarded (and have not yet been awarded) and the Exchange Ratio was not further negotiated. In view of the cash positions of both companies, all discussions assumed a stock for stock transaction. On December 23, 1997, the STR Board of Directors met and approved the Merger Agreement and the DEI Board of Directors met and approved the Merger Agreement, Charter Amendment, the Long-Term Incentive Plan amendment, the issuance of shares of DEI Common Stock pursuant to the Merger and various other related matters. At these meetings, each Board of Directors received the advice of its respective financial advisor. The DEI Board also discussed Dr. Sanders' status as a director of STR and the facts and circumstances with respect to his involvement in the Merger. Based upon all of the facts known to it, the DEI Board determined that Dr. Sanders had no conflict of interest substantial enough to cause him to be unable to fulfill his fiduciary duty as a director of DEI and had acted in the best interests of DEI and its stockholders in all respects. The STR Board made a similar determination with respect to Dr. Sanders ability to fulfill his duty as an STR director. The STR Board of Directors determined that since all material negotiations regarding the Merger were being conducted through STR's management, as opposed to STR's Acquisition Committee of which Dr. Sanders is a member, the potential of Dr. Sanders' conflict was of no concern to the STR Board of Directors. In addition, management was reporting to the entire Board as opposed to the Acquisition Committee, thereby further insulating the entire process from any conflict associated with Dr. Sanders. Dr. Sanders had no role in the negotiation of the terms of the Merger and had no interest in the Merger other than as a shareholder and director. See "The Merger and Related Matters - -- Opinion of DEI's Financial Advisor" and "The Merger and Related Matters -- Opinion of STR's Financial Advisor." Following such approvals, the Merger Agreement, the employment agreements with Messrs. Ory and Stanich and the Voting Agreement were executed by the respective parties to those agreements. There are no contracts or arrangements between DEI and STR other than those disclosed in this Joint Proxy Statement/Prospectus. CERTAIN EFFECTS OF THE MERGER The Merger will become effective when Articles of Merger are filed with the Virginia State Corporation Commission. It is anticipated that such filing will be made as promptly as practicable after the required stockholder approvals have been obtained and the other conditions to the consummation of the Merger have been satisfied or waived. Upon consummation of the Merger, Merger Sub will be merged with and into STR, which will be the surviving corporation. The separate existence of Merger Sub will cease. At the Effective Time, each issued and outstanding share of STR Common Stock (other than shares held by stockholders of STR who perfect their dissenters' rights in the manner described in this Joint Proxy Statement/Prospectus) will be converted into the right to receive 2.58 newly issued shares 25 31 of DEI Common Stock. On January 31, 1998, there were 1,325,786 shares of STR Common Stock outstanding. Except for options to purchase 34,000 shares, there are no outstanding warrants or options to purchase, or securities convertible into, STR Common Stock. The Merger will result in a change of control of DEI due to the issuance of an additional 3.4 million shares of DEI Common Stock to STR's stockholders and the appointment of STR's directors to fill a majority of the positions on DEI's Board of Directors. No fractional shares of DEI Common Stock will be issued in the Merger. In lieu of fractional shares of DEI Common Stock, each person entitled thereto will receive a cash payment (from working capital) equal to the product of (i) the fractional interest of a share of DEI Common Stock to which such holder would have been entitled (computed based upon the aggregate number of shares of STR Common Stock owned by such holder and the aggregate number of shares of DEI Common Stock to which such holder is entitled) and (ii) the average of the published bid and asked prices per share of DEI Common Stock for the trading day immediately prior to the Effective Time. Promptly after the Effective Time, DEI will forward a letter of transmittal to stockholders of STR containing detailed instructions for the surrender of certificates representing STR Common Stock. See "The Merger Agreement -- Effective Time," "-- Conversion and Exchange of STR Common Stock" and "-- Conditions to Consummation of the Merger." Based upon the capitalization of DEI and STR at January 31, 1998 and the Exchange Ratio, the number of shares of DEI Common Stock outstanding after giving effect to the Merger will be approximately 3,955,102 and the holders of STR Common Stock immediately prior to consummation of the Merger will own approximately 86.5% of the outstanding shares of DEI Common Stock immediately following consummation of the Merger (assuming no STR stockholders perfect their dissenters' rights). The principal stockholders, executive officers and directors of DEI beneficially own 88,866 outstanding shares or approximately 16.6% of the outstanding shares of DEI Common Stock on the Record Date and will beneficially own 114,346 outstanding shares or approximately 2.9% of the outstanding shares of DEI Common Stock immediately following the consummation of the Merger. The principal stockholders, executive officers and directors of STR will beneficially own 2,141,887 outstanding shares or approximately 54.2% of the outstanding shares of DEI Common Stock immediately following the consummation of the Merger. DEI'S REASONS FOR THE MERGER; RECOMMENDATION OF DEI'S BOARD OF DIRECTORS; FAIRNESS TO DEI'S STOCKHOLDERS DEI's Board of Directors has unanimously approved the Merger and authorized the execution and delivery of the Merger Agreement and believes that the Merger is in the best interests of DEI and its stockholders. Accordingly, the Board of Directors of DEI unanimously recommends that the DEI stockholders vote to approve the Charter Amendment, which is a condition to the Merger. In making its determination with respect to the Merger, the Board of Directors of DEI considered a number of factors, including, but not limited to, the following factors. - The financial condition and results of operations of DEI and STR, including the positive trend in STR's financial results, the continuing deterioration of DEI's financial results and the information disclosed under "Risk Factors -- DEI's Substantial Dependence on Its Line of Credit and Going Concern Considerations", "-- DEI's Urgent Need For Additional Capital", "-- Potential Unprofitability and Variability of Operating Results" and "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations"; - The business and financial prospects of DEI and STR on a combined basis, the opportunity to expand into new markets afforded by the Merger and the negative prospects of DEI if it were to continue doing business without combining with STR; - The historical market prices and trading of DEI Common Stock, including the fact that the trading market was very inactive and required a greater public float to create greater liquidity for DEI's stockholders and that recent trading values were less than DEI's book value per share (see "Risk Factors -- No Active Market for the DEI Common Stock"); - The $8.07 per share appraised value of STR Common Stock as of December 31, 1996, determined by Corporate Finance of Washington, Inc. for purposes of STR's ESOP, which was the most recent valuation available with respect to such shares; - DEI's inability to find any more attractive business partner or combination and its inability to find needed equity capital; - Information relating to the historical operation of DEI's business, including the information disclosed under "Risk Factors -- Intense Competition", "-- Potential Inability to Implement DEI's Growth Plan" and "Information About DEI -- Business"; - The December 1997 appraisal of DEI's real estate which disclosed that the appraised value was appreciating and was substantially consistent with the prior 1995 valuation (see "The Merger and Related Matters -- Report of Appraiser"); - The terms of the Merger Agreement, including, without limitation, the type of consideration to be given to STR stockholders, the Exchange Ratio and the ability to have board representation following the Merger, the employment agreements which were to be executed by DEI with Messrs. Ory and Stanich in order to provide continuity of management, and the Voting Agreement; and - The opinion of Roney that the terms of the Merger are fair to the stockholders of DEI from a financial point of view. In this regard, the Board took into account the fact that due to the small size of the Merger and the relatively small fee being paid to Roney in connection with the rendering of its opinion, a detailed quantitative written analysis of the terms of the Merger was unwarranted and was not prepared or presented to the Board. DEI had been seeking a strategic business partner to provide additional equity and marketing assistance since early 1995. Although DEI had discussions with several companies in this regard, and exchanged financial information and proposed terms with three companies, none of the companies were found to be suitable partners after further investigation other than STR due to issues related to geographic locations of the companies in one instance and because of terms perceived by the DEI Board of Directors to be unfair to DEI's stockholders in the other. The factors that the DEI Board perceived to be unfair to DEI's stockholders in the second case included the fact that the price offered was less than the book value of DEI, that the transaction would result in a change of control, the other party's lack of sufficient equity capital to permit the combined companies to grow following the proposed transaction, and the DEI Board's anticipation of a more favorable offer. The DEI Board of Directors views the Merger as a means of accomplishing its goal of acquiring a significant amount of additional equity capital to permit DEI to continue to operate its business and to move forward with its growth 26 32 plan, while also diversifying its sources of revenues. The DEI Board believes that the addition of STR's complementary technologies through the Merger will provide access to new markets for DEI's products and technology and may result in certain synergies in sales, marketing and administrative costs by eliminating duplicative expenses and enabling personnel to offer a broader set of products to customers to increase the likelihood of fulfilling any particular customer's needs. See "-- STR's Reasons for the Merger; Recommendation of STR's Board of Directors; Fairness to STR's Stockholders." Finally, as a result of the Merger, the number of shares of DEI Common Stock will increase significantly, which the Board hopes will generate better liquidity in the market for the DEI Common Stock and improved returns for its stockholders. Although the voting power of the current DEI stockholders will be significantly diluted as a result of the Merger, the DEI Board of Directors believes that the benefits discussed above far outweigh the dilution of voting power. The Board was aware that the Merger, like other business combinations, would result in restructuring charges to the combined companies following consummation of the Merger. Such charges were not considered material to the Board's decision to approve the Merger in light of the significant benefits to DEI of the Merger and such charges were not specifically identified or quantified until after the Merger was approved by the Board and management began preparation of post-Merger financial plans and the unaudited pro forma financial statements contained in this Joint Proxy Statement/Prospectus. The Board was also aware of the prospect of STR's private placement and the Merger Agreement included a provision permitting the proposed private placement to occur. Roney was also aware of the prospect of the private placement and had reviewed the Merger Agreement. Although the private placement will result in the issuance of additional shares of DEI Common Stock in the Merger, the consummation of the private placement in January 1998 was viewed by the Board as favorable overall to DEI in view of the additional working capital it would provide to DEI if the Merger is consummated. See "Risk Factors -- DEI's Urgent Need for Additional Capital". In view of the importance of the Merger to DEI's short and long term prospects and the other factors described above, the DEI Board of Directors does not consider it necessary to obtain an updated fairness opinion from Roney as a result of STR's private placement of stock. See "Summary -- Private Placement". The Board of Directors of DEI did not undertake a separate analysis of each of these factors nor did the Board reach a separate conclusion with respect to each such factor in its determination as to the fairness of the terms of the Merger. The consideration of such factors resulted from information relating to such factors being added to the collective business knowledge, experience and understanding of the Board of Directors of DEI so as to enable the Board of Directors to consider such information in its deliberative process. In view of the above and the variety of factors considered by the Board of Directors of DEI in reaching its conclusion as to the fairness of the Merger, the Board of Directors of DEI did not find it practical to and did not quantify or otherwise assign relative weights to the specific factors considered in reaching its determination as to the fairness of the terms of the Merger. While the foregoing discussion is not intended to be exhaustive, DEI believes it includes all of the material factors considered by its Board of Directors in connection with its approval of the Merger. OPINION OF DEI'S FINANCIAL ADVISOR On December 23, 1997, Roney & Co. ("Roney"), DEI's financial advisor in connection with the transactions contemplated by the Merger Agreement, gave an opinion to the Board of Directors of DEI that the financial terms of the Merger are fair to the stockholders of DEI from a financial point of view. In arriving at its opinion, Roney performed the following procedures: (i) reviewed the Annual Reports and related financial information for the fiscal years ended 1993 to 1997 for DEI; (ii) reviewed the audited financial statements for the fiscal years ended 1992 to 1997 for STR; (iii) reviewed the 1998 budgets for both DEI and STR; (iv) reviewed the Merger Agreement; (v) reviewed the appraisal of DEI's facility prepared by Gerald Alcock Company, L.L.C. as of June 30, 1995 and was informed of the results of the December 1997 appraisal; (vi) reviewed the fair market value of ESOP shares of STR prepared by Corporate Finance of Washington, as of December 31, 1996 (which was the most recent valuation available with respect to such shares and served as an additional indicia of the value of STR Common Stock); (vii) researched current industry conditions and trends concerning the valuation of recent mergers and acquisitions as it deemed relevant; and (viii) conducted discussions with members of senior management of DEI and STR concerning their respective business and prospects and the benefits of the Merger Agreement. In arriving at its opinion, in addition to the review described above, Roney analyzed the transaction by comparing DEI's earnings before interest and taxes with comparable companies, analyzing estimated future cash flows discounted to present value, analyzing DEI's estimated internal rate of return and determining a liquidation value (utilizing DEI's balance sheet and the aforementioned appraisal). Such analyses indicated that the Merger consideration was within an acceptable range. Roney also examined the expected financial position and business prospects of the combined companies on a pro forma basis, based upon the financial statements of DEI and STR furnished to it, and compared these expectations with DEI's prospects if the Merger were not consummated, and determined that DEI's prospects were more favorable if the Merger was consummated. See "Risk Factors -- DEI's Substantial Dependence on Its Line of Credit and Going Concern Considerations", "-- DEI's Urgent Need For Additional Capital", "-- Potential Unprofitability and Variability of Operating Results" and "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations". In its opinion, Roney noted that (i) its opinion necessarily was based on assumptions with respect to industry performance, business and economic conditions, and other matters, many of which are beyond the control of DEI and STR; (ii) any estimates contained in its analyses were not necessarily indicative of future results or value, which could be significantly more or less favorable than such estimates; (iii) estimates of values of companies did not purport to be appraisals or necessarily reflect the price at which companies or their securities actually could be sold; and (iv) no company or transaction utilized in its analysis was identical to DEI or the Merger Agreement. Accordingly, such analyses were not based solely on arithmetic calculations. Rather, the analyses involved complex considerations and judgments concerning differences in financial and operating characteristics of DEI and STR, the timing of the relevant transactions and prospective buyer interests, as well as other factors that could affect companies to which DEI and STR were compared. None of the analyses performed by Roney was assigned a greater significance than any other. Roney also noted, among other things, that its opinion necessarily was based upon the accuracy and completeness of all financial and other information provided by others and made available to it that was not independently verified. With respect to the financial forecasts, Roney assumed, without any further independent investigations and analysis by it, that they had been reasonably prepared and reflect the best currently available estimates and judgments of DEI's and STR's management as to their respective expected future financial performance. 27 33 Finally, Roney noted that its opinion necessarily was based on the economic and market conditions and other circumstances existing on, and information made available to it as of the date of its written opinion. The full text of the written opinion of Roney, which contains information as to the assumptions made, matters considered and the scope of and limitations on the review undertaken by Roney, is set forth as Annex B to this Joint Proxy Statement/Prospectus and should be read in its entirety. The consideration to be paid to the stockholders of STR by DEI in connection with the Merger was determined through negotiations between the parties, and was not determined by Roney. No limitations were placed on Roney by the Board of Directors of DEI with respect to the investigations made or the procedures followed by Roney in preparing and rendering its opinion. DEI selected Roney as its financial advisor on the basis of Roney's expertise and reputation and the amount of the fee it proposed to charge for its services. Roney is an investment banking firm with experience in evaluating transactions similar to the Merger and is regularly engaged in the valuation of businesses and their securities in connection with mergers and acquisitions. DEI's management selected Roney as its financial advisor primarily because of Roney's reputation, expertise and the amount of the fee it proposed to charge for its services. Roney was retained as financial adviser to DEI pursuant to the terms of an engagement letter dated October 20, 1997. In connection with such engagement, DEI has agreed to pay Roney a fee of $20,000. Roney is also being reimbursed for reasonable expenses incurred by it in its role as financial adviser and in connection with its fairness opinion. DEI has agreed to indemnify Roney for certain liabilities, including liabilities under federal securities laws. REPORT OF APPRAISER On December 15, 1997, Gerald Alcock Company, L.L.C. ("GAC") issued an appraisal report of DEI's facility, which stated that the current "as is" market value of DEI's property, as of December 8, 1997, was $1,840,000. The appraisal report states that it is intended for use by DEI for assistance in determining asset value of DEI's facility in connection with the Merger, and the scope of the appraisal encompasses the necessary research and analysis to prepare a report in accordance with such intended use and with the Uniform Standards of Professional Appraisal practice of the Appraisal Foundation. In addition, the appraisal report notes that GAC employed the following data sources: (i) physical inspection of the subject property and the surrounding neighborhood; (ii) interview of Ms. Jane E. Barrett regarding various aspects of the property, including ownership history and building layout; (iii) review of government records, including records of Washtenaw County and Scio Township, Michigan; (iv) research regarding information pertaining to such things as adequacy of infrastructure, availability of utilities, employment statistics, zoning, flood hazards, environmental hazards, and anticipated development trends; (v) contact of government officials and real estate brokers regarding supply, demand and market trends; and (vi) research of general market data. In arriving at its valuation of the subject property, GAC employed a two-step valuation procedure. First, GAC estimated the "highest and best use" of the property. Second, GAC considered the three traditional valuation methods as applicable to the subject property: the cost approach, the sales comparison approach and the income approach and selected the sales comparison and income approaches. GAC determined that the cost approach was inappropriate because of the difficulty in accurately measuring depreciation in buildings over five years old. The appraisal report also noted that the appraisal necessarily was based on certain assumptions and limitations, including that (i) the subject building and site are free and clear of any toxic or hazardous substances; (ii) the appraisal is not a survey, legal opinion, engineering or property inspection report, or an environmental issues or hazardous materials reports; and (iii) the appraisal has been performed with a limited amount of data because of the inherent limitations of relying upon information provided by others and budget limitations. GAC is an appraisal firm with over twenty years of experience in appraising real property located in Washtenaw County, Michigan. GAC was retained by DEI to perform a complete appraisal and was selected to perform the appraisal because it had performed an appraisal of the subject property in June 1995 for DEI and therefore was familiar with the property, and because of its expertise and reputation in the area in which the property is located. DEI imposed no limitations on GAC. STR'S REASONS FOR THE MERGER; RECOMMENDATION OF STR'S BOARD OF DIRECTORS; FAIRNESS TO STR'S STOCKHOLDERS STR's Board of Directors has unanimously approved the Merger and the Merger Agreement and believes that the terms of the Merger are fair to and in the best interests of STR and its stockholders. Accordingly, the Board of Directors of STR unanimously recommends that the STR stockholders vote to approve the Merger and the Merger Agreement. In making its determination with respect to the Merger, the Board of Directors of STR considered a number of factors, including, but not limited to, the following factors. - Historical information relating to the business, financial condition and results of operations of STR and DEI, including the information disclosed under "Risk Factors" (see also the discussion below); - The market prices and trading of DEI Common Stock, including the fact that the trading market was currently very inactive and that an increase in public float could be expected to create a more active market and greater liquidity for STR's stockholders, and the information disclosed under "Risk Factors -- No Active Market for the DEI Common Stock"; - The business and financial prospects of STR and DEI, the opportunity to expand into new markets afforded by the Merger and the prospects of STR if it were to continue doing business without combining with DEI (see the discussion below); - The terms of the Merger Agreement, including, without limitation, the fact that STR stockholders will receive shares of a publicly traded company, the Exchange Ratio, the fact that STR will control the DEI board of directors following the Merger and the fact that the Employment Agreements to be entered into in connection with the Merger Agreement provide for continuity of DEI's management; - The December 1997 appraisal of DEI's real estate which disclosed that the appraised value was appreciating and was substantially consistent with the prior 1995 valuation (see "The Merger and Related Matters -- Report of Appraiser" and the discussion below); - The $8.07 per share appraised value of STR Common Stock as of December 31, 1996, determined by Corporate Finance for purposes of STR's ESOP, which was the most recent valuation available with respect to such shares; - The greater liquidity available to STR stockholders as a result of holding shares of DEI Common Stock following the Merger (see the discussion below); and - The opinion of Corporate Finance that the financial terms of the Merger are fair to the stockholders of STR from a financial point of view. In this regard, the Board took into account the fact that due to the small size of the Merger and the relatively small fee being paid to Corporate Finance in connection with the rendering of its opinion, a detailed quantitative written analysis of the terms of the Merger was unwarranted and was not prepared or presented to the Board. The STR Board of Directors recognized that DEI had little, if any, value to STR as a stand alone company. The Board believed that the resources available to DEI through STR, primarily marketing support, would better enable DEI to achieve its potential and justify STR's acquisition. The Board of Directors understood the various risks inherent in DEI (see "Risk Factors"), especially in view of DEI's recent financial performance. Therefore, the STR Board desired to limit the amount of the consideration devoted to the Merger, measured by the dilution the STR stockholders would sustain in the Merger, to the projected realizable value of the DEI assets. In determining this realizable value, the Board primarily relied upon the most recent appraisal of DEI's real property. The Board also considered the impact that the Merger would have on the outstanding shares of STR Common Stock and, for this purpose, primarily utilized the factors which Corporate Finance of Washington, STR's financial advisor, set forth in the analysis it presented to the STR Board of Directors. The Board was aware that the Merger, like other business combinations, would result in restructuring charges to the combined companies following consummation of the Merger. Such charges were not considered material to the Board's decision to approve the Merger in light of the significant benefits to STR of the Merger and such charges were not specifically identified or quantified until after the Merger was approved by the Board and management began preparation of post-Merger financial plans and the unaudited pro forma financial statements contained in this Joint Proxy Statement/Prospectus. See "The Merger and Related Matters -- Opinion of STR's Financial Advisor." No further financial analysis was performed at the time the STR Board of Directors considered the Merger. In September 1996, STR adopted a strategic plan to substantially expand the size of STR's business. A significant part of this growth was premised on acquisitions. These acquisitions would require capital, liquid securities or a combination of both. STR reasoned that if it became a public company through its own public offering or merged with an already-public company preferably with excess liquidity, it would derive the capital and liquid securities necessary to undertake acquisitions. The STR Board of Directors believes that the Merger will accomplish many of the goals of its strategic plan by enhancing STR's growth and providing STR with a more liquid security that can be issued in connection with future acquisitions. The complementary technologies possessed by DEI are expected to improve the prospects of STR by enhancing the capabilities of STR's existing products and expanding the applications of DEI's products to the markets served by STR. By combining the resources inherent in DEI and STR, the STR Board believes that new state of the art equipment can be developed to receive and intelligently process data from multiple sensors covering communications, radar, infrared and optical frequency spectra. 28 34 In addition, as a result of the Merger, STR believes it will be better able to introduce and market the DEI products to its customers and market place and will be able to more fully utilize certain technical employees of DEI. DEI will be able to utilize STR's European based marketing representative in working with its European customers. Material savings will also be achieved from a reduction in total professional service expenses and other administrative costs, such as insurance premiums and line of credit fees. Because DEI's Common Stock is publicly traded and registered under the Exchange Act, STR will be in a position to achieve additional growth through acquisitions accomplished in whole or in part with shares of DEI Common Stock. The fact that the public markets will be available for recipients of DEI Common Stock to sell their shares, subject to applicable securities laws, should provide a greater incentive for acquisition candidates to accept acquisition proposals. Finally, STR has been a private company since its inception. Many current STR employees are stockholders of STR through the STR ESOP. By receiving publicly traded shares of DEI Common Stock, STR stockholders, including STR ESOP participants, are expected to derive greater liquidity in their investments. In addition, absent the Merger, STR would need to contribute cash to the STR ESOP to repurchase shares of former STR employees. Because employees are expected to be able to sell their shares in open market transactions, the contributions which would otherwise be required for the STR ESOP can be redirected to other retirement programs to allow employees to gain more diversification of their retirement funds. The Board was also aware of the prospect of STR's private placement and the Merger Agreement included a provision permitting the proposed private placement to occur. Corporate Finance was also aware of the prospect of the private placement and had reviewed the Merger Agreement. The consummation of the private placement in January 1998 was viewed by the Board as favorable overall to STR in view of the additional working capital it provided for the operation of the combined company if the Merger is consummated and therefore made the Merger more desirable for STR. As a result of these factors, the STR Board of Directors does not consider it necessary to obtain an updated fairness opinion from Corporate Finance as a result of STR's private placement of stock. See "Summary -- Private Placement". The Board of Directors of STR did not undertake a separate analysis of each of these factors nor did the Board reach a separate conclusion with respect to each such factor in its determination as to the fairness of the terms of the Merger. The consideration of such factors resulted from information relating to such factors being added to the collective business knowledge, experience and understanding of the Board of Directors of STR so as to enable the Board of Directors to consider such information in its deliberative process. In view of the above and the variety of factors considered by the Board of Directors of STR in reaching its conclusion as to the fairness of the Merger, the Board of Directors of STR did not find it practical to and did not quantify or otherwise assign relative weights to the specific factors considered in reaching its determination as to the fairness of the terms of the Merger. While the foregoing discussion is not intended to be exhaustive, STR believes it includes all of the material factors considered by its Board of Directors in connection with its approval of the Merger. OPINION OF STR'S FINANCIAL ADVISOR On December 23, 1997, Corporate Finance of Washington, Inc., STR's financial advisor in connection with the transactions contemplated by the Merger Agreement, rendered its opinion to the Board of Directors of STR that the terms of the Merger are fair to the stockholders of STR from a financial point of view. In arriving at its opinion, Corporate Finance performed the following procedures: (i) reviewed the financial information for the fiscal years ended 1993 to 1997 for STR; (ii) reviewed the audited financial statements and Form 10-Ks for the fiscal years ended 1992 to 1997 for DEI; (iii) reviewed 1998 forecasts for both STR and DEI; (iv) reviewed the Merger Agreement; (v) reviewed the appraisal of DEI's facility prepared by Gerald Alcock Company, LLC as of December 1997; (vi) reviewed the 1997 stock transfer and bid and ask quotations for DEI stock; (vii) researched current industry conditions and trends concerning the valuation of recent mergers and acquisitions as well as the valuation of similar companies' common stock; (viii) conducted discussions with members of senior management of STR concerning its business and prospects and the benefits of the Merger Agreement; and (ix) the pro forma financial effects of the Merger upon shares of STR Common Stock. Corporate Finance, in an analysis presented to the STR Board of Directors, determined that (a) STR's per share net assets and working capital would be enhanced by virtue of the Merger, (b) the Merger would cause a minor diminution in revenue pre-Merger per share from $6.83 to $6.30 and (c) if STR and DEI were able to achieve consolidated earnings before interest, taxers, depreciation and amortization ("EBITDA") matching the median EBITDA margin (11.9%) and multiple of debt free price to EBITDA (7.3%) of 22 other defense electronics manufacturers set forth in an analysis which Houlihan, Lokey, Howard & Zuikin published, the indicated pre-Merger market price for an STR share, considering revenue and net assets alone, would be $6.50 per share ($2.52 post-Merger). In undertaking the above analysis, Corporate Finance recognized the prospective private placement anticipated by STR. Therefore, for purposes of its per share analysis, Corporate Finance considered the impact the Merger would have on the holder of an STR share both before and after the private placement. The results of Corporate Finance's analysis also served to support STR's valuation for purposes of its private placement. Corporate Finance noted, among other things, that its opinion necessarily was based upon the accuracy and completeness of information provided by others that was not independently verified. With respect to the financial forecasts, Corporate Finance assumed that they had been reasonably prepared and reflect the best currently available estimates and judgments of DEI's and STR's management as to their respective expected future financial performance. In its opinion, Corporate Finance also noted that its opinion necessarily was based on economic and market conditions and other circumstances existing on, and information made available as of the date of its written opinion. The full text of the written opinion of Corporate Finance, which contains information as to the assumptions made, matters considered 29 35 and the scope of and limitations on the review undertaken by Corporate Finance, is set forth as Annex E to this Joint Proxy Statement/Prospectus and should be read in its entirety. The consideration to be paid to the stockholders of STR by DEI in connection with the Merger was determined through negotiations between the parties, and was not determined by Corporate Finance. No limitations were placed on Corporate Finance by the Board of Directors of STR with respect to the investigations made or the procedures followed by Corporate Finance in preparing and rendering its opinion. Corporate Finance is a firm with experience in evaluating transactions similar to the Merger and is regularly engaged in the valuation of businesses and their securities in connection with mergers and acquisitions. STR's management selected Corporate Finance as its financial advisor primarily because of Corporate Finance's reputation, expertise and familiarity with STR's business as the annual appraiser of STR Common Stock for the STR ESOP, and the amount of the fee it proposed to charge for its services. Corporate Finance was retained as financial adviser to STR pursuant to the terms of an engagement letter dated October 24, 1997. In connection with such engagement, STR has agreed to pay Corporate Finance a fee of $12,500. STR has agreed to indemnify Corporate Finance for certain liabilities, including liabilities under federal securities laws. CONFLICTS OF INTEREST In considering the recommendation of STR's Board of Directors with respect to the Merger and the Merger Agreement and the recommendation of DEI's Board of Directors with respect to the Charter Amendment, stockholders should be aware that certain members of STR's Board of Directors and DEI's Board of Directors have interests in the Merger that are in addition to and potentially in conflict with the interests of stockholders of STR and DEI generally. The Boards of Directors of STR and DEI were aware of these interests and considered them, among other matters, in approving the Merger Agreement. As a condition to the parties' obligations to consummate the Merger, Thomas Ory, the President, Chief Executive Officer and a Director of DEI, and Charles Stanich, the Vice President - Research and Development, Chief Operating Officer and a Director of DEI, have entered into employment agreements with DEI effective at the Effective Time. See "The Employment Agreements." John D. Sanders, a director of both DEI and STR, Philip Power, a director of DEI and S. R. Perrino, the Chairman, Chief Executive Officer and President of STR, hold shares in both companies. Dr. Sanders holds 26,250 shares of DEI Common Stock and 3,000 DEI options along with 5,876 shares of STR Common Stock and 10,000 STR options. Mr. Perrino holds 314,900 shares of STR Common Stock and 2,500 shares of DEI Common Stock. Mr. Power owns 12,900 shares of DEI Common Stock, 3,000 DEI options and 4,000 shares of STR Common Stock. See "Principal Stockholders of STR and Security Ownership of STR Management" and "Principal Stockholders of DEI and Security Ownership of DEI Management." Certain directors and principal stockholders of STR have indicated they will vote to approve the Merger. These same persons will be nominated or appointed to serve on DEI's Board of Directors. If the Merger is approved by STR stockholders, the size of the DEI Board of Directors will be increased to seven, S. R. Perrino, James Busey, Charles Bernard and S. Kent Rockwell will become directors of DEI and Messrs. Stanich and Panschar will resign from the DEI Board. In addition, in connection with the Merger, DEI, certain stockholders of DEI and certain stockholders of STR have entered into a Voting Agreement, dated as of December 23, 1997. The Voting Agreement provides that if the Merger Agreement has not been terminated in accordance with its terms (or notice of termination given and not withdrawn), the DEI VA Stockholders (i) will vote all of the shares of DEI Common Stock with respect to which they have or share voting power for the approval of the Charter Amendment and the DEI Long-Term Incentive Plan amendment at the DEI Annual Meeting; and (ii) will not sell, transfer or assign any of their shares of DEI Common 30 36 Stock prior to the earlier of the Merger, the termination of the Merger Agreement or July 1, 1998. The Voting Agreement also provides that if the Merger Agreement has not been terminated in accordance with its terms (or notice of termination given and not withdrawn), the STR VA Stockholders (i) will vote all of the shares of STR Common Stock with respect to which they have or share voting power for approval of the Merger Agreement, the Merger and the consummation of the transactions contemplated thereunder at the STR Special Meeting; and (ii) will not sell, transfer or assign any of their shares of STR Common Stock prior to the earlier of the Merger, the termination of the Merger Agreement or July 1, 1998. For a period beginning at the Effective Time and ending on the date following the conclusion of the second annual meeting of the stockholders of DEI after the Effective Time, DEI has agreed pursuant to the Voting Agreement that (i) except under certain circumstances, the number of directors on its Board of Directors shall be fixed at seven and (ii) it will nominate Thomas R. Ory, John D. Sanders, Philip H. Power, S. R. Perrino, S. Kent Rockwell, James Busey and Charles Bernard for election as directors at each meeting of the stockholders of DEI at which directors are elected, subject to the consent of such persons to serve in such capacity. See "The Voting Agreement." At the Effective Time, each outstanding option to purchase STR Common Stock will be assumed by DEI and will be deemed to constitute an option to acquire, on the same terms and conditions as were applicable under such option, the same number of shares of DEI Common Stock as the holder of such options would have been entitled to receive pursuant to the Merger had such holder exercised such option in full immediately prior to the consummation of the Merger (not taking into account whether such option was in fact exercisable at such time). As of January 31, 1998, executive officers and directors of STR had outstanding options to purchase STR Common Stock as follows:
Pre-Merger Number of DEI shares Post-Merger exercise subject to option exercise Number of STR shares price immediately following price Name and Position subject to option per share the Effective Time per share - ----------------- -------------------- ----------- --------------------- ----------- Charles Bernard, Director 10,000 $1.94 25,800 $0.75 John Sanders, Director 10,000 8.69 25,800 3.37 Robert Bower, Senior Vice President-Finance/CFO 6,000 8.69 15,480 3.37
DISSENTERS' RIGHTS The rights of STR's dissenting stockholders are governed by Article 15 (Sections 13.1-729 through 13.1-741) of the VSCA. DEI stockholders are not entitled to dissent from the Merger because DEI is not a constituent corporation in the Merger. The following summary of applicable provisions of Sections 13.1-729 through 13.1-741 of the VSCA contains all material information with respect thereto, but is not intended to be a complete statement of such provisions and therefore is qualified in its entirety by reference to the full text of the dissenters' rights provisions of the VSCA, which is included herein as Annex C. STR stockholders who comply with the applicable procedures of Article 15 of the VSCA will be entitled to dissent from the Merger. A person having a beneficial interest in the STR Common Stock held of record in the name of another person, such as broker of nominee, must act promptly to cause the record holder to follow the steps summarized below properly and in a timely manner to perfect dissenters' rights. The Merger Agreement provides that notwithstanding the conversion and exchange provisions of the Merger Agreement, shares of STR Common Stock outstanding immediately prior to the Effective Time and held by a holder who has not voted in favor of the Merger or consented thereto in writing and who has timely and properly exercised dissenters' rights for such shares in accordance with Virginia law will not be converted into a right to receive DEI Common Stock. If, after the Effective Time, such holder fails to perfect or withdraws or loses his, her or its right to 31 37 dissent, such shares will be treated as if they had been converted as of the Effective Time into a right to receive DEI Common Stock. The failure of an STR stockholder to vote against the Merger will not, in and of itself, constitute a waiver of such stockholder's dissenters' rights under Article 15. Under Virginia law, holders of shares who follow the procedures set forth in Article 15 will be entitled to demand payment of their shares for an amount deemed equivalent to the fair value of their shares. STR stockholders who desire to exercise their dissenters' rights must deliver to STR, before the vote on the Merger, a written demand for payment of their shares. This written demand for payment must be in addition to and separate from any proxy vote abstaining from or voting against the Merger. Voting against, abstaining from voting, or failing to vote on the Merger will not constitute a demand for payment within the meaning of Article 15. STR stockholders who desire to exercise their dissenters' rights under Article 15 must not vote for approval of the Merger. If a stockholder returns a signed proxy but does not specify a vote against approval of the Merger or a direction to abstain, the proxy will be voted for approval of the Merger and will effectively waive that stockholder's dissenters' rights. Within ten days following stockholder approval of the Merger, STR will deliver a dissenters' notice to all STR stockholders from whom an intent to demand payment has been properly received. The notice shall state where the payment demand shall be sent and where certificates shall be deposited. The notice shall also supply a form for demanding payment and set a date, not fewer than 30 nor more than 60 days after delivery of the dissenters' notice by which STR must receive a payment demand from a dissenting stockholder. Within the time frame set forth in STR's notice, a dissenter must demand payment of the estimated fair value of the shares less the amount received from STR. If a dissenters' demand for payment remains unsettled, STR shall commence a proceeding in the Circuit Court of Fairfax County, Virginia to have the court determine fair value. As part of this proceeding, the court is authorized to appoint one or more appraisers. The court assesses all costs, including appraisers appointed by the court, against STR except that the court shall have the right to make an assessment against any dissenters who did not act in good faith in demanding payment after receipt of STR's payment. All other fees and expenses, other than counsel fees, can be equally assessed. Therefore, dissenters will be responsible for the payment of their own attorney's fees. Any STR stockholder contemplating the exercise of dissenter's rights is urged to review carefully the provisions of the VSCA relating to dissenters' rights, a copy of which is attached hereto as Annex C. Failure by an STR stockholder to follow precisely all the steps required by such provisions for perfecting dissenters' rights will result in the loss of those rights. Dissenters' rights are the exclusive remedy of a dissenting stockholder in the absence of unlawful or fraudulent action by STR with respect to its stockholders. THE ABOVE DISCUSSION IS NOT A COMPLETE STATEMENT OF THE LAW PERTAINING TO DISSENTERS' RIGHTS UNDER THE VSCA AND IS QUALIFIED IN ITS ENTIRETY BY THE FULL TEXT OF SECTIONS 13.1-729 THROUGH 13.1-741 OF THE VSCA, WHICH IS REPRINTED IN ITS ENTIRETY AS ANNEX C TO THIS JOINT PROXY STATEMENT/PROSPECTUS. 32 38 FEDERAL INCOME TAX CONSEQUENCES The following summary describes the material federal income tax consequences of the Merger to holders of STR Common Stock who are citizens or residents of the United States and who hold their shares of STR Common Stock as capital assets and is based upon the opinion of Michaels, Wishner & Bonner, P.C. to such effect. The opinion is attached as an exhibit to the Registration Statement. Neither the summary below nor such opinion discuss all the tax consequences that may be relevant to STR stockholders who acquired their shares of STR Common Stock pursuant to the exercise of employee stock options or otherwise as compensation. In addition, the summary does not discuss the application of any state, local, foreign or other tax rules to the Merger. The rendering of the opinion is not a condition to the consummation of the Merger. Michaels, Wishner & Bonner, P.C., counsel to STR, has opined that the Merger will constitute a reorganization for federal income tax purposes within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code") assuming certain non-statutory requirements with respect to continuity of business enterprise and interest are met subsequent to the Merger, and, accordingly, the tax basis of the DEI Common Stock received by STR stockholders in the Merger will be the same as the tax basis of the STR Common Stock surrendered in exchange therefor reduced by any basis allocable to fractional share interests in DEI Common Stock for which cash is received, subject to adjustments described below. The holding period of the shares of DEI Common Stock received in the Merger by STR stockholders will include the period during which the shares of STR Common Stock surrendered in exchange therefor were held, provided that such shares of STR Common Stock were held as capital assets at the Effective Time. Moreover, the Merger will not result in the recognition of gain or loss by DEI, STR or Merger Sub. Cash received by a holder of STR Common Stock in lieu of a fractional share interest in DEI Common Stock will result in the recognition of gain or loss for federal income tax purposes, measured by the difference between the amount of cash received and the portion of the basis of the share of STR Common Stock allocable to such fractional share interest. Such gain or loss will be capital gain or loss, provided that such share of STR Common Stock was held as a capital asset at the Effective Time and will be long-term capital gain or loss if such share of STR Common Stock has been held for more than one year and will qualify for the lower level of capital gains rates prescribed by the Taxpayer Relief Act of 1997 if the shares were held for more than 18 months. THE FOREGOING DISCUSSION CONSTITUTES ONLY A GENERAL DISCUSSION OF THE FEDERAL TAX CONSEQUENCES OF THE MERGER WITHOUT REGARD TO THE PARTICULAR FACTS AND CIRCUMSTANCES OF EACH STOCKHOLDER OF STR. NO INFORMATION IS PROVIDED HEREIN WITH RESPECT TO THE TAX CONSEQUENCES, IF ANY, OF THE MERGER UNDER APPLICABLE FOREIGN, STATE AND LOCAL LAWS. STR STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISERS AS TO THE SPECIFIC TAX CONSEQUENCES TO THEM OF THE MERGER, INCLUDING TAX RETURN REPORTING REQUIREMENTS, THE APPLICABILITY AND EFFECT OF FEDERAL, FOREIGN, STATE, LOCAL AND OTHER APPLICABLE TAX LAWS AND THE POSSIBLE EFFECT OF ANY PROPOSED CHANGES IN THE TAX LAWS. ACCOUNTING TREATMENT Inasmuch as former STR shareholders will own approximately 86.5% of the outstanding shares of DEI Common Stock immediately following the Merger, STR will be deemed for accounting purposes to be the "acquiring" corporation and DEI will be deemed the "acquiree." In accordance with generally accepted accounting principles, the recorded assets and liabilities of STR will be carried forward at recorded book values and the purchase price will be allocated to the DEI assets and liabilities based upon the estimated fair values of such assets and liabilities. The purchase price was determined by the fair value of the DEI Common Stock for a reasonable period of time before and after the announcement of the Merger. Any portion of the purchase price in excess of the fair value of the identifiable assets and liabilities will be allocated to goodwill. See "Unaudited Pro Forma Combined Financial Statements." Subsequent to the Merger, DEI intends to change its fiscal year-end from July 31 to September 30. 33 39 FEDERAL SECURITIES LAW CONSEQUENCES All shares of DEI Common Stock received by STR stockholders in the Merger will be freely transferable, except that shares of DEI Common Stock received by persons who are deemed to be "affiliates" (as such term is defined under the Securities Act) of STR prior to the Merger may be resold by them only in transactions permitted by the resale provisions of Rule 145 (or Rule 144 in the case of such persons who become affiliates of DEI) or as otherwise permitted under the Securities Act. Persons who may be deemed "affiliates" of STR generally include individuals or entities that control, are controlled by or are under common control with STR and may include certain officers and directors of STR as well as principal stockholders of STR. The Merger Agreement requires STR to cause each of its affiliates to execute a written agreement to the effect that such affiliate will not sell, pledge, transfer or otherwise dispose of any shares of DEI Common Stock issued to such affiliate pursuant to the Merger, except pursuant to an effective registration statement or in compliance with Rule 145 or another exemption from the registration requirements of the Securities Act. THE MERGER AGREEMENT GENERAL The following description of the terms and conditions of the Merger Agreement contains all of the material information with respect thereto, but does not purport to be complete and is therefore qualified in its entirety by reference to the Merger Agreement, a copy of which is attached to this Joint Proxy Statement/Prospectus as Annex A and incorporated herein by reference. All DEI and STR stockholders are urged to read the Merger Agreement in its entirety. The Merger Agreement provides, among other things, for the merger of Merger Sub with and into STR in accordance with Virginia law, and the conversion of shares of STR Common Stock into DEI Common Stock as described in "Conversion and Exchange of STR Common Stock" below. If the Merger is consummated, Merger Sub's separate existence will cease. EFFECTIVE TIME Following approval of the Merger and subject to satisfaction or waiver of the terms and conditions, including conditions to closing, contained in the Merger Agreement, the Merger will be effective when Articles of Merger are filed with the Virginia State Corporation Commission. The filing of the Articles of Merger will be made as promptly as practicable after the required stockholder approvals have been obtained and the other conditions to the consummation of the Merger have been satisfied or waived. It is currently contemplated that the Effective Time will occur as soon after the DEI Annual Meeting and the STR Special Meeting as practicable, assuming the conditions set forth in the Merger Agreement are fully satisfied or waived. See "The Merger Agreement -- Conditions to Consummation of the Merger." CONVERSION AND EXCHANGE OF STR COMMON STOCK As of the Effective Time, by virtue of the Merger and without any action of the part of any holder of STR Common Stock, each outstanding share of STR Common Stock (other than dissenters' shares) will be converted into 2.58 shares of DEI Common Stock. As of the Effective Time, until surrendered and exchanged, each certificate evidencing STR Common Stock will be deemed, for all purposes, to evidence only the right to receive the number of shares of DEI Common Stock which the holder of such certificate is entitled to receive pursuant to the Merger. Fractional shares of DEI Common Stock will not be issued in connection with the Merger. Instead, each person entitled thereto will receive a cash payment equal to the product of (i) the fractional interest of a share of DEI Common Stock to which such holder would have been entitled (computed based upon the aggregate number of shares of STR Common Stock owned by such holder and the aggregate number of shares of DEI Common Stock to which such holder 34 40 is entitled) and (ii) the average of the published bid and asked prices per share of DEI Common Stock for the trading date immediately prior to the Effective Time. Promptly after the Effective Time, DEI will forward a letter of transmittal to stockholders of record of STR containing detailed instructions for the surrender of certificates representing STR Common Stock. The letter of transmittal will contain detailed instructions with respect to surrender of certificates representing STR Common Stock and the distribution in exchange therefor of certificates representing DEI Common Stock. STOCKHOLDERS OF STR SHOULD NOT SEND CERTIFICATES REPRESENTING THEIR SHARES TO STR OR DEI PRIOR TO RECEIPT OF THE LETTER OF TRANSMITTAL. CONDITIONS TO CONSUMMATION OF THE MERGER The obligations of DEI, STR and Merger Sub to consummate the Merger are subject to the fulfillment prior to the Effective Time of the following conditions: (i) the Merger shall have been duly approved by the holders of the requisite number of the shares of STR Common Stock in accordance with applicable law and STR's Articles of Incorporation and Bylaws, and the Charter Amendment shall have been duly approved by the holders of requisite number of the shares of DEI Common Stock in accordance with applicable law and DEI's Certificate of Incorporation and Bylaws; (ii) all required governmental and regulatory approvals for the Merger, including any approvals required under federal or state securities laws, shall have been received; and (iii) the Form S-4 Registration Statement containing this Joint Proxy Statement/Prospectus shall be effective under the Securities Act and no stop order suspending the effectiveness of the Form S-4 Registration Statement shall have been issued and no proceeding for such purpose shall have been initiated and be continuing or threatened by the Commission. The respective obligations of DEI and Merger Sub to consummate the Merger are subject to the fulfillment or waiver at or prior to the Effective Time of each of the following conditions, among others: (i) the representations and warranties of STR set forth in the Merger Agreement shall be true and correct at and as of the closing date; (ii) STR shall have performed and complied with all of its covenants under the Merger Agreement in all material respects through the closing; (iii) there shall be no more than 35,000 shares of STR Common Stock that are held by stockholders of STR who vote against the Merger Agreement and who comply with all of the relevant provisions of Sections 13.1-729 through 13.1-741 of the VSCA; (iv) no action, suit, or proceeding shall be pending or threatened before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator wherein an unfavorable injunction, judgment, order, decree, ruling, or charge would (a) prevent consummation of any of the transactions contemplated by the Merger Agreement, (b) cause any of the transactions as set forth in the Merger Agreement to be rescinded following consummation, (c) affect adversely the right of STR to own its assets and to operate its business as it currently operates, or (d) if determined adversely to STR or any director, officer, employee or agent of STR, have a material adverse effect on the business, financial condition or prospects of STR and no such injunction, judgment, order, decree, ruling, or charge described in (a), (b), (c) or (d) shall be in effect; (v) all actions to be taken by STR in connection with the consummation of the Merger and all certificates, opinions, instruments, and other documents delivered at the Closing or required to effect the Merger shall be satisfactory in form and substance to DEI and its counsel; (vi) STR shall have made, or caused to be made, all of the deliveries required to be made under the Merger Agreement; (vii) there shall not have occurred since the date of the Merger Agreement any event which has had or with the passage of time, is reasonably likely to have a material adverse effect on the condition (financial or otherwise), assets, liabilities, results of operations or prospects of STR; and (viii) each affiliate of STR shall have executed and delivered to DEI an agreement regarding the sale, pledge, transfer or other disposition of DEI Common Stock issued to such affiliate pursuant to the Merger. The obligation of STR to consummate the Merger is subject to the fulfillment or waiver at or prior to the Effective Time of each of the following conditions, among others: (i) the representations and warranties of DEI set forth in the Merger Agreement shall be true and correct at and as of the closing date; (ii) DEI and Merger Sub shall have performed and complied with all of their covenants under the Merger Agreement in all material respects through the 35 41 closing; (iii) no action, suit, or proceeding shall be pending or threatened before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator wherein an unfavorable injunction, judgment, order, decree, ruling, or charge would (a) prevent consummation of any of the transactions contemplated by the Merger Agreement, or (b) cause any of the transactions as set forth in the Merger Agreement to be rescinded following consummation, and no such injunction, judgment, order, decree, ruling, or charge described in (a) and (b) shall be in effect; and (iv) all actions to be taken by DEI and Merger Sub in connection with the consummation of the Merger and all certificates, opinions, instruments, and other documents delivered at the Closing or required to effect the Merger shall be satisfactory in form and substance to STR and its counsel. At any time prior to the Effective Time, the parties may waive compliance with any of the agreements or conditions contained in the Agreement which may be legally waived. COVENANTS Each of DEI and STR has agreed to use its best efforts to take all action and do all things necessary, proper or advisable in order to consummate and make effective the transactions contemplated by the Merger Agreement. As soon as practicable following the date of the Merger Agreement, each of DEI and STR, acting through its Board of Directors, is required to take all action necessary in accordance with its Articles of Incorporation or Certificate of Incorporation, as the case may be, and Bylaws and applicable law to duly call, give notice of, convene and hold a special meeting of its stockholders for the purpose of voting, in the case of DEI, upon the approval of the Charter Amendment and an amendment to the DEI Long-Term Incentive Plan increasing the number of shares available thereunder to 400,000; and in the case of STR, upon the approval of the Merger and the transactions contemplated thereby. Each of DEI and STR have agreed that prior to the Effective Time, unless the other party otherwise agrees or as otherwise contemplated by the Merger Agreement, their respective businesses will be conducted only in the ordinary course and neither will take certain actions not in the ordinary course of business, without the prior written consent of the other party, including without limitation: (i) amending its Articles of Incorporation or Certificate of Incorporation, as the case may be, or its Bylaws; (ii) paying or declaring any cash dividend, or other dividend or distribution with respect to its capital stock; (iii) issuing, transferring, selling or committing to issue, transfer, sell or deliver, any shares of its capital stock (or options, warrants or any rights thereto including, without limitation, any securities convertible into or exchangeable, with or without additional consideration, for such capital stock) except pursuant to the exercise of stock options or warrants existing on the date of this Agreement or under certain specified conditions; (iv) increasing or reducing the number of shares of its capital stock by split-up, reverse split, reclassification or distribution of stock dividends; (v) purchasing or otherwise acquiring for any consideration any outstanding shares of its capital stock or securities carrying the right to acquire, or convertible into or exchangeable for such stock, with or without additional consideration; (vi) acquiring by merger or consolidation with, or merging or consolidating with, or purchasing substantially all of the assets of, or otherwise acquiring any business of any other corporation, partnership, association or other business organization or division thereof, or making any investment of a capital nature either by purchase of stock or securities, contributions to capital, property transfer or otherwise, or by the purchase of any property or assets of any other individual, partnership, firm or corporation; (vii) incurring additional indebtedness for borrowed money except pursuant to existing lines of credit; (viii) adopting or materially modifying any bonus, pension, profit-sharing or other compensation plan or entering into any contract of employment with any employee which is not terminable at will without cost or other liability; (ix) adopting, entering into or amending in any material respect any collective bargaining, employment, severance or termination agreement or arrangement with any person or making any change in its key management structure, including, but not limited to, the hiring of additional employees or the termination of existing employees; (x) discharging or satisfying any lien or encumbrance or paying any obligation or liability (whether accrued, absolute, contingent or otherwise), except current liabilities incurred in the ordinary course of business; (xi) mortgaging, pledging or subjecting to lien, charge, security interest or any other encumbrance any of its assets or property; (xii) transferring or leasing any of its assets or property except in the ordinary course of business; (xiii) canceling or compromising any debt or claim other than in the ordinary course of business in an aggregate amount in excess of specified amounts; (xiv) waiving or releasing any rights, or settling any claim, in an aggregate amount which 36 42 is in excess of specified amounts; (xv) transferring or granting any rights under any leases, licenses or other agreements, other than in the ordinary course of business; (xvi) making or granting any general or individual wage or salary increase to any of its officers; (xvii) failing to pay or discharging its accounts payable, debts or liabilities when due; (xviii) suffering any material adverse change in its financial condition, properties or business; (xix) except in the ordinary course of business, making or entering into any contract, commitment or transaction which involves an expenditure in excess of specified amounts, or renewing, extending, amending or modifying any contract, commitment or transaction involving in excess of a specified amount; or (xx) entering into or amending any contract, agreement or other transaction with any of its officers, directors or shareholders, or any affiliate of such an officer, director or shareholder, on terms that are less favorable than could be obtained from an unrelated third party on an arm's length basis. REPRESENTATIONS AND WARRANTIES; ADDITIONAL AGREEMENTS The Merger Agreement contains various customary representations and warranties of the parties. DEI and Merger Sub have made representations to STR, and STR has made representations to DEI and Merger Sub, including, but not limited to, representations with respect to authority relative to the Merger Agreement, organization and qualification, noncontravention, absence of certain changes or events, no undisclosed liabilities, compliance with all applicable laws, litigation and employee benefits. DEI has agreed that effective at the Effective Time and conditional upon the consummation of the Merger, William Panschar and Charles Stanich will have submitted their resignations as directors to the DEI Board of Directors, DEI's Board of Directors will increase the number of directors on the DEI Board of Directors to seven, and DEI's Board of Directors will appoint S. R. Perrino, S. Kent Rockwell, James Busey and Charles Bernard to fill the resulting vacancies. MANAGEMENT OF DEI AFTER THE MERGER If the Merger is approved, the Board of Directors of DEI will consist of three directors who are currently members of DEI's Board of Directors - -- Thomas R. Ory, Philip H. Power and John D. Sanders -- and four persons who are currently directors of STR -- S. R. Perrino, S. Kent Rockwell, James Busey and Charles Bernard. Dr. Sanders also serves on STR's Board of Directors. In addition, Mr. Perrino will become President and Chief Executive Officer, and Mr. Ory will become a Vice President. See "Election of DEI Directors." TERMINATION; AMENDMENT; WAIVER The Merger Agreement may be terminated at any time prior to the Effective Time, whether before or after approval by the stockholders of DEI or STR, upon the occurrence of certain events, including without limitation, the following: (i) by mutual written agreement of DEI and STR; (ii) by either DEI or STR if the Merger has not been consummated by May 31, 1998; (iii) by DEI or STR if there is a material adverse change in the business or financial condition of the other; and (iv) by DEI or STR if there is a material condition precedent which cannot be satisfied and is not waived. If the Merger is not completed because: (i) the STR Board of Directors recommended to the stockholders of STR a proposal with respect to a merger, consolidation, share exchange or similar transaction or series of transactions involving STR, or any purchase of all or any significant portion of the assets of STR, or resolved to do any of the foregoing; (ii) STR entered into a definitive agreement accepting an offer with respect to all STR Common Stock that is more favorable than the Merger, DEI is entitled to receive from STR all costs and out-of-pocket expenses which DEI may have incurred in connection with the negotiation and preparation of the Merger Agreement and related documentation, due diligence investigations, and the preparation, filing and mailing of the Form S-4 registration statement and this Joint Proxy Statement/Prospectus. If the Merger is not completed because: (i) the DEI Board of Directors recommended to the stockholders of DEI a proposal with respect to a merger, consolidation, share exchange or similar transaction or series of transactions involving DEI, or any purchase of all or any significant portion of the assets of DEI, or resolved to do any of the foregoing; (ii) DEI entered into a definitive agreement accepting an offer with respect to all DEI Common Stock that is more favorable than the Merger, STR is entitled to receive from DEI all costs 37 43 and out-of-pocket expenses which STR may have incurred in connection with the negotiation and preparation of the Merger Agreement and related documentation, due diligence investigations, and the preparation, filing and mailing of the Form S-4 registration statement and this Joint Proxy Statement/Prospectus. Any term of the Merger Agreement may be amended or waived only in writing signed by the party to be bound thereby, subject to applicable law. The Board of Directors of either STR or DEI has the right to waive certain conditions precedent to the consummation of the Merger other than those conditions which are a legal necessity for the Merger to occur such as STR stockholder approval of the Merger or DEI stockholder approval of the Charter Amendment. In the event either Board waives any condition, each company intends to resolicit shareholder approval unless in the opinion of such company's Board, the delay associated with the resolicitation process is likely to have a material adverse effect on the business or financial condition of such company. THE EMPLOYMENT AGREEMENTS DEI has entered into an employment agreement with each of Thomas Ory and Charles Stanich, effective upon consummation of the Merger and extending for two years following the Effective Time. The employment agreement with Mr. Ory provides that he will be employed as a Vice President of DEI and President of DEI's Sensing and Imaging Systems Division. Mr. Ory's compensation under his employment agreement provides for an annual salary of $154,800, and fringe benefits, perquisites and benefits of employment provided to salaried officer-level executives of DEI serving in a capacity similar to that of Mr. Ory. In addition, Mr. Ory's employment agreement requires DEI to cause Mr. Ory to be nominated for election to DEI's Board of Directors. The employment agreement of Charles Stanich provides that he will be employed as a Vice President of DEI and Executive Vice President of DEI's Sensing and Imaging Systems Division. Mr. Stanich's compensation under his employment agreement provides for an annual salary of $136,800, and fringe benefits, perquisites and benefits of employment provided to salaried officer-level executives of DEI serving in a capacity similar to that of Mr. Stanich. DEI may terminate either employment agreement for cause or without cause. If DEI terminates either employment agreement for cause, DEI is liable only for the compensation set forth in such employment agreement with respect to periods of time prior to the date of such termination. If DEI terminates either employment agreement without cause, DEI is required to pay the compensation and provide the fringe benefits to Mr. Ory or Mr. Stanich, as the case may be, at the rate or level, as applicable, in effect on the date of such termination until the date two years from the Effective Time. DEI also may terminate the employment agreements in the event of the disability of Mr. Ory or Mr. Stanich, as the case may be. Each employment agreement will terminate automatically upon the death of Mr. Ory or Mr. Stanich, as the case may be. In the event that an employment agreement is terminated because of the disability or death of Mr. Ory or Mr. Stanich, DEI is liable only for the compensation set forth in such employment agreement with respect to periods of time prior to the date of such termination. Each of Mr. Ory and Mr. Stanich may terminate his respective employment agreement (i) upon the failure of DEI to provide him with the compensation and fringe benefits described in his agreement; (ii) upon any other material breach of his employment agreement by DEI; (iii) upon any diminution of his authority, duties and responsibilities, or a significant change in the nature or scope of his duties; (iv) any change in his status or title, except for a bona fide promotion or with his consent; or (v) if DEI moves his office to a location that is more than 25 miles from its present location in Ann Arbor, Michigan without his consent. If Mr. Ory or Mr. Stanich terminates his employment for any of the reasons set forth above, DEI is required to pay the compensation and provide the fringe benefits to Mr. Ory or Mr. Stanich, as the case may be, at the rate or level, as applicable, in effect on the date of such termination until the date two years from the Effective Time. If Mr. Ory or Mr. Stanich terminates his employment other than for a reason set forth above, DEI is required to pay him, within ten (10) days following such termination, a lump sum equal to three months' salary at the higher of the rate being paid to him on the date of such termination or the rate originally set forth in his employment agreement. 38 44 Under their respective employment agreements, each of Mr. Ory and Mr. Stanich are prohibited from engaging, directly or indirectly, in any activity which is in direct competition with the activities of DEI for a period of two years after the Effective Time. No other employment agreements will exist for any officers of DEI and STR following the Merger other than for Mr. Ory and Mr. Stanich. No severance obligations will arise for any DEI or STR employee solely as a result of the Merger. THE VOTING AGREEMENT In connection with the Merger, Thomas Ory, Charles Stanich, John Sanders and Philip Power (the "DEI VA Stockholders"), S. R. Perrino, Robert Bower, John Sanders and Donald Reiser (the "STR VA Stockholders") and DEI have entered into a Voting Agreement, dated as of December 23, 1997. The Voting Agreement provides that if the Merger Agreement has not been terminated in accordance with its terms, the DEI VA Stockholders (i) will vote all of the shares of DEI Common Stock with respect to which they have or share voting power for the approval of the Charter Amendment and the DEI Long-Term Incentive Plan amendment at the DEI Annual Meeting; and (ii) will not sell, transfer or assign any of their shares of DEI Common Stock prior to the earlier of the Effective Time, the termination of the Merger Agreement or July 1, 1998. The Voting Agreement also provides that if the Merger Agreement has not been terminated in accordance with its terms, the STR VA Stockholders (i) will vote all of the shares of STR Common Stock with respect to which they have or share voting power for approval of the Merger Agreement, the Merger and the consummation of the transactions contemplated thereunder at the STR Special Meeting; and (ii) will not sell, transfer or assign any of their shares of STR Common Stock prior to the earlier of the Effective Time, the termination of the Merger Agreement or July 1, 1998. For a period beginning at the Effective Time and ending on the date following the conclusion of the second annual meeting of the stockholders of DEI after the Effective Time, DEI has agreed pursuant to the Voting Agreement that (i) except under certain circumstances, the number of directors on its Board of Directors shall be fixed at seven and (ii) it will nominate Thomas R. Ory, John D. Sanders, Philip H. Power, S. R. Perrino, S. Kent Rockwell, James Busey and Charles Bernard for election as directors at each meeting of the stockholders of DEI at which directors are elected, subject to the consent of such persons to serve in such capacity. UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS The following sets forth certain historical financial information of DEI and STR on an unaudited pro forma basis after giving effect to the Merger on a "reverse acquisition purchase" basis (as if STR had acquired DEI) and the Stock Issuance. The unaudited pro forma combined statement of operations includes the results of operations of DEI and STR for the respective periods presented and gives effect to pro forma adjustments as if the Merger and Stock Issuance had occurred at the beginning of the period. The unaudited pro forma combined balance sheet includes the historical balance sheet of DEI and STR as of December 31, 1997 and gives effect to the pro forma adjustments as if the Merger and Stock Issuance had occurred on that date. This data should be read in conjunction with the selected historical information, the comparative per share data and the separate historical financial statements of DEI and STR and the notes thereto included elsewhere in this Joint Proxy Statement/Prospectus. The unaudited pro forma combined financial statements are not necessarily indicative of the operating results or financial position that would have been achieved had the Merger been consummated at the beginning of the periods presented and should not be construed as representative of future operations. Management does not expect significant changes to the preliminary valuation of the transaction. Changes to the allocation of the purchase price to property and equipment may occur as a result of profits or losses generated by DEI in the period from the date of the pro forma balance sheet to the Effective Time. Subsequent to the Merger, DEI intends to change its fiscal year-end from July 31 to September 30. As a result, the pro forma combined statements of operations have been prepared assuming a September 30 fiscal year end. 39 45 In addition to the pro forma adjustments described below, it is anticipated that the combined companies will incur a restructuring charge of approximately $1,000,000 ($620,000, net of taxes). The charge is expected to relate to costs associated with reengineering the combined companies' processes, policies and procedures. Costs are expected to be incurred for external consultants, for personnel terminations and for relocation and moving. Other costs are expected to be incurred to realign products, services and facilities around the combined companies' core businesses. The restructuring charge has not been reflected in the unaudited pro forma combined financial statements. It is anticipated that the restructuring will commence shortly after the Merger. 40 46 PRO FORMA COMBINED BALANCE SHEET (UNAUDITED)
STR ADJUSTED STR DEI AS OF AS OF AS OF DECEMBER 31, STOCK DECEMBER 31, OCTOBER 31, PRO FORMA 1997 ISSUANCE(A) 1997 1997 ADJUSTMENTS COMBINED ---------------------------------------------------------------------------------------------------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 119,524 $ 119,524 $ 7,293 $ 126,817 Accounts receivable 4,045,201 4,045,201 137,279 4,182,480 Unbilled contract costs, net 5,374,597 5,374,597 225,117 5,599,714 Inventories - at cost 203,311 203,311 575,842 779,153 Deferred tax asset 226,737 226,737 - 226,737 Other current assets 174,553 174,553 19,151 193,704 Prepaid income taxes 155,152 155,152 - 155,152 ------------ ----------- ---------- ----------- Total current assets 10,299,075 10,299,075 964,682 11,263,757 PROPERTY AND EQUIPMENT 875,532 875,532 1,143,269 (836,952) b 1,140,583 (41,266) d2 OTHER ASSETS Land and building held for sale 836,952 b 1,450,000 613,048 d1 Deposits 83,975 83,975 250 84,225 ------------ ----------- ---------- ----------- ----------- TOTAL ASSETS $ 11,258,582 $11,258,582 $2,108,201 $ 571,782 $13,938,565 ============ =========== ========== =========== =========== LIABILITIES AND STOCKHOLDERS EQUITY CURRENT LIABILITIES Note payable - line of credit $ 4,208,614 $(3,783,000) $ 425,614 $ 310,000 $ 735,614 Accounts payable 3,038,408 3,038,408 71,233 3,109,641 Accrued salaries, benefits and related expenses 1,370,998 1,370,998 76,817 1,447,815 Other accrued expenses 112,225 112,225 97,235 209,460 Capital leases 52,055 52,055 - 52,055 Mortgage debt - - 237,332 237,332 ------------ ----------- ----------- ---------- ----------- ----------- Total current liabilities 8,782,300 (3,783,000) 4,999,300 792,617 -0- 5,791,917 LONG-TERM LIABILITIES Capital leases 8,993 8,993 - 8,993 ------------ ----------- ----------- ---------- ----------- ----------- TOTAL LIABILITIES 8,791,293 (3,783,000) 5,008,293 792,617 -0- 5,800,910 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Common stock 72,379 58,200 130,579 5,346 (5,346) e 39,035 f (96,890) f 5,346 c Additional paid-in capital 1,232,716 3,724,800 4,957,516 1,165,778 (1,165,778) e 6,936,426 96,890 f 1,882,020 c Retained earnings 1,162,194 1,162,194 144,460 (144,460) e 1,162,194 ------------ ----------- ----------- ---------- ----------- ----------- Total stockholders' equity 2,467,289 3,783,000 6,250,289 1,315,584 571,782 8,137,655 ------------ ----------- ----------- ---------- ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 11,258,582 $ 0 $11,258,582 $2,108,201 $ 571,782 $13,938,565 ============ =========== =========== ========== =========== ===========
41 47 a. On January 30, 1998, STR issued 582,000 shares of common stock for cash of $6.50 per share for aggregate cash proceeds of $3,783,000. The cash was used to repay outstanding bank borrowings under STR's short-term line of credit. b. It is anticipated that the land and building currently used by DEI in the business will not be owned in the future. The property is currently for sale and as a result has been reclassified as land and building held for sale. c. Because the Merger will be accounted for as a reverse acquisition purchase and STR, which is treated as the acquiror for accounting purposes, is receiving DEI Common Stock rather than DEI's assets and liabilities, the fair market value of the DEI Common Stock outstanding for a reasonable period of time before and after the announcement of the Merger determines the purchase price for accounting purposes. For purposes of the pro forma statements, the purchase price of DEI consists of the following: Stock $ 1,737,366 Direct expenses of the purchase 150,000 ----------- Total purchase price $ 1,887,366 ===========
The average market value of DEI stock for a reasonable period of time before and after the announcement of the Merger was $3.25 per share and there were 534,574 shares issued and outstanding. Therefore, the aggregate value of the stock used to record the purchase for purposes of the pro forma combined balance sheet is $1,737,366. The direct expenses of the purchase consist primarily of legal, accounting and other fees. d. For purposes of determining the pro forma effect of the acquisition on the combined financial statements, the fair value of DEI's net assets has been estimated in accordance with Accounting Principles Board Opinion No. 16: Net assets of DEI at October 31, 1997 $ 1,315,584 Fair value adjustments: d1. Adjustment of land and building held for sale to estimated fair value 613,048 d2. Adjustment of machinery and equipment to estimated fair value (41,266) ----------- $ 1,887,366 ===========
The approximate value of the land and building was determined by appraisal. The companies anticipated utilizing the DEI net operating losses available under existing Code provisions to offset any gain on the sale of the property; therefore, no deferred tax liability has been recorded for the land and building held for sale fair value adjustment. Remaining net operating losses of DEI available to offset future income after the Merger will be significantly limited by provisions of the Code; therefore, a full valuation allowance has been recorded against the remaining net operating losses. e. DEI's stockholders' equity as of October 31, 1997 is eliminated. f. According to the Merger Agreement, each share of STR Common Stock is converted into 2.58 shares of DEI Common Stock. At December 31, 1997, there were 723,792 shares of STR Common Stock outstanding. Therefore, for purposes of the unaudited pro forma combined balance sheet, 3,368,943 shares of DEI Common Stock will be issued. The following summarizes the shares to be issued and the determination of par value of the common stock on a pro forma combined basis: 42 48 STR shares outstanding at December 31, 1997 723,792 STR stock issuance 582,000 ---------- 1,305,792 Exchange ratio 2.58 ---------- 3,368,943 DEI shares outstanding at October 31, 1997 534,574 ---------- Pro forma combined shares outstanding 3,903,517 Par value per share $ .01 ---------- Pro forma combined par value $ 39,035 ========== 43 49 PRO FORMA COMBINED STATEMENT OF OPERATIONS (UNAUDITED)
STR ADJUSTED STR DEI FOR THE FOR THE FOR THE THREE THREE THREE MONTHS ENDED MONTHS ENDED MONTHS ENDED DECEMBER 31, STOCK DECEMBER 31, OCTOBER 31, PRO FORMA 1997 ISSUANCE(A) 1997 1997 ADJUSTMENTS(C) COMBINED ----------------------------------------------------------------------------------------- REVENUE Contract Revenue $ 5,837,376 $ 5,837,376 $ 483,669 $ 6,321,045 COSTS AND EXPENSES Cost of revenues 5,134,910 5,134,910 365,432 $ (10,000)b1 5,490,342 General and administrative expenses 710,076 710,076 204,333 914,409 ----------- ----------- ----------- ---------- ----------- Total costs and expenses 5,844,986 5,844,986 569,765 (10,000) 6,404,751 ----------- ----------- ----------- ---------- ----------- INCOME (LOSS) FROM OPERATIONS (7,610) (7,610) (86,096) 10,000 (83,706) OTHER INCOME (EXPENSES) Interest expense (103,143) 85,118 (18,025) (10,507) (28,532) ----------- ----------- ----------- ----------- ---------- ----------- INCOME (LOSS) BEFORE INCOME TAXES (110,753) 85,118 (25,635) (96,603) 10,000 (112,238) INCOME TAX BENEFIT (PROVISION) 42,000 (32,278) 9,722 -- 39,928 b2 $ 42,650 ----------- ----------- ----------- ----------- ---------- ---------- NET INCOME (LOSS) $ (68,753) $ 52,840 $ (15,913) $ (96,603) 42,928 $ (69,588) =========== =========== =========== =========== ========== ========== PER SHARE AMOUNT Net income (loss) per share-basic $ (0.09) $ (0.01) $ (0.18) $ (0.02) ============ =========== =========== ========== Net income (loss) per $ (0.09) $ (0.01) $ (0.18) $ (0.02) share-diluted =========== =========== =========== ========== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING Basic 723,792 582,000 1,305,792 534,391 2,063,151 3,903,334 Diluted 744,116 582,000 1,326,116 534,391 2,095,263 3,955,770
a. On January 30, 1998, STR issued 582,000 shares of common stock for cash of $6.50 per share for aggregate cash proceeds of $3,783,000. The cash was used to repay outstanding bank borrowings under STR's short-term line of credit. Interest at an assumed rate of 10% ($85,118 for the quarter ended December 31, 1997) is eliminated. The income tax provision is adjusted to reflect the interest savings. b. Adjustments to the Pro Forma Combined Statement of Operations for the three months ended December 31, 1997 in connection with the proposed Merger are presented below:
Increase in income ------------- 1. As a result of recording land and building and machinery and equipment at fair market value and assigning new useful lives, depreciation expense is decreased on a pro forma basis. $10,000 2. Pro forma income tax effect of consolidating the companies, which includes the tax effect of pro forma adjustments as well as the tax benefit of utilizing DEI's current year losses to reduce taxable income of STR. $32,928
44 50 c. The unaudited pro forma combined statement of operations excludes a one-time restructuring charge of approximately $620,000 (net of related income tax benefit) relating to reengineering the companies' processes, policies and procedures. Note: The results of operations for STR's first quarter ending December 31, 1997 and DEI's first quarter ending October 31, 1997 were used for purposes of the interim pro forma combined statement of operations. For the three months ending January 31, 1998, DEI incurred a net loss of $209,406 on revenue of $364,750. STR's results of operations for the three months ending March 31, 1998 are not yet available. PRO FORMA COMBINED STATEMENT OF OPERATIONS (UNAUDITED)
STR ADJUSTED STR DEI YEAR ENDED YEAR ENDED YEAR ENDED SEPTEMBER 30, STOCK SEPTEMBER 30, JULY 31, PRO FORMA 1997 ISSUANCE(a) 1997 1997 ADJUSTMENTS(c) COMBINED ------------------------------------------------------------------------------------------ REVENUE $23,953,070 $23,953,070 $3,001,458 $26,954,528 Contract revenue COSTS AND EXPENSES Cost of revenues 20,761,886 20,761,886 1,971,918 $ (40,000) b1 22,693,804 General and administrative expenses 2,654,218 2,654,218 1,033,429 3,687,647 ----------- ----------- ---------- --------- ---------- Total costs and expenses 23,416,104 23,416,104 3,005,347 (40,000) 26,381,451 ----------- ----------- ---------- --------- ---------- INCOME (LOSS) FROM OPERATIONS 536,966 536,966 (3,889) 40,000 573,077 OTHER INCOME (EXPENSES) Interest expense (345,086) 340,470 (4,616) (63,800) (68,416) ----------- -------- ----------- ---------- --------- ---------- INCOME (LOSS) BEFORE INCOME TAXES 191,880 340,470 532,350 (67,689) 40,000 504,661 INCOME TAX BENEFIT (PROVISION) (72,000) (127,756) (199,756) 3,546 4,439 b2 $ (191,771) ----------- -------- ----------- ---------- --------- ---------- NET INCOME (LOSS) $ 119,800 $212,714 $ 332,594 $ (64,143) $ 44,439 $ 312,890 =========== ======== =========== ========== ========= ========== PER SHARE AMOUNT Net income (loss) per share-basic $ 0.17 $ 0.25 $ (0.12) $ 0.08 =========== =========== ========== ========== Net income (loss) per share-diluted $ 0.16 $ 0.25 $ (0.12) $ 0.08 =========== =========== ========== ========== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING Basic 723,827 582,000 1,305,827 533,464 2,063,207 3,902,498 Diluted 748,216 582,000 1,330,216 533,464 2,101,741 3,965,421
45 51 a. On January 30, 1998, STR issued 582,000 shares of common stock for cash of $6.50 per share for aggregate cash proceeds of $3,783,000. The cash was used to repay outstanding bank borrowings under STR's short-term line of credit. Interest at an assumed rate of 10% ($340,470 for the year ended September 30, 1997) is eliminated. The income tax provision is adjusted to reflect the interest savings. b. Adjustments to the Pro Forma Combined Statement of Operations for the year ended September 30, 1997 in connection with the proposed merger are presented below:
Increase in income -------------- 1. As a result of recording land and building and machinery and equipment at fair market value and assigning new useful lives, depreciation expense is decreased on a pro forma basis. $40,000 2. Pro forma income tax effect of consolidating the companies, which includes the tax effect of pro forma adjustments as well as the tax benefit of utilizing DEI's current year losses to reduce taxable income of STR. $ 4,439
c. The Unaudited Pro Forma Combined Statement of Operations excludes a one-time restructuring charge of approximately $620,000 (net of related income tax benefit) relating to reengineering the companies' processes, policies and procedures. PROPOSAL TO AMEND THE DEI CERTIFICATE OF INCORPORATION The proposed amendment to the DEI certificate of incorporation would change the name of DEI from "Daedalus Enterprises, Inc." to "Sensys Technologies Inc." and increase DEI's authorized Common Stock from 2,000,000 to 5,000,000 shares in order to authorize the additional shares to be issued pursuant to the Merger Agreement. The Charter Amendment also restates the current certificate of incorporation and makes certain non-substantive changes thereto. A copy of the Charter Amendment is reproduced in full as Annex D. The affirmative vote of the holders of a majority of the shares of DEI Common Stock issued and outstanding on the DEI Record Date is required to approve the Charter Amendment. CHANGE IN DEI'S NAME As a condition to consummation of the Merger, DEI agreed to amend its certificate of incorporation to change its name. DEI and STR believe that DEI's current name will not properly reflect DEI's more diverse business strategy and business operations after the Merger and that "Sensys Technologies Inc.", the new name chosen for DEI following the Merger, is more reflective of the broader sensing systems business of the combined operations of DEI and STR following the Merger. The new name is also intended to give the combined companies a new, more marketable image in the investment community. If approved by the stockholders of DEI at the DEI Annual Meeting, the new name will become effective upon the filing of the Charter Amendment with the Delaware Secretary of State. The change in corporate name will not effect the validity or transferability of stock certificates currently outstanding and stockholders of DEI will not be required to exchange any certificates they currently hold. 46 52 INCREASE IN THE NUMBER OF AUTHORIZED SHARES The Charter Amendment will also increase the number of shares of DEI Common Stock to 5,000,000 shares from 2,000,000 shares. Following the Merger, there will be approximately 3.9 million shares of DEI Common Stock outstanding (including the 3.4 million shares of DEI Common Stock to be issued to STR stockholders pursuant to the Merger) and an additional 644,288 shares will be reserved for issuance pursuant to the DEI Long-Term Incentive Plan and other outstanding options to purchase DEI Common Stock. See AProposal to Amend the DEI Long-Term Incentive Plan." Any additional authorized shares would be available to the Board of Directors for issuance without further stockholder approval (unless required by applicable law, regulation or rule). The additional shares of DEI Common Stock could be issued for any proper corporate purpose, including the acquisition of other businesses, the raising of additional capital for use in DEI's business, stock splits, the payment of stock dividends or other distributions in shares of stock or in connection with employee stock incentive programs. While DEI currently has no understandings or commitments with respect to the issuance of the additional shares of DEI Common Stock (other than pursuant to the Merger and outstanding options), it is considered advisable to have the authorization to issue such shares in order to enable DEI, as the need may arise, to move promptly to take advantage of market conditions and the availability of other favorable opportunities without the delay and expense involved in calling a special stockholders meeting for such purpose. The authorization of additional shares of DEI Common Stock will not, by itself, have any effect on the rights of holders of existing DEI Common Stock. Depending on the circumstances, any issuance of additional shares of DEI Common Stock may dilute the present equity ownership of current stockholders. Holders of DEI Common Stock have no preemptive rights to participate in any such issuance. VOTE REQUIRED The affirmative vote of the holders of a majority of the shares of DEI Common Stock outstanding is required to adopt the Charter Amendment. Abstentions and broker non-votes have the same effect as a vote against the proposal. If the Charter Amendment is adopted by the stockholders of DEI, it will become effective upon being duly filed with the Secretary of State of Delaware. The Charter Amendment will not become effective if the Merger Agreement has been terminated. THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT DEI STOCKHOLDERS VOTE FOR APPROVAL OF THE CHARTER AMENDMENT. PROPOSAL TO AMEND THE DEI LONG TERM INCENTIVE PLAN On December 23, 1997, the DEI Board of Directors unanimously approved an amendment to DEI's Long-Term Incentive Plan (the "Plan") to increase the number of shares issuable under the Plan from 64,000 to 400,000 shares of DEI Common Stock and to increase the limit on the number of shares of DEI Common Stock that may be subject to options granted to any salaried employee in any three consecutive fiscal years from 25,000 to 100,000. Certain other minor changes were made to the Plan which are not being presented to DEI stockholders for approval. Outstanding options under the Plan will not be affected by the Merger. The Board of Directors of DEI has determined, and the Merger Agreement requires, that additional shares should be made available under the Plan if the Merger is consummated to attract, retain and motivate highly qualified individuals to serve as employees and consultants of DEI and its subsidiaries. Awards under the Plan are intended to align the interests of employees and consultants with those of DEI's stockholders and encourage employees to acquire an ownership interest in DEI. Since stock options granted under the Plan only gain value if the price of the DEI Common Stock increases above the option exercise price, grants of options to executives under the Plan reflect DEI's philosophy and objective of linking executive compensation to DEI's performance. As DEI realizes future business 47 53 success, the Plan may provide compensation incentives which it cannot presently provide through salary or bonus. Neither DEI nor STR has made any commitments to grant any stock options following consummation of the Merger. Section 162(m) of the Code and certain regulations promulgated thereunder by the Internal Revenue Service contain rules regarding the federal income tax deductibility of compensation paid to a publicly traded corporation's chief executive officer and to each of its four most highly paid executive officers. Under Section 162(m), DEI may deduct compensation paid to such an executive only to the extent that it does not exceed $1,000,000 during any fiscal year, unless the compensation constitutes "performance-based" compensation. In general, compensation attributable to a stock option or stock appreciation right is deemed to be based on performance if (i) the grant is made by the corporation's compensation committee, (ii) the plan under which the grant is made includes a per-employee limit on the number of shares with respect to which options may be granted during a specific period; and (iii) the amount of compensation the employee could receive under the terms of the option is based solely on the increase in value of the stock after the date of the grant. In 1994, when the Plan was adopted, the DEI Board concluded that it would be advisable to establish certain restrictions on the granting of options under the Plan to exempt from the Section 162(m) limitation compensation realized in connection with future exercises of options granted under the Plan. Accordingly, the Plan currently limits to 25,000 the number of shares of Common Stock that may be included in options granted to any salaried employee in any three consecutive fiscal years (which constitutes 39% of the total number of shares of DEI Common Stock reserved for issuance under the Plan). In order to give DEI additional flexibility in making grants to participants in the Plan, and to increase the limitation to a level consistent with the proposed increase in the number of shares of DEI Common Stock subject to the Plan and the number of shares of DEI Common Stock outstanding after the Merger, the DEI Board is proposing to increase the limitation to 100,000 shares (or 25% of the total number of shares of DEI Common Stock which will be reserved for issuance under the Plan if the Plan amendment is approved). The increase in the number of shares of DEI Common Stock subject to the Plan and the increase in the limitation on the number of shares of DEI Common Stock that may be subject to options granted to any salaried employee in any three consecutive fiscal years will only become effective if approved by a majority of the shares of DEI Common Stock voting on the proposal at the DEI Annual Meeting and if the Merger is consummated. DEI'S BOARD OF DIRECTORS RECOMMENDS A VOTE FOR APPROVAL OF THE PLAN AMENDMENT. GENERAL On December 13, 1994, the stockholders of DEI approved the Plan, which is intended to attract and motivate highly qualified individuals to serve as employees of DEI and to encourage employees of DEI and its subsidiaries to acquire an ownership interest in DEI. Approximately 16 employees of DEI are currently eligible to participate in the Plan and approximately 180 employees will be eligible upon consummation of the Merger. The Plan is administered by the Executive Compensation/Stock Option Committee of the DEI Board of Directors (the "Committee"), which is comprised of no fewer than two non-employee members of the DEI Board of Directors. The Committee is authorized to administer and interpret the Plan and to adopt such rules and regulations as it determines are appropriate. Shares subject to the canceled, forfeited, terminated or expired portion of grants and awards made under the Plan may again be used for grants and awards under the Plan. Awards may be made by the Committee to employees as the Committee may select and may be in the form of stock options, restricted stock or performance shares. Options under the Plan to purchase 29,975 shares of DEI Common Stock are currently outstanding. 48 54 STOCK OPTION GRANTS Options granted under the Plan may be either incentive stock options under Section 422 of the Code or nonqualified stock options. The exercise price of any option granted under the Plan may be no less than the fair market value per share of DEI Common Stock on the date of grant. Options granted under the Plan become exercisable at such times as the Committee may determine and will generally have a term of ten years unless the Committee determines a shorter term. The aggregate fair market value, determined on the grant date, of the DEI Common Stock with respect to which incentive stock options may first become exercisable for an optionee during any calendar year may not exceed $100,000. No salaried employee currently may receive options during any three year period to purchase more than 25,000 shares. Payment for shares to be acquired upon exercise of options granted under the Plan may be made in cash, by check or, at the discretion of the Committee, an optionee may exercise an option through a cashless exercise procedure whereby the optionee provides an option exercise notice to DEI and simultaneously irrevocably instructs a broker to sell a sufficient number of the shares from the option exercise to pay the option exercise price and accompanying taxes. At the Committee's discretion, shares may be tendered to DEI or the cashless exercise procedure may be used to satisfy tax obligations. TERMINATION; CHANGE IN CONTROL Options which are not yet exercisable, restricted stock which is not yet transferable and performance share awards with respect to which performance goals have not yet been achieved will generally be forfeited if the holder's employment is terminated. The Committee, however, is granted discretion under the Plan to accelerate the exercisability of options and waive the restrictions or conditions applicable to restricted stock or performance share awards and such acceleration and waiver will occur automatically upon a change in control of DEI (as defined in the Plan). An option (or portion thereof) which is exercisable at the time of the holder's termination may be exercised after such time to the extent it was exercisable at the time of the holder's termination until such option terminates. Unless the Committee otherwise provides, an exercisable option will terminate at various times after the holder's employment terminates, based upon the reason for the holder's termination. If employment is terminated for any reason other than death, disability or retirement, such option will terminate on the earlier of the expiration date of the option and the first anniversary of the option holder's termination. If employment terminates because the holder has died or becomes disabled, such option will terminate one year following the date of the option holder's termination. If employment terminates due to retirement, the option will terminate on the earlier of the expiration date of the option and the second anniversary of the option holder's termination. AMENDMENT The Plan may be terminated or amended at any time by the Board of Directors. No amendment, modification or termination of the Plan may adversely affect any option, restricted stock award or performance share award previously granted under the Plan without the consent of the participant. Unless the Plan is terminated sooner by the Board, no new awards or grants may be authorized under the Plan after October 18, 2004. RESTRICTED STOCK GRANTS AND PERFORMANCE SHARE AWARDS The Plan authorizes the Committee to grant restricted stock awards pursuant to which shares of DEI Common Stock will be awarded, subject to restrictions on transfer which lapse over a period of time or upon achievement of performance goals, as determined by the Committee. Participants who receive restricted stock grants are eligible to dividend and voting rights on the awarded shares prior to the lapse of restrictions on such awards. The Committee is also authorized to grant performance share awards under the Plan, which are payable at the discretion of the Committee in cash or shares of DEI Common Stock upon achievement of performance goals established by the Committee. The 49 55 terms and conditions of restricted stock and performance share awards, including the acceleration or lapse of any restrictions or conditions of such awards, will be determined by the Committee. PREVIOUS GRANTS The following table sets forth the number of shares subject to outstanding options granted under the Plan to DEI's Chief Executive Officer and Chief Operating Officer, all persons who received options to purchase 5% or more of the shares subject to the Plan, all current executive officers as a group, all other employees as a group and all non-employee directors as a group. Except as set forth below, no other options have been granted under the Plan. Options outstanding under the Plan have exercise prices ranging from $2.25 to $2.75 per share. Name Number of Options ---- ----------------- Thomas R. Ory 0 Charles G. Stanich 0 Jane E. Barrett 5,000 Fred G. Osterwisch 7,000 David S. Dilworth 3,500 All current executive officers as a group 5,000 All other employees as a group 24,975 All non-employee directors as a group 0 FEDERAL INCOME TAX CONSEQUENCES Under the Code as now in effect, at the time an ISO is granted or exercised, the optionee will not be deemed to receive any income and DEI will not be entitled to any deduction. However, the difference between the exercise price and the fair market value of the shares of DEI Common Stock on the date of exercise is a tax preference item, which may subject the optionee to the alternative minimum tax in the year of exercise. The holder of an ISO generally will be accorded capital gain or loss treatment on the disposition of DEI Common Stock acquired by exercise of an ISO, provided the disposition occurs more than two years after the date of grant and more than one year after exercise. An optionee who disposes of shares acquired upon exercise of an ISO prior to the expiration of the foregoing holding periods realizes ordinary income upon the disposition equal to the difference between the exercise price and the lesser of the fair market value of the shares on the date of exercise or the disposition price. To the extent ordinary income is recognized by the optionee, DEI may deduct a corresponding amount as compensation expense. Payment of the exercise price by surrendering shares of DEI Common Stock generally will not result in the recognition of a capital gain or loss on the shares surrendered. Upon the exercise of a nonqualified stock option, an optionee will recognize ordinary income equal to the difference between the exercise price and the fair market value of the DEI Common Stock acquired at the time of exercise and DEI will receive a corresponding deduction. Payment of the exercise price by surrendering shares of DEI Common Stock generally will not result in the recognition of a capital gain or loss on the shares surrendered. When the optionee disposes of the shares acquired by the exercise of the option, any difference from the fair market value of the shares on the date of exercise will be treated as capital gain or loss. DEI may withhold from an optionee's salary or other compensation (or to secure payment from the optionee in lieu of withholding) all or any portion of any withholding or other tax due with respect to any shares of DEI Common Stock deliverable under such optionee's option or the Committee may permit payment of such withholding by DEI's retention of shares of DEI Common Stock which would otherwise be transferred to the optionee upon exercise of the option. In the event any DEI Common Stock is retained by DEI to satisfy all or any part of the withholding, the part of the withholding deemed to have been satisfied by such DEI Common Stock will be equal to the fair market value of the shares of DEI Common Stock retained by DEI. 50 56 A participant who receives a restricted stock or performance share award realizes ordinary income equal to the fair market value of the DEI Common Stock on the date the restrictions lapse or the date of receipt, respectively, and, upon withholding for income and employment taxes, DEI will receive a compensation tax deduction equal to the ordinary income realized by the participant. INFORMATION ABOUT DEI BUSINESS GENERAL DEI, which was incorporated in Michigan in August 1968 and reincorporated in Delaware in January 1969, manufactures products for, and performs development projects in, the field broadly described as "remote sensing." Remote sensing is the detection or measurement of various physical parameters of an object or system without making direct contact with the observed object. DEI's customers use these remote sensing products to detect and measure either the emitted or reflected radiation of objects or systems. DEI is also developing a remote sensing service operation that would utilize DEI's technology to acquire and process remote sensing data for users of such data. See "Information About DEI -- Business -- Growth Plan." PRODUCTS The principal products manufactured by DEI are airborne imaging systems. DEI's customers install these systems in aircraft and use them to acquire optical radiation data from objects on the earth's surface and in the atmosphere. This data is then processed into a useful form by data handling and data processing equipment which, in some cases, is also manufactured by DEI. A principal application of DEI's remote sensing products has been the measurement of environmental parameters in support of pollution control programs and environmental impact studies. DEI manufactures these products by integrating precision optical, mechanical and electronic components into unified systems. These components are either purchased off the shelf, or custom designed by DEI and manufactured by DEI, or designed and specified by DEI for outside manufacture. Highly technical personnel, supported by supervisors and engineers, assemble, test and calibrate these systems in preparation for delivery to customers. DEI engages in customer-funded projects for the development of advanced equipment in the remote sensing field. In addition to being a source of revenue, DEI undertakes these projects to increase its technical expertise in areas demonstrating strong potential for use in future products. Some of these projects may lead to the incorporation of newly developed technology into the existing product line or an expansion of the product line. One type of customer-funded project in which DEI is actively involved is the Small Business Innovation Research ("SBIR") program, a U. S. Government program designed to provide increased opportunities for small businesses to participate in federal research and development. The SBIR program's specific objectives are to stimulate U.S. technological innovations, use small businesses to meet federal research and development needs and increase private sector commercialization of innovations derived from federal research and development. The contractor is entitled to retain ownership of any technologies developed as a result of the program. The size and scope of SBIR projects typically fall into one of three categories. Phase I contracts provide an opportunity to establish the feasibility and technical merit of a proposed innovation. Phase I contracts are selected competitively, last for six months and typically have values up to $100,000. Phase II contracts involve a major research and development effort and are awarded only to firms conducting the most promising Phase I research project based on its scientific and technical merit, expected value to the government agency and commercial potential and the firm's capability. Phase II contracts generally last for a period of 24 months and typically have values up to $750,000. Phase III of an SBIR project is the 51 57 commercial sale and marketing of a product and does not receive U. S. Government funding (unless the U. S. Government is the customer). During fiscal 1997, DEI shared costs on two SBIR programs. One of these programs, Large Format Multispectral Camera, was completed in February 1998. The other, Laser Search and Rescue, has been expanded with completion now scheduled for early fiscal 1999. DEI has applied for a patent related to the Laser Search and Rescue technology developed under the SBIR program, which application was recently approved and is expected to result in the issuance of a patent. DEI is conducting marketing efforts and actively seeking partners for participation in Phase III commercialization efforts for these two programs. None of DEI's revenue during the last three fiscal years is attributable to patented technologies. Therefore, the loss of patent protection, if obtained in the future, does not constitute a material risk to DEI. Revenue from standard remote sensing systems and customer-funded product development systems during the three most recent fiscal years ended July 31 was approximately as follows: FISCAL STANDARD CUSTOMER-FUNDED PRODUCT YEAR SYSTEMS DEVELOPMENT SYSTEMS TOTAL ------ -------- ----------------------- ----- (in thousands) 1997 $2,200 $ 788 $2,988 1996 1,657 430 2,087 1995 2,340 1,278 3,618 MARKETING Marketing activities are conducted principally through DEI's office in Ann Arbor, Michigan, primarily through direct customer contact. DEI markets its products through direct sales and leases with a purchase option. In addition to direct marketing of its standard systems, DEI is engaged in seeking customer-funded product development projects for advanced equipment. See "Information About DEI -- Business -- Growth Plan" for a description of expected changes in DEI's marketing strategy as it implements its growth plan. Products are marketed to government customers in the United States and Canada by DEI's sales force which consists of three persons, one of whom is an officer who carries on other duties in addition to sales efforts, and a commissioned representative who handles commercial customers. DEI has no active international subsidiaries or branch offices. In several countries, DEI has exclusive sales agency agreements with existing high technology marketing operations. These agents' efforts are supported by DEI's own sales personnel, who also travel to other countries where there is no formal representation. CUSTOMERS DEI's customers include aerospace, aerial survey, oil and mineral exploration companies, universities and domestic and foreign federal and state government agencies. DEI's ability to continue to contract with such parties is dependent on political, economic and social factors. Revenue from international markets are sometimes subject to receiving approved U.S. government export licenses. A substantial portion of revenue in both domestic and international markets is generated by customers who depend, at least in part, upon federal, state or local government appropriations. Many of these customers are involved in programs aimed at improving man's impact on the environment. See "Information About DEI -- Business -- Growth Plan" for a description of DEI's efforts to diversify its customer base. The following table sets forth information with respect to domestic and international revenue during the three most recent fiscal years ended July 31: 52 58
FISCAL INTERNATIONAL DOMESTIC --------------------------------------------- ---------------------------------------- YEAR ASIA EUROPE OTHER(1) U.S. GOV'T. OTHER TOTAL - ---- ---- ------ -------- ----------- ----- ----- (in thousands) 1997 $1,178 $ 154 $0 $1,625 $31 $2,988 1996 562 814 0 618 93 2,087 1995 43 2,255 8 1,228 84 3,618
(1) Revenue from geographic areas that amount to less than 10% of total revenue are shown as "Other." Contracts with U.S. Government agencies generally provide that the contracts may be terminated at the convenience of the customer, and that the U. S. Government agency will be liable only for work performed up to the date of termination. Certain of DEI's U.S. Government revenues are derived from contracts which are subject to bidding procedures. From time to time, DEI is requested to bid on work to upgrade an existing DEI system owned by the U.S. Government. These procurements are generally sole source non-competitive bids or DEI is the only bidder. International revenue normally consists largely of standard products, while domestic revenue is largely customer-funded product development. The standard product and customer-funded product development portions of the business are conducted by the same pool of personnel using the same operating space and equipment and constitute a single industry segment. For further information regarding DEI's revenue by geographic area and operations, see the table included under the caption "DEI Selected Consolidated Financial Data" and Note J to DEI's Consolidated Financial Statements. To protect against foreign currency transaction losses, international sales are generally contracted in U.S. dollars and many large contracts are secured by irrevocable letters of credit. DEI also generally receives substantial deposits on large orders from international customers. A majority of DEI's revenue each year is derived from a small number of high dollar value equipment sales and contracts to a relatively small number of customers. Because each customer may represent a substantial portion of total revenue for that fiscal year, a small increase or decrease in the number of customers with whom DEI has contracts could generate a relatively large percentage increase or decrease in total revenue. Revenue during a particular fiscal year may result, in substantial part, from contracts with a single customer. Revenue from U.S. Government agencies accounted for approximately 54%, 30% and 34% of revenue for fiscal 1997, 1996 and 1995, respectively. Asian customers are an important source of revenue for DEI, generating 38% and 29% of operating revenue for fiscal years ended July 31, 1997 and 1996. Italian customers were an important source of revenue for DEI in fiscal 1995 (28%), but no significant orders were received in fiscal 1997 or fiscal 1996 as the Italian market for DEI's current products is near saturation. In fiscal 1997, 1996 and 1995, DEI had three, four and three major customers, respectively, each accounting for at least 10% of DEI's revenue from operations. Such major customers accounted for approximately 91%, 81% and 91% of DEI's revenue from operations in fiscal 1997, 1996 and 1995, respectively. See Note J to DEI's Consolidated Financial Statements. No single customer has generated a majority of DEI's revenue during any consecutive years during this period. Management does not consider DEI's business to be dependent upon a single customer or group of customers. PRODUCT DEVELOPMENT DEI is in an industry characterized by technological change, which requires continuous expenditure of funds for research, development and product improvement. DEI currently intends to use, whenever possible, external contract funds and licensing agreements to expand its product line and minimize internal research and development costs. DEI has incurred research and development expense of approximately $102,000, $469,000 and $586,000 for fiscal 1997, 1996 and 1995, respectively. In fiscal 1997, 1996 and 1995 DEI expended approximately $661,000, 53 59 $395,000 and $839,000, respectively, in performing customer-funded product development under contracts for advanced equipment in the field of remote sensing. DEI has five employees whose primary responsibility is product development and five employees who, in addition to their primary production, manufacturing and administrative duties, also contribute to the product development effort. RAW MATERIALS DEI's operations require a variety of unique precision optical-mechanical and electronic components and other supplies. Although most components and supplies are generally available from many commercial sources, certain components, which are designed and specified to meet DEI's particular requirements, have a limited number of manufacturing sources. Due to the specialized nature of these components and the limited quantities in which they are purchased, procurement lead times may be as long as six months. However, DEI believes that the loss of a single supplier would not be expected to have a material adverse effect on DEI. COMPETITION There are several competitors that compete with individual products produced by DEI. During the past few years, one of these competitors has begun offering to build products that compete with more of DEI's standard remote sensing systems. To date, DEI has not been materially affected by this direct competition. DEI expects an increase in the number of competitors as governments worldwide continue to reduce military spending since many companies selling similar instruments for military purposes are now beginning to pursue non-military customers. In addition, DEI's products compete with related technologies, such as satellite remote sensing systems. In general, the superior spectral and spatial resolution and scheduling flexibility of DEI's products enable DEI to compete effectively with suppliers of satellite-based data when the capabilities of DEI's products justify the generally more costly airborne data. DEI has been able to compete successfully against its competitors through the demonstrated performance of its products and its product support mechanisms, and through the excellent reputation it has earned and maintained for the durability of its products. DEI also competes on the basis of its continuous efforts to offer product improvements and new products that keep its technology at the leading edge and offer customers the latest innovations. Management believes that DEI competes successfully in the field of product development due to DEI's special capabilities in remote sensing technology and its history of successful completion of such development products. See "Information About DEI -- Business -- Growth Plan" for a description of expected changes in competition as DEI implements its growth plan. BACKLOG At the end of the second quarter of fiscal 1998, backlog of unfilled customer orders was approximately $467,000 compared to approximately $1,691,000 at the end of the comparable period in fiscal 1997. See "Information About DEI - -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- New Orders and Backlog." GROWTH PLAN DEI is in the process of implementing a growth plan that is focused on two initiatives to provide growth in revenues and profits from new market areas. The goal of the growth plan is to diversify DEI's revenue-producing activities and reduce fluctuations in DEI's revenue and earnings. Management has focused its efforts on two areas of the plan with the most near-term potential. 54 60 The first growth area involves the use and sale of airborne digital cameras ("ADC") developed by DEI for the mapping of infrastructure within narrow corridors. Examples of the types of infrastructure that would be mapped with such a system include gas pipelines, electrical distribution systems, railroads and highways. DEI has developed an enhanced version of the ADC and an image processing system that can be bundled with the ADC for delivery to its customers and for use by DEI in performing services for customers. DEI completed three contracts in fiscal 1996 for which it has utilized the ADC, and in the fourth quarter of fiscal 1996, DEI entered into a marketing alliance with a major company which provides infrastructure maintenance services to the electric and gas utilities, and railroads in the United States and Canada. Although DEI did not receive any such contracts in fiscal 1997, marketing efforts by DEI and its marketing partner have generated considerable interest from attendees at presentations made across the United States in the data produced by the ADC, which DEI hopes will generate orders in fiscal 1998. DEI has also been requested to team with several engineering companies to provide airborne digital camera services for a large multi-year inventory program that would establish a foothold in this emerging market. DEI is continuing to pursue various alternatives to obtain the additional funding necessary to bring these services to market. However, there can be no assurance that such funding will be obtained. See "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Sources of Capital." DEI has entered into strategic and marketing alliances with various companies and has signed formal agreements with two of these. DEI signed a licensing agreement with the James W. Sewall Company (ASewall") in 1994. This agreement gives DEI access to the technology for a prototype airborne digital camera owned by Sewall. DEI is required to pay Sewall a royalty of 3% of the net selling price for each digital camera sold until the total of royalty payments reaches $50,000. DEI does not expect to produce any more digital cameras of this type or to pay any royalty payments to Sewall in the future. DEI has also entered into a Strategic Alliance Agreement with ERIM International, Inc. ("ERIM") in 1997, which obligates each party to continue evelopment of specific technological improvements to the Airborne Multispectral Digital Camera ("AMDC") prototype product. Each party retains title to and commercial rights to the technologies developed by that party. The agreement defines a basis to share revenues from the sale of complete AMDC systems by either party. DEI is also a party to a Cooperative Development and Service Agreement with ERIM which calls for the production of a complete AMDC system which will be used to perform commercial service contract activities for third parties. Under the terms of this agreement, ERIM will fund the production of an AMDC with ownership of the system shared between DEI and ERIM. ERIM will market and develop products and services that use the AMDC. Each party will continue the development of the AMDC product on a mutually agreed upon basis. The other growth area involves performing domestic environmental surveys to provide a better applications market for DEI's airborne multispectral scanners. In order to exploit this market, DEI must perform specific applications and show the results to be reliable and cost-effective. To date, DEI has completed several contracts in this area for customers such as the U.S. Environmental Protection Agency and the U. S. Bureau of Reclamation, and continues to pursue other demonstration projects. In addition, DEI has completed development of an airborne digital multispectral camera for NASA under a SBIR project and has negotiated a strategic alliance to bring this product to the commercial market in the spring of 1998. Competition in these new areas of business will be different than that faced by DEI in its core business and competitors will be more numerous since there are many more companies offering products and services in each of these areas of new business. Competition will include conventional aerial survey firms using film cameras and commercial remote sensing satellite data. The commercial remote sensing satellite competitors are in the formative stage and will not have products to offer until two to three years in the future. DEI believes, however, that its capabilities in providing the source of unique data using its airborne digital camera and Multispectral scanners for each of these market areas, coupled with its strategy to team with selected partners in processing and analyzing such data, will provide the opportunity to secure significant new business and will enable DEI to compete successfully in each of these market areas. 55 61 These growth plan initiatives will require changes in DEI's sales and marketing strategies and budgets. The marketing alliance for the infrastructure information service calls for DEI's partner to perform most marketing and sales functions. However, DEI will provide brochures, data samples, and other support to its partner. In addition, it is anticipated that this market will require more participation in trade shows and more space advertising than DEI has engaged in during previous years. The customers for these new products and services will also be different than those involved in DEI's core product business. It is expected that these customers are unfamiliar with DEI. However, they are familiar with the services provided by DEI's marketing alliance partner and this is one of the primary strategies to accelerate access to these markets. Although implementation of the growth plan began in fiscal 1995, material revenue impact is not expected until late fiscal 1998 at the earliest. These strategies are intended to reduce fluctuations in DEI's revenue and earnings and enhance DEI's profitability and stockholder value. However, DEI's implementation of these growth initiatives has been slowed by the small size of DEI's staff, by its current financial position and by the lack of solid market information caused by DEI's limited resources. DEI is seeking partners and additional financing to help bring these services into the market more quickly. See "Information About DEI -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Sources of Capital." PERSONNEL As of January 31, 1998, DEI had 15 full-time employees, three of whom were executive officers. EXECUTIVE OFFICERS OF DEI The executive officers of DEI (who serve as such at the pleasure of the Board of Directors), their ages and the position or office held by each are as follows: Name Age Positions with DEI - ---- --- ------------------ Thomas R. Ory 58 President and Chief Executive Officer and Director Charles G. Stanich 53 Vice President-Research and Development and Chief Operating Officer and Director Jane E. Barrett 46 Vice President-Finance, Treasurer and Chief Financial Officer Mr. Ory, who was appointed President and Chief Executive Officer in August 1987, joined DEI in 1972 as Director of its Applications Division, served as Vice President-Marketing from 1979 to 1984, and Executive Vice President from 1985 to 1987. Mr. Stanich, who was appointed Chief Operating Officer in 1987, joined DEI in 1974 and served as Manager, Research and Development from 1979 to 1984, and Vice President-Research and Development since 1984. Ms. Barrett, who was appointed Vice President-Finance and Chief Financial Officer in March 1997 and who was appointed Treasurer in August 1996, joined DEI in May 1996 as its Controller. Prior to joining DEI, Ms. Barrett was employed by Federal-Mogul Corporation, a Fortune 500 manufacturer and distributor of automotive parts, from 1984 to 1996 in various managerial accounting positions. Her most recent position was International Accounting Manager with responsibility for the financial functions of a $600 million international division. 56 62 PROPERTIES The Company's office is located in Ann Arbor, Michigan. The office and research facility is situated on approximately 11 acres of property. The building encompasses 24,000 square feet, of which approximately 17,500 square feet are devoted to engineering, manufacturing, testing and research and development; and 3,800 square feet are devoted to marketing and administrative activities. This facility, which is owned by DEI, is subject to a mortgage. DEI is attempting to sell its building and lease back a portion of the facility from the new owner. If DEI must relocate, management is confident that a suitable facility can be found and that DEI's business will not be materially disrupted. MARKET PRICE AND DIVIDEND INFORMATION DEI Common Stock is traded over the counter. The following table sets forth the quarterly range of high and low bid prices for the common stock and dividends declared on the common stock since July 31, 1995. Prices shown are as reported by National Quotation Bureau, Incorporated. Such quotations reflect inter-dealer prices without retail mark-up, mark-down or commission and may not represent actual transactions. QUARTER ENDED
OCT. 31 JAN. 31 APR. 30 JULY 31 OCT. 31 JAN. 31 APR. 30 JULY 31 OCT. 31 JAN. 31 1995 1996 1996 1996 1996 1997 1997 1997 1997 1998 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- High $2 3/4 $2 3/4 $2 1/4 $2 1/4 $2 1/4 $2 $2 3/8 $2 5/8 $2 7/8 $3 1/8 Low 2 1 1/2 1 9/16 1 1/2 1 5/8 1 5/8 1 7/8 2 1/8 2 5/8 2 7/8
As of January 31, 1998, DEI's Common Stock was held by 172 holders of record. DEI has not paid any cash dividends during the last two fiscal years. The payment of future dividends will depend on the operating performance of DEI, its prospects, its operating cash requirements and the consent of its principal bank lender. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL DEI manufactures products for, and performs development projects in, the field broadly described as "remote sensing." The principal products manufactured by DEI are airborne imaging systems which are installed in aircraft for acquisition of data on environmental parameters. A principal application of DEI's remote sensing products has been the measurement of environmental parameters in support of pollution control programs and environmental impact studies. DEI is also engaged in customer-funded projects for the development of advanced equipment in the remote sensing field. Some of these projects may lead to the incorporation of newly developed technology into existing or future product lines. These two portions of the business are conducted by the same pool of personnel using the same equipment and operating space and constitute a single industry segment. The margins associated with these two portions of the business are different, with standard products generally having higher margins than customer-funded development projects. DEI receives the majority of its revenue from a small number of relatively large contracts. Standard product contracts are generally of higher dollar value than customer-funded product development contracts, with each contract representing 57 63 a substantial portion of total revenue each year. Therefore, the timing of the receipt of a standard product sales contract as well as the related manufacturing endeavor can have a material impact on a quarter-to-quarter or year-to-year comparison of DEI's results of operations. Most standard product sales contracts and some customer-funded product development contracts are also accompanied by a significant deposit. Therefore, the timing of the contract receipt can have a material impact on DEI's cash flow. DEI incurred a loss in each of the periods presented. These losses have caused DEI to experience severe liquidity problems and its bank line of credit is being utilized to maintain operations. DEI's short-term viability and operating results are dependent on its ability to acquire additional equity capital or increase the level of new business and cash flow. The consummation of the Merger will make available a significant amount of additional equity capital. DEI's long-term viability is dependent upon its ability to successfully implement its Growth Plan or otherwise attain consistent profitability. See "Information About DEI -- Business -- Growth Plan." MERGER Consummation of the Merger is expected to dramatically increase DEI's consolidated revenues and expenses and improve its profitability. However, the obligations of DEI and STR to consummate the Merger are subject to the satisfaction of certain conditions, including obtaining the approval of the STR stockholders of the Merger Agreement and the approval of the DEI stockholders of the Charter Amendment. See "The Merger Agreement -- Conditions to Consummation of the Merger." There can be no assurance that the Merger will be consummated or that DEI will be profitable if the Merger is consummated. If the Merger is not consummated, DEI will continue to pursue additional equity financing through discussions with potential investors possessing related technological and/or marketing capabilities and will continue to attempt to sell its building and lease back a portion of the facility from the new owner. Pending the sale of the building or the receipt of additional equity financing, DEI will continue to operate supported by its line of credit, but the lending bank has indicated that it may limit the amount which DEI is permitted to borrow under the line of credit in the absence of continued improvement in DEI's business prospects or progress toward the acquisition of a significant amount of equity capital. See "-- Liquidity and Capital Resources". If the Merger is not consummated and DEI is unable to borrow amounts necessary to fund its operations, its financial position would be materially and adversely affected and DEI may have no choice but to cease operations if other sources of capital are not available. Forward-looking statements in the following discussion and analysis refer to DEI without regard to the effects of the Merger, unless otherwise indicated. RESULTS OF OPERATIONS Operating Revenue
STANDARD PRODUCT TOTAL PRODUCT DEVELOPMENT OPERATING REVENUE REVENUE REVENUE ---------------- ---------------- ---------- % OF % OF (dollars in thousands) $ TOTAL $ TOTAL $ ----- ------ ----- ----- ----- SIX MONTHS ENDED JANUARY 31, 1998 $ 666 80% $ 169 20% $ 835 1997 1,017 68 488 32 1,505 FISCAL YEAR - ----------- 1997 $2,200 74% $ 788 26% $2,988 1996 1,657 79 430 21 2,087 1995 2,340 65 1,278 35 3,618
58 64 Standard product revenue and product development revenue for the six month period ended January 31, 1998 decreased from the comparable period of fiscal 1997 due to the low level of backlog at the beginning of fiscal 1998 and the low level of bookings received during the period. Standard product revenue during fiscal 1997 was higher than fiscal 1996 due to the revenue recognized on a significant standard product order received at the beginning of fiscal 1997. The decrease in standard product revenue in fiscal 1996 compared to fiscal 1995 was attributable to reduced backlog at the beginning of fiscal 1996 and the low number of new contracts received in fiscal 1996. Product development revenue was higher in fiscal 1997 compared to fiscal 1996 due to the recognition of revenue on two product development contracts received in late fiscal 1996. The decrease in product development revenue in fiscal 1996 compared to fiscal 1995 was attributable to the low level of product development backlog at the beginning of fiscal 1996 and delays in the receipt of new product development contracts until late in the fiscal year. The decline in customer-funded product development revenue was largely due to the delay by the U.S. Congress in approving its fiscal 1996 budget resulting in a delay in awarding Small Business Innovation Research contracts and in DEI's recognition of revenue from such contracts. The level of DEI's revenues and profits has historically fluctuated from quarter-to-quarter and from year-to-year as the majority of its revenue is derived from a small number of high dollar value contracts. Although fluctuations are normal, given DEI's reliance on a small number of high value contracts for the majority of its revenue, the low level of standard product orders received in the last several years has caused severe liquidity problems. Domestic vs. International Revenue
INTERNATIONAL DOMESTIC TOTAL OPERATING OPERATING OPERATING REVENUE REVENUE REVENUE -------------- ---------------- ---------- % OF % OF $ TOTAL $ TOTAL $ ----- ----- ----- ------- ----- (dollars in thousands) SIX MONTHS ENDED JANUARY 31, 1998 $ 159 19% $ 676 81% $ 835 1997 782 52 723 48 1,505 FISCAL YEAR 1997 $1,332 45% $1,656 55% $2,988 1996 1,376 66 711 34 2,087 1995 2,306 64 1,312 36 3,618
International revenue represented 19% and 52% of operating revenue during the first half of fiscal 1998 and 1997, respectively. International revenue decreased primarily due to DEI's low level of international backlog at the beginning of fiscal 1998 and the low level of bookings received during the period. The increase in domestic operating revenue during the first quarter of fiscal 1998 from the same period in fiscal 1997 is due to DEI's recognition of revenue on several domestic contracts that were in backlog at the beginning of fiscal 1998. International operating revenue remained relatively constant during fiscal 1997 compared to fiscal 1996. The increase in domestic operating revenue during fiscal 1997 compared to fiscal 1996 was due to the revenue earned on the NASA contract received in the second quarter of fiscal 1997 and the recognition of revenue on the two domestic product development contracts received in late 1996. The decrease in international operating revenue during fiscal 1996 and 1997 compared to fiscal 1995 was primarily due to DEI's receipt of contracts with a lesser value during fiscal 1996 and 1997 than the relatively large contract orders received in fiscal 1995 and, to a lesser extent, to the low international backlog as of the beginning of fiscal 1996 and 1997. The decrease in domestic operating revenue during fiscal 1996 compared to fiscal 1995 was due to the delay by the U.S. Congress in approving its fiscal 1996 budget resulting in a 59 65 delay in awarding Small Business Innovation Research contracts and in DEI's recognition of revenue from such contracts. Management expects a significant portion of DEI's revenue to be generated from the international market in fiscal 1998 and future years. To mitigate foreign currency transaction losses, international contracts are denominated in U.S. dollars and large standard product contracts are generally secured by irrevocable letters of credit. DEI also receives substantial deposits on many large contracts with international customers. Other Income Other income, for the periods presented, is comprised principally of rental fees for equipment. The level of such income is dependent on the requirement for equipment owned by DEI. DEI does not expect significant other income for fiscal 1998. Major Customers
(dollars in thousands) FISCAL YEAR ENDED JULY 31, --------------------------------- CUSTOMER DESCRIPTION 1997 1996 1995 - --------------------- ---- ----- ------ Asian standard product customer $1,144 $562 European standard product customer 436 $1,152 European standard product customer 186 917 European product development customer 90 U.S. government agencies 1,625 618 1,228
The customers to whom DEI sells change from year-to-year. No single customer has generated a majority of DEI's revenue during any consecutive years during this period. Revenue from U.S. government agencies accounted for approximately 54%, 30% and 34% of revenue for fiscal 1997, 1996 and 1995, respectively. Asian customers are an important source of revenue for DEI, generating 38% and 29% of operating revenue for fiscal years ended July 31, 1997 and 1996, respectively. Italian customers were an important source of revenue for DEI in fiscal year 1995 (28%), but no significant orders were received in fiscal 1997 and fiscal 1996 as the Italian market for DEI's current products is near saturation. New Orders and Backlog In the six months ended January 31, 1998, DEI received orders in the amount of approximately $650,000 as compared to approximately $2,185,000 in the comparable period of fiscal 1997. DEI's backlog at the end of the second quarter of fiscal 1998 was approximately $467,000, compared to approximately $1,691,000 at the end of the comparable period in fiscal 1997. Approximately $399,000 of the January 31, 1998 backlog is for standard products with the balance being related to customer service orders and the two Phase II Small Business Innovation Research (product development) contracts. In fiscal 1997, DEI received orders in the amount of approximately $2,629,000 as compared to approximately $2,517,000 in fiscal 1996. Approximately $2,459,000 of the bookings received by DEI in fiscal 1997 were for standard products, with the remainder for product development orders. DEI's backlog at the end of fiscal 1997 was approximately $652,000, compared to approximately $1,014,000 at the end of fiscal 1996. Approximately $369,000 of the fiscal 1997 backlog is for standard products, with the majority of the balance being related to the two Phase II Small Business Innovation Research (product development) contracts awarded during fiscal 1996. The Company has also been selected for the award of two Phase I Small Business Innovation Research contracts in the third quarter of fiscal 1998 for $140,000 and the Company is negotiating an extension to an existing NASA contract for a value of approximately $100,000. 60 66 DEI is engaged in negotiations for several standard products orders. The negotiations for these orders have not been finalized and there can be no assurance that these orders will be received. DEI has some high value components in inventory that will enable DEI to immediately recognize revenue upon receiving one of these standard product orders. The results of operations for future periods are dependent upon the receipt and timing of future orders, the success of management's growth strategy and the completion of the Merger. One of the large standard product contracts that DEI has pursued for more than three years was not awarded to DEI due to final price concessions and contract terms requested by the customer to which DEI could not agree. A second large international standard product program has encountered export licensing problems which now seem to threaten the viability of the program. The current economic crisis in several Asian countries has delayed several programs that DEI expected to be awarded in late 1997 or early 1998. DEI has received new orders at a level below that required for DEI to be profitable in the last several fiscal years. Therefore, DEI's ability to retain its line of credit and continue operations depends upon the receipt of additional significant orders during fiscal 1998. Management is hopeful that such orders will be received although no assurances can be given. The results of operations for future periods are dependent upon the receipt and timing of future orders and the success of management's growth strategy. Cost of Revenue The following table sets forth, for the six months ended January 31, 1998 and 1997 and for the three most recent fiscal years, cost of standard product revenue as a percentage of standard product revenue, cost of product development revenue as a percentage of product development revenue and cost of operating revenue as a percentage of operating revenue.
AS A PERCENTAGE OF ------------------------------------------------ STANDARD PRODUCT OPERATING PRODUCT DEVELOPMENT REVENUE -------- ----------- ------- FOR THE SIX MONTHS ENDED JANUARY 31, 1998 71% 129% 82% 1997 50 89 63 FISCAL YEAR 1997 61% 80% 66% 1996 63 92 69 1995 50 66 56
In the first half of fiscal 1998, cost of revenue increased as a percentage of revenue compared to the same period in fiscal 1997 due primarily to higher cost standard product revenue contracts in fiscal 1998 and also due to higher than anticipated costs on the two Small Business Innovative Research programs. In fiscal 1997, cost of standard product revenue, cost of product development revenue and overall cost of revenue decreased as a percentage of related revenue compared to the previous fiscal year due primarily to economies of scale resulting from the higher revenues in fiscal 1997 and more efficient operations with a reduced work force. In fiscal 1996, cost of standard product revenue and cost of product development revenue increased as a percentage of related revenue compared to the previous fiscal year due primarily to DEI operating significantly below its capacity during the fiscal year, causing overhead rates to increase substantially. Contributing to the high cost of 61 67 revenue in fiscal 1996 were increases in DEI's provision for obsolete and excess inventory caused by the reappraisal of excess inventory due to the recent low level of contracts received for standard products. The cost of revenue percentage for fiscal 1998 will be dependent upon the timing and mix of future contracts. Research and Development % OF (dollars in thousands) COST REVENUE ---- ------- SIX MONTHS ENDED JANUARY 31, 1998 $29 3% 1997 73 5 FISCAL YEAR 1997 $102 3% 1996 469 22 1995 586 16 Research and development expense declined in the first half of fiscal 1998 as compared to the same period one year earlier primarily due to Airborne Digital Camera enhancements in the comparable period of fiscal 1997. Research and development in fiscal 1997 decreased from the comparable period in the prior year primarily since the majority of the ADC enhancements were completed in fiscal 1996. Contributing to the fiscal 1997 research and development expense were costs associated with the improvement of DEI's current products and other areas of research. The majority of DEI's investment in research and development in fiscal 1996 was related to enhancements to the ADC developed in fiscal 1995. DEI also shared costs in a number of customer funded product development projects during fiscal 1997, 1996 and 1995 but did so to a lesser extent in fiscal 1997 and fiscal 1996 than in the preceding years. See Note G of Notes to DEI's Consolidated Financial Statements. Management's goal is to maintain research and development expense in the near future at approximately the current levels, and then in the long-term have research and development expense average approximately 5% of revenue so as to continually improve its existing product line and develop new products that are consistent with management's growth plan. Management realizes that from time to time it may be required to invest more than 5% of revenues into research and development to develop the products and services that DEI will require to meet its customers' needs and to establish steady growth in its level of operations and profits. Selling and Administrative Expense % OF COST REVENUE (dollars in thousands) ---- ------- SIX MONTHS ENDED JANUARY 31, 1998 $413 49% 1997 477 32 FISCAL YEAR 1997 $ 932 32% 1996 947 45 1995 1,473 41 Selling and administrative expense decreased in the first half of fiscal 1998 compared to the same period in fiscal 1997, primarily due to agent commissions paid in the comparable period of fiscal 1997. 62 68 Selling and administrative expense in absolute terms decreased slightly in fiscal 1997 compared to fiscal 1996, due primarily to DEI's third quarter staffing reductions which were offset by DEI's increased commissions on international sales. The selling and administrative expense decreased as a percentage of revenue due to the higher sales volume in fiscal 1997. Selling and administrative expense in absolute terms decreased in fiscal 1996 compared to fiscal 1995, primarily due to DEI's 1996 third quarter staffing reductions and also due to nonrecurring marketing research expenses which were incurred in fiscal 1995. The selling and administrative expense increased as a percentage of revenue due to the lower sales volume in fiscal 1996. Interest Interest expense decreased in the first half of fiscal 1998 compared to the same period in fiscal 1997 due principally to DEI's reduced borrowings. Interest expense decreased over the last three fiscal years due principally to DEI's reduced borrowings. Interest expense for fiscal 1998 will be dependent upon future interest rates and the extent to which DEI utilizes its line of credit during the year. Provision (Credit) for Income Taxes The credit for income taxes in fiscal 1997 results primarily from a prior year refund related to a foreign sales corporation. DEI's recognition of income tax benefit was again limited in fiscal 1997 due to the uncertainty of realizing the net operating loss carry forward. See Note E of Notes to DEI's Consolidated Financial Statements. The provision for income taxes in fiscal 1996 results from the increase in the valuation allowance for deferred taxes. Such increase is attributable to the effect of the taxable losses during the three most recent fiscal years on DEI's liquidity and the resulting uncertainty of realizing the net operating loss carryforward. The fiscal 1996 provision reverses a portion of the income tax benefit recognized in the fiscal 1995 provision. LIQUIDITY AND SOURCES OF CAPITAL DEI's primary sources of liquidity are funds from operations and borrowings under a line of credit secured by substantially all of DEI's assets including real estate. DEI's line of credit provides for borrowings of up to $1,550,000 with availability subject to a formula, bearing interest at one and one-half percent above the lending bank's prime rate. The formula permits borrowing up to $950,000 based on the value of the real estate, with the remaining available borrowings based on 50% of the value of certain receivables specified in the line of credit agreement. As of January 31, 1998, DEI had an outstanding balance of $490,000 under the line of credit, an additional $59,000 reserved for a standby letter of credit and additional borrowing availability of $401,000. DEI's mortgage indebtedness requires DEI to make monthly payments of $3,685 for both principal and interest and to make a balloon payment on November 1, 2000. The mortgage bears interest at one and one-half percent over prime. DEI has classified its total mortgage liability as current as the mortgage agreement is cross-collateralized and cross-defaulted with the line of credit which is a secured master demand note. See Note D of Notes to DEI's Consolidated Financial Statements. In the event the lending bank believes that the prospect of payment of DEI's indebtedness under the line of credit is impaired, the lending bank is permitted under the agreement governing the line of credit to declare such indebtedness due and payable. The lending bank has indicated that it may limit the amount which DEI is permitted to borrow under the line of credit in the absence of continued improvement in DEI's business prospects or progress toward the acquisition of a significant amount of equity capital. If DEI is unable to borrow amounts necessary to fund its operations, its financial position would be materially and adversely affected and DEI may have no choice but to cease operations if other sources of capital are not available. Moreover, DEI must increase its backlog during fiscal 1998 in order to generate sufficient cash flow to sustain its operations. 63 69 In order to provide additional working capital and retire current debt, DEI is attempting to sell its building and lease back a portion of the facility from the new owner. There can be no assurance that the building can be sold at a price acceptable to DEI or that an acceptable lease-back agreement can be negotiated. If DEI must relocate, management is confident that a suitable facility can be found and that DEI's business will not be materially disrupted. The sale of the building is expected to result in the termination of the existing line of credit. Management believes that a new line of credit supported by receivables and other assets of DEI can be negotiated with the current bank lender or a substitute bank which will be adequate to support DEI's working capital needs provided that DEI's backlog increases significantly over the current level. DEI also can negotiate a line of credit secured by the irrevocable letters of credit received on large orders from international customers. However, any new line of credit is likely to permit substantially less borrowing than the current line of credit. There can be no assurance that DEI will be able to acquire a replacement line of credit at all or that the level of borrowing permitted under any replacement line of credit will be adequate for DEI's working capital needs. DEI has entered into the Merger Agreement which, if consummated, management believes will provide DEI with additional equity capital and related technological and marketing capabilities and will have a positive effect on DEI's short and long term liquidity. The closing of the Merger is subject to the satisfaction or waiver of certain conditions contained therein. As a result, there can be no assurance that the Merger will be consummated. See "The Merger and Related Matters" and "The Merger Agreement." Working capital decreased to a deficit of $88,000 at January 31, 1998 from a surplus of $268,000 at July 31, 1997 due primarily to the decreased revenue and earnings for the first half. Working capital increased at July 31, 1997 from approximately $213,000 at July 31, 1996, due primarily to the utilization of inventory parts in stock for orders received in fiscal 1997. Funds from billed receivable collections and from customer deposits were used for payments on the line of credit. Cash used by operating activities was $392,000 during the first half of fiscal 1998 as compared to cash provided of $556,000 in the first half of fiscal 1997, due primarily to the $211,000 increase in accounts receivable and the $152,000 reduction in accounts payable and accrued expenses. Current liabilities decreased in fiscal 1997 largely due to the payment of the line of credit. Cash flow from operating activities was approximately $899,000 during fiscal 1997, primarily due to the approximately $537,000 reduction in accounts receivable. DEI expects continued investment during the remainder of fiscal 1998 for capital expenditures, primarily for equipment and software relating to the DEI's growth plan. Due to its current financial position, DEI intends to reduce internal research and development and to keep marketing and other administrative costs to a minimum until its financial condition improves significantly. The foregoing discussion and analysis contains a number of "forward-looking statements," as that term is used in the Exchange Act, with respect to DEI's expectations for future periods. Such statements are subject to various risks and uncertainties, which are described in the foregoing discussion and analysis and in "Risk Factors." YEAR 2000 DEI is unable to assess whether the Year 2000 computing problems will have a material impact on its business operations since it is still in the process of investigating the problem with outside consultants. ELECTION OF DEI DIRECTORS NOMINEES Five directors, constituting the entire Board of Directors of DEI, will be elected at the DEI Annual Meeting, each to hold office until the next annual meeting of DEI stockholders or until his successor is elected and qualified. The 64 70 individuals nominated by management for election to the DEI Board of Directors at the DEI Annual Meeting are listed in the following table. Each of the nominees is presently a director and has served as a director since first elected as such. THE PERSONS NAMED IN THE ACCOMPANYING FORM OF PROXY WILL VOTE FOR THE ELECTION OF THE NOMINEES UNLESS DEI STOCKHOLDERS SPECIFY OTHERWISE IN THEIR PROXIES. If any nominee at the time of election is unable to serve, or otherwise is unavailable for election, and if other nominees are designated, the persons named in such proxy will have discretionary authority to vote or refrain from voting in accordance with their judgment on such other nominees. If any nominees are substituted by the Board, the persons named in the accompanying form of proxy intend to vote for such nominees. Management of DEI is not aware of the existence of any circumstance which would render the nominees named hereunder unavailable for election.
YEAR FIRST ELECTED OR APPOINTED NAME AGE POSITIONS WITH THE COMPANY DIRECTOR - ------------------------------------------------------------------------------------------------------ John D. Sanders 59 Director and Chairman of the Board 1982 Thomas R. Ory 58 President and Chief Executive Officer and Director 1987 William S. Panschar 40 Director 1989 Philip H. Power 59 Director 1985 Charles G. Stanich 53 Vice President-Research and Development, Chief 1989 Operating Officer and Director
Dr. Sanders serves as a business consultant to emerging technology companies. He was Chairman and Chief Executive Officer of Tech News, Inc., a news publisher, from 1988 to 1996, prior to its sale to The Washington Post Company. In addition, Dr. Sanders has been a Registered Representative of Wachtel & Co., Inc., a Washington D.C.-based stock brokerage firm, since 1968. Dr. Sanders serves on the boards of Hadron Inc., ITC Learning Corp. and STR. Mr. Ory, who was appointed President and Chief Executive Officer of DEI in August 1987, joined DEI in 1972 as Director of its Applications Division, served as Vice President-Marketing from 1979 to 1984, and as Executive Vice President from 1985 to 1987. Mr. Panschar is an insurance agent at The Equitable Life Assurance Society of the United States, a life insurance and annuity company, and a registered representative at EQ Financial Consultants, Inc., a company which sells mutual funds and other various products, since June 1996. Prior to that he was a Vice-President of National City Bank, Indiana from October 1993 to May 1996. Prior to taking the position at National City Bank, Mr. Panschar was the Director-Corporate Development of The Alquin Group from 1991 to October 1993. Prior to joining The Alquin Group, Mr. Panschar was employed by Avis Enterprises, Inc. as Vice President-Mergers and Acquisitions from 1987 to 1990 and by Citicorp Industrial Credit Inc. from 1981 to 1987. Mr. Power has served as Chairman of Hometown Communication Network, Livonia, Michigan (formerly known as Suburban Communications Corp.), for more than 20 years. Mr. Power currently serves on the board of Jacobson Stores Inc. Mr. Stanich, who was appointed Chief Operating Officer in 1987, joined DEI in 1974 and served as Manager, Research and Development from 1979 to 1984, and Vice President-Research and Development since 1984. 65 71 CHANGES AND APPOINTMENTS TO DEI'S BOARD OF DIRECTORS AND EXECUTIVE OFFICERS DEI's Board of Directors currently consists of five members. If the Merger is not consummated, the five nominees elected at the DEI Annual Meeting will serve as DEI's Board of Directors until DEI's next annual stockholders meeting. If the Merger is consummated, the number of directors on the Board of Directors of DEI will increase to seven and Messrs. Panschar and Stanich will resign. The following four individuals, each of whom is currently a director of STR, will be appointed by the DEI Board of Directors in accordance with DEI's Bylaws to fill the four vacancies: S. R. Perrino, S. Kent Rockwell, James Busey and Charles Bernard. See "Information about STR -- Management" for a description of the background of these individuals. If the Merger is consummated, it is expected that the new Board of Directors of DEI will appoint a new slate of executive officers which combines the management of DEI and STR. The following table sets forth the slate of executive officers expected to be appointed in such event. See "Information about DEI -- Executive Officers of DEI" and "Information about STR -- Management" for a description of the background of these individuals.
NAME EXPECTED POSITION AFTER MERGER CURRENT POSITION - ---- ------------------------------ ---------------- S. R. Perrino Chief Executive Officer and President Chief Executive Officer and President of STR Robert Bower Chief Financial Officer and Treasurer Senior Vice President-Finance/CFO of STR Donald Reiser Senior Vice President Senior Vice-President of STR Thomas Ory Vice-President and President of Chief Executive Officer of DEI Sensing and Imaging Division
MEETINGS AND COMMITTEES OF THE BOARD The Board of Directors of DEI has a standing Audit Committee and a Executive Compensation/Stock Option Committee. During fiscal 1997, the DEI Board met a total of four times. The Audit Committee and the Executive Compensation/Stock Option Committee each met once in fiscal 1997. Each director attended at least 75% of the meetings of the Board and the committees of which he is a member during fiscal 1997. The members of the Audit Committee are Messrs. Panschar, Power, and Sanders. Generally, the Audit Committee selects the independent auditors, reviews with the independent auditor the scope and results of the auditing engagement and any non-audit services to be performed by the independent auditors, examines the scope and results of DEI's procedures and the adequacy of its system of internal accounting and financial controls, and evaluates the independence of the independent auditors and their fees for services. The members of the Executive Compensation/Stock Option Committee are Messrs. Power and Sanders. The Executive Compensation/Stock Option Committee reviews the performance of and recommends salaries and other compensation arrangements for officers of DEI, develops bonus, pension and other compensation plans for consideration by the DEI Board of Directors and performs such functions as may be delegated to it under the provisions of any bonus, stock option, pension or other compensation plan adopted by DEI. 66 72 COMPENSATION OF EXECUTIVE OFFICERS SUMMARY COMPENSATION TABLE The following table provides a summary of compensation paid or accrued by DEI and its subsidiaries during fiscal 1997, 1996 and 1995 to or on behalf of DEI's Chief Executive Officer and Chief Operating Officer (the "DEI Named Officers"). None of DEI's other executive officers earned more than $100,000 in salary and bonus during fiscal 1997 for services rendered to DEI and its subsidiaries.
LONG-TERM COMPENSATION ------------ ANNUAL SECURITIES NAME AND PRINCIPAL FISCAL COMPENSATION UNDERLYING ALL OTHER POSITION YEAR SALARY OPTIONS/SARS COMPENSATION (1) -------- ---- ------ ------------ ----------------- Thomas R. Ory 1997 $148,000 20,000 $25,865 President and CEO 1996 $148,000 -0- $26,501 1995 $148,000 -0- $28,824 Charles G. Stanich 1997 $130,000 20,000 $24,653 Vice President-Research 1996 $130,000 -0- $25,406 and Development 1995 $130,000 -0- $26,439
(1) Detail of amounts reported in the "All Other Compensation" column is provided in the table below.
DIRECTOR MEDICAL REIMBURSE- IMPUTED INTEREST ON PENSION PLAN OFFICER'S NAME FEES MENT & RELATED TAX INTEREST-FREE LOAN CONTRIBUTION -------------- ---------- ------------------- ------------------ ------------ Thomas R. Ory $4,800 $2,630 $50 $18,385 Charles G. Stanich $4,500 $4,125 $0 $16,028
OPTIONS The following table sets forth information concerning stock option grants during fiscal 1997 to the DEI Named Officers. Such options were not granted pursuant to any of DEI's plans.
OPTION/SAR GRANTS IN LAST FISCAL YEAR INDIVIDUAL GRANTS ----------------------------------------------------- NUMBER OF PERCENT OF SECURITIES TOTAL UNDERLYING OPTIONS/SARS OPTIONS/SARS GRANTED TO EXERCISE GRANTED EMPLOYEES IN PRICE EXPIRATION NAME (#) (a) FISCAL YEAR ($/SHARE) DATE ---- ------- ----------- --------- ---------- T. Ory 20,000 35.2% $2.25 12/10/06 C. Stanich 20,000 35.2% $2.25 12/10/06
(a) 50% of the options became exercisable immediately upon grant and the remainder become exercisable on the first anniversary of the grant date. 67 73 The following table provides information concerning unexercised stock options held as of the end of fiscal 1997 by the DEI Named Officers. There were no options exercised by the DEI Named Officers during fiscal year 1997. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION/SAR VALUES
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED IN-THE-MONEY OPTIONS/SARS AT OPTIONS/SARS AT FISCAL YEAR-END FISCAL YEAR-END --------------------------- ------------------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE(a) UNEXERCISABLE ---- ----------- ------------- -------------- -------------- T. Ory 25,000 10,000 $10,000 -0- C. Stanich 23,000 10,000 $11,500 -0-
(a) The value of unexercised in-the-money options was calculated using the last sale price of DEI's Common Stock at July 31, 1997. TERMINATION OF EMPLOYMENT Each of the DEI Named Officers is a party to a Senior Officer Severance Agreement that would require DEI to pay each such officer an amount equal to one and one-half times each officer's highest annual W-2 compensation from DEI during the three calendar years immediately preceding each officer's termination of employment if such termination of employment meets one of several criteria. In general, such amounts would be payable upon termination in anticipation of, or after, a change in control or upon resignation following a reduction in such officer's salary or other compensation, any diminution of the officer's authority or duties or a significant change in the nature and scope of the officer's duties, any change in the officer's status or title (other than a bona fide promotion) or any required relocation of the officer's residence should any event occur after a change in control or within six months prior to a change in control. The officer would also be entitled to continuation of coverage under DEI benefit plans for up to 18 months and to outplacement services. The cash payment required under the agreement may be paid in a lump sum or in monthly installments over an 18 month period, depending upon the circumstances of the change in control. These agreements will be terminated and replaced with the employment agreements signed in connection with the Merger Agreement if the Merger is consummated. See "The Employment Agreements." COMPENSATION OF DIRECTORS Directors receive $900 per quarter with an additional payment of $300 for each Board or Committee meeting attended, and are reimbursed for travel expenses incurred in connection with their attendance at Board and Committee meetings. In addition, Dr. Sanders received payments of $1,500 per month for consulting services from DEI from January 1997 through December 1997. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Exchange Act requires DEI's officers and directors, and persons who own more than 10% of a registered class of DEI's equity securities, to file reports of ownership and changes in ownership with the Commission. Officers and directors and greater than 10% shareholders are required by Commission regulation to furnish DEI with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it since August 1, 1996, or written representations from certain reporting persons that no Forms 5 were required for those persons, DEI believes that all Section 16(a) filing requirements applicable to its officers, directors, and greater than 10% beneficial owners were complied with. PRINCIPAL STOCKHOLDERS OF DEI AND SECURITY OWNERSHIP OF DEI MANAGEMENT The following table sets forth certain information with respect to the beneficial ownership of shares of DEI Common Stock, as of January 31, 1998, by each person who is known by DEI to have been the beneficial owner of 5% 68 74 or more of the shares of DEI Common Stock outstanding as of such date, by each director, director-nominee, officer named in the table under "Election of Directors -- Compensation of Executive Officers -- Summary Compensation Table" and by all directors and executive officers as a group. The table also sets forth such information assuming the Merger were consummated on such date. Unless otherwise noted, each stockholder exercises sole voting and investment power with respect to the shares beneficially owned.
NAME OF NUMBER OF PERCENT OF NUMBER OF SHARES PERCENT OF BENEFICIAL OWNER SHARES(1) CLASS(2) FOLLOWING THE MERGER(1) CLASS(2) - ----------------------- --------- ---------- ----------------------- ---------- Thomas R. Ory 66,230(3) 11.6 66,230 1.7 Charles G. Stanich 47,226(4) 8.4 47,226 1.2 John D. Sanders 28,500(5) 5.3 69,460(7) 1.7 William S. Panschar 2,760 * 2,760 * Philip H. Power 15,150 2.8 25,470(8) * All directors and executive officers as a group (6 persons) 165,616(6) 27.1 216,896(9) 5.3
* Less than one percent. (1) The column sets forth shares of DEI Common Stock which are deemed to be "beneficially owned" by the persons named in the table under Rule 13d-3 of the Commission, including shares of DEI Common Stock that may be acquired upon the exercise of stock options or warrants that are currently exercisable or become exercisable within 60 days after January 31, 1998 as follows: Mr. Ory -- 35,000 shares; Mr. Stanich -- 30,000 shares; Messrs. Sanders, Power and Panschar -- 2,250 shares each; and all directors and executive officers as a group -- 76,750 shares. (2) For purposes of calculating the percentage of DEI Common Stock beneficially owned, the shares issuable to such person upon exercise of stock options or warrants that are currently exercisable or become exercisable within the next 60 days are considered outstanding. (3) Includes 24,565 shares with respect to which Mr. Ory shares voting and investment power with his spouse. Mr. Ory's address is P.O. Box 1869, Ann Arbor, Michigan 48106. (4) Includes 3,526 and 2,700 shares with respect to which Mr. Stanich shares voting and investment power with his wife and mother, respectively. Mr. Stanich's address is P.O. Box 1869, Ann Arbor, Michigan 48106. (5) Includes 550 shares owned by Dr. Sanders' wife. Dr. Sanders' address is P.O. Box 7262, Arlington, Virginia 22207. (6) Includes the shares described in notes (1), (3), (4) and (5). (7) Dr. Sanders owns 5,876 shares of STR Common Stock which will convert into 15,160 shares of DEI Common Stock. In addition to the shares disclosed in note (1) which may be acquired upon exercise of stock options, Dr. Sanders will have an option to purchase an additional 25,800 shares following the Merger due to his ownership of a previously granted option to purchase 10,000 STR shares which will be converted at the Effective Time pursuant to the Merger Agreement. (8) Mr. Power owns 4,000 shares of STR Common Stock which will convert into 10,320 shares of DEI Common Stock. (9) Includes the shares described in notes (1), (3), (4), (5), (7) and (8). 69 75 INFORMATION ABOUT STR GENERAL DESCRIPTION OF BUSINESS STR was started in 1972 by its principal founder, S. R. Perrino. The initial focus of the business was to provide field service support to the United States Navy for electronic warfare equipment and the development of components for the missile industry. As STR's capability expanded into the development of microprocessor-based systems, the business base was expanded to support customers requiring state-of-the-art, cost-effective, innovative solutions. There is now a broad capability for the development of equipment from the audio spectrum through microwave frequencies, in addition to real time signal processing and the development of antennas and subsystems. PRODUCTS STR designs, develops, manufactures and markets intelligence sensory and electronic reconnaissance systems for defense and commercial markets. STR is a leader in high probability of intercept technology used to detect short duration radar signals in a crowded signal environment, which is of great importance in modern electronic warfare. It also performs studies and systems engineering contracts related to electronic reconnaissance and signal processing technology. STR's high probability of intercept systems are employed on military platforms such as ships, submarines, patrol aircraft, and ground installations for the interception, analysis and identification of radar signals. Communications reconnaissance systems are employed in aircraft and ground installations for the acquisition of communications signals of tactical military interest. STR's reconnaissance systems are sold to the U.S. Government, prime contractors and foreign governments. STR's studies and systems engineering activities are performed for agencies of the U.S. Government in support of the procurement of major surveillance and signal processing systems used by the intelligence community. A substantial number of STR's contracts require STR to have both facility and personnel clearances with the U.S. Government. Modern military operations have become substantially dependent upon the use of electromagnetic signals in such critical battlefield functions as target detection, weapons guidance, communications and intelligence. This has led, in turn, to the emergence of increasingly sophisticated and rapidly evolving electronic support measures ("ESM") and electronic countermeasures, which broadly define electronic warfare. For example, the reliance of most modern offensive weapons systems upon radar targeting and guidance has prompted the development of defensive reconnaissance systems which rapidly and reliably detect and identify hostile weapons and weapons platforms by means of their radar emissions. Interception and interpretation of potentially hostile communications signals has assumed similar importance in modern combat. In peacetime, electronic reconnaissance information is of great strategic value in assessing the strength and technical capabilities of potentially unfriendly forces. Reconnaissance of electromagnetic signals involves monitoring the signal environment to detect signals of tactical or strategic interest. The analysis of these signals permits the determination of such factors as the direction of arrival, the location and movement of the equipment emitting the signal, the identity of such equipment, and the type of platform on which it is located. Signal characteristics may reveal hostile intent; for example, if search radar signals are superseded by those of a high-pulse-rate fire control radar, it may mean that a missile has been launched. Communications signal reconnaissance provides important information to military commanders as to the types of weapons platforms in the area, the location of command centers, and data for targeting and directing weapons against specific threats. With the proliferation of sophisticated communications equipment throughout the world, the reconnaissance of both military communications signals and commercial communications signals has become increasingly important and difficult. The communications signal environment is characterized by the vast number of signals that are present both in peacetime and wartime, including signals from adversaries, from friendly forces and from commercial services such as radio, television and commercial communications. The profusion of signals competing for the same portion of the 70 76 electromagnetic spectrum creates a significant technical problem for communications reconnaissance equipment to sort potential enemy signals from the complex background. The problem is compounded by the increasing use of masking techniques such as frequency hopping, in which the frequency of the transmitter is rapidly varied; spectrum spreading, in which a narrow band signal may be spread over a large portion of the spectrum; and short duration transmission, which in a tactical setting might consist of nothing more than several brief clicks of a microphone switch. Modern commercial communication systems are available worldwide and can be obtained for a very small investment. These worldwide systems employ sophisticated encryption techniques in addition to complex digital transmission formats. Terrorists and others engaged in illegal activities are using commercial communications today for most of their operations. Virtually every country today has access to the sophisticated technology which can create these masked transmissions. STR has addressed these challenges through the development of sophisticated new receiver technology designed to create a high probability of signal acquisition and by use of advanced digital processing techniques and proprietary software to handle the vast amounts of complex data associated with communications reconnaissance. The technical requirements and performance characteristics of both radar and communications reconnaissance systems vary considerably depending upon the particular tactical or strategic applications involved. In a tactical combat situation, the velocity of modern weapons, the use of deceptive hardware and the reconnaissance of signals from potentially hostile forces or weapons systems require highly sensitive reception as well as accuracy of signal parameter measurement. STR has developed technologies for both tactical and strategic settings and a range of product designs capable of meeting the requirements of a variety of complex applications. RADAR THREAT WARNING SYSTEMS Radar is used by military forces for target detection, weapon guidance and navigation. It is also being used by terrorist groups and others engaged in illegal activities for navigation. Radar typically operates in the microwave portion of the electromagnetic spectrum at frequencies between 500 MHz and 40 GHz. A radar signal strikes a potential target and is reflected back to the transmitter where it can provide information as to the targets bearing, range, course, speed and in some cases, size. A radar threat warning system can intercept a transmitted radar signal which can be then analyzed for its intelligence value. Radar signals exhibit a variety of characteristics such as frequency, direction of arrival, pulse duration, pulse repetition frequency ("PRF"), and antenna rotation rate, all of which vary with the type of radar emitting the signal. Once these characteristics have been determined, they can be compared to parameters of radars known to be associated with specific platforms and identification of the emitter and its platform may also be possible. A typical radar threat warning system consists of a specialized antenna which is configured either to meet the platform or specific requirements of the user, receivers, signal processors, and display and interface equipment whose performance characteristics involve important trade-offs in system design. Antenna design is critical to the performance of a system. Antennas convert the incoming radar signals into electrical signals which the receiver can detect and pass through a signal processor. The specific antenna design will, in the majority of the cases, be directly applicable to the sensitivity of the system as well as to the accuracy of the direction of arrival of the intercepted signal. STR has the ability to design specific antennas to meet the applications and requirements of its customers. Receivers can be classified as either narrowband or broadband. A receiver which is designed to intercept a narrow portion of the frequency spectrum at any instant may be capable of detecting very weak signals in that portion of the spectrum at the expense of missing important signals in other portions of the spectrum. Conversely, a broadband receiver, though not as sensitive, can simultaneously monitor a large portion of the spectrum. STR is well known for its applications of one type of broadband receiver design called the Digital Frequency Measurement Receiver. This equipment has the capability of detecting and measuring the frequency of each incoming radar pulse over its entire operating band thus resulting in a high probability of interception. The advantages of this type of receiver include the 71 77 simultaneous surveillance of all radars in a broad spectrum, the ability to detect frequency hopping radars, and the assurance of intercepting a radar which transmits for only a short period of time. The signal processor, using the detected signal and deinterleaving all of the detailed parameters of that intercepted signal, manipulates the data to compare these parameters with known radars whose characteristics can be stored in a library or database. The signal processor can then make assessments as to the host platform for the radar emitting the signal, the potential threat to friendly forces and in some cases, the specific intentions of an enemy weapons system. The challenge is to process vast amounts of data from all directions over a broad frequency spectrum. In addition, signal parameters have become extremely complex, for example, in some cases parameters such as frequency and PRF that change from pulse to pulse can present increasingly difficult problems for analysis and storing. STR believes that as a result of major research and development efforts, particularly in advanced distributed microprocessor applications, it is at the forefront of signal processing technology in terms of its ability to rapidly handle complex environments of exotic signals. Display and interface equipment processes the data to the decision maker. The important function of this step is to present only the relevant information from the total signal environment but also allow all the detailed information to be available for later analysis. STR's experience and talent in understanding the operational use of reconnaissance data is essential in the proper design of display and interface equipment. Threat warning systems produced by STR typically sell from between $500,000 to $1,500,000 depending upon the system configuration and complexity. STR can configure its threat warning systems for small patrol boats as well as large aircraft carriers and has configured systems specifically for road vehicles. STR is presently investigating applications of its threat warning technology for airborne applications. STR frequently provides support in the forms of maintenance service and spare parts for its installed systems. These activities can continue for the life of a system and STR expects this aspect of its business to increase as the installed product base expands. COMMUNICATIONS RECONNAISSANCE SYSTEMS Today, both military and commercial communications systems have been designed to make maximum utilization of the assigned available bandwidth to ensure growth capacity both for new customers and the ability to provide added features. The communication transmission techniques are only limited by the imagination of the providers. State-of-the-art of digital technology allows the use of extremely sophisticated modulation techniques to improve performance while still reducing cost. Worldwide commercial communications systems are now becoming the systems of choice for terrorists and drug runners. Many third world countries are using commercial communications instead of developing special purpose military communication control centers. Almost all commercial communication systems are now employing sophisticated encryption for their transmissions. The ability to monitor the utilized spectrum and rapidly reuse frequencies as they become available are among the techniques employed to better utilize the existing bandwidth. Previously, most communications reconnaissance systems would scan the frequencies of interest, searching for signals of interest and when one was detected, would derive more detail information from the signal. These techniques are no longer available for modern communications systems. It is imperative to monitor the entire frequency bands of interest and be able to instantly determine the activity and also derive the information necessary to detect and analyze the signal. STR has been developing intercept technology which is both hardware and software based specifically aimed at the existing deployed global communications systems as well as emerging satellite and land based systems planned for future insertion into the marketplace. STR has been providing commercial communications intercept equipment which range in price from $175,000 to $2,000,000, depending upon the system and applications. STR has also been investing in broadband digital receiver technology and real time signal processing as a means to sort through the crowded environment to detect, identify and analyze the signals of interest. 72 78 RESEARCH AND DEVELOPMENT STR believes that continued success of STR depends, in a large part, on its ability to develop and apply new technology. Funding for these activities comes both from internally sponsored research and development as well is from customer funded contracts. Funded internal research and development over the past three years, exclusive of cost reimbursed from customers, is as follows:
YEAR ENDED SEPTEMBER 30, ----------------------------------- (in thousands) 1997 1996 1995 ---- ---- ---- Internal research and development $ 517 $ 817 $ 683 Customer funded research and development 6,318 6,352 4,491 ------ ------- ----- Total $6,835 $ 7,169 5,174 ====== ======= ======
Current funded programs include development of (1) a digital receiver, which is software controllable to respond to the new digital communications formats, (2) advanced signal processing techniques to perform radar signal sorting and analysis techniques for examination of exotic radar transmitters, (3) advanced digital processing techniques to perform demodulation and filtering of communications signals and (4) phase coherent synthesizer techniques for the generation of broad band signals. MARKETING AND CUSTOMERS Marketing of STR's products and services is conducted primarily by members of the technical staff assisted by a relatively small marketing staff located in Newington, Virginia who concentrate on developing an understanding of the customer's technical requirements and maintaining close contact with the customers. STR has opened an office in London, England, with an effort to concentrate marketing skills on the European marketplace. STR also utilizes sales representatives in various countries who work closely with STR's sales force. Export sales of the threat warning systems and commercial communication intercept systems must be approved by the U.S. Department of State which limits the markets for such products and may result in delay or possible cancellation of an order. Any tightening of restrictions on exports of military hardware could adversely affect STR's revenue from foreign customers. During the last fiscal year approximately 95% of STR's revenues were attributable to contracts with numerous offices and agencies of the U.S. Government. Most of these contracts were prime contracts. STR has a full mixture of contract types including cost plus, fixed fee, cost plus incentive fee, time and material and fixed price contracts with the U.S. Government. The fixed price contracts are not subject to adjustment by reason of costs incurred in the performance of the contract. With this type of contract STR assumes the risk that it will be able to perform at a cost below the fixed price except for costs incurred because of contract changes ordered by the customer. STR is subject to various statutes and regulations governing defense contracts, which carry substantial penalty provisions including denial of future contracts in the event STR is found to have abused any of these regulations. STR carefully monitors all of its contracts and contractual efforts to minimize the possibility of any abuses associated with its government contracts. STR has experienced minimal audit adjustments over the past ten years. The Defense Contract Audit Agency ("DCAA") has completed its audit of STR contracts through the fiscal year ended September 30, 1996. PATENTS STR holds one patent and has applied for three others. STR believes that the ownership of patents is not a significant factor in its business and that its success depends primarily on innovative skills, technical competence, and the ability to rapidly adapt to new and emerging requirements from its customers. None of STR's revenue during the last three fiscal years is attributable to patented technologies. Therefore, the loss of patent protection does not constitute a material risk to STR. STR has registered no trademarks. 73 79 COMPETITION There is substantial competition in both the domestic and foreign threat warning and communications intercept business. Competitors for U.S. Government contracts include companies such as Raytheon Company, Lockheed-Martin Corporation, Litton Industries, Inc., Condor Systems, Inc., and others. The size and reputation of these companies can give them a significant advantage in competing for contracts. STR competes in those market niches where it has typically both a technological and cost advantage. In the foreign market, a number of overseas companies are competitors, such as Racal Communications (UK), Electronica (Italy), Thompson-CFS and Dassault Electronique (France). These companies are larger and better known than STR and, in some cases, they have an advantage in their home countries. Nevertheless, STR believes it is one of the top five suppliers of threat warning systems to the U.S. Government and has an opportunity to compete favorably in the foreign marketplace. The principal competitive factors in the threat warning marketplace are technical performance, reliability, experience and installation as well as operation and price. Based on a combination of these factors, STR believes that it competes very favorably in its markets. STR's most important competitive attributes are its emphasis on technical superiority and a willingness and capability to modify its products to meet customer specific needs. Once a particular supplier's products have been selected for incorporation in a military electronic system, further competition by other vendors during the life cycle of the program is usually very limited. BACKLOG At December 31, 1997, STR had a funded backlog of $15,900,000 compared to a funded backlog of $15,000,000 at December 31, 1996. A significant part of STR's business is a short term effort which is typically transacted in a six to nine month period. Programs are many times funded in phases with the next phase not being funded until the prior phase is nearing completion. Multi-year funded contracts are generally related to multi-year production efforts. In addition, at December 31, 1997, STR has unfunded backlog of $6,000,000 and government options outstanding of $936,000, which it expects the U.S. Government to exercise and fund in accordance with the terms of the respective contracts. In addition, there are programs on which STR, based on prior experience, expects the U.S. Government to negotiate continuing contractual coverage. GOVERNMENT CONTRACTS STR does business with the U.S. Government through various types of prime government contracts including firm fixed price, cost plus fixed fee, cost plus incentive or award fee, time and material and others. Certain of the fixed price contracts have provisions which provide for progress payments. STR also has similar U.S. Government subcontracts. Many of the contracts require facility and personal security clearances which STR has the capability to provide. STR's contracts are obtained both by competitive bid and by sole source negotiation where STR's technological and administrative capabilities provide the basis for such an award. EMPLOYEES At December 31, 1997, STR employed 162 persons. Of these employees, 3 are executive officers, 6 are non-executive officers, 54 were engaged in engineering, 50 in technical support, 32 in administrative, and 17 in clerical. Many of STR's employees are highly skilled, with advanced degrees. STR's continued success depends upon its ability to continue to attract and retain highly skilled employees. STR has experienced very low turnover of its employees and key managers and executives. STR has never had a work stoppage, and none of its employees are represented by a labor organization. STR considers its employee relations to be good. 74 80 PROPERTIES STR's owned and leased facilities are suitable for their respective operations. Each facility is well maintained and capable of supporting higher levels of revenue. The table below sets forth certain information about STR's principal facilities.
ADDRESS SQUARE FEET OWNED OR LEASED DESCRIPTION PRINCIPAL ACTIVITY - ------- ----------- --------------- ----------- ------------------ 8419 Terminal Road 67,000 Leased Two 1-story and Engineering/ Newington, VA 22122 one partial Manufacturing/ 2-story adjacent Administration block. Building is in an industrial park 5440 Cherokee Avenue 15,000 Leased Partial occupancy Engineering Suite 200 of 2-story brick Alexandria, VA 22312 building. In an office park area 1259 Courthouse Road 1,500 Leased 2-story brick Software Suite 202 office condo development Stafford, VA 22554
STR's principal facility in Newington is equipped with equipment used for the design, development and manufacture of its products. Facilities include Sensitive Compartmented Information Facility ("ASCIF"), anechoic chamber, secure test areas, environmental equipment, antennas, as well as general purpose equipment required to manufacture and test its products. MARKET PRICE AND DIVIDEND INFORMATION As of January 31, 1998, STR had 47 stockholders of record and 193 beneficial holders of its shares. There is no established public trading market for the STR Common Stock. No dividends have been paid on STR Common Stock during the last two fiscal years. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OPERATING CYCLE In accordance with industry practice, STR classifies as current assets amounts relating to long-term contracts which may have terms extending beyond one year but are expected to be realized during the normal operating cycle of STR. The liabilities in the accompanying balance sheets which have been classified as current liabilities are those expected to be satisfied by the use of assets classified as current assets. At September 30, 1997, substantially all contracts will be completed within the next twelve months. Therefore, substantially all current assets and current liabilities are expected to be liquidated in the next twelve months. 75 81 RESULTS OF OPERATIONS Three Months Ended December 31, 1997 Compared to Three Months Ended December 31, 1996 The following table sets forth, for the periods indicated, the percentage relationship of certain items to total revenue for the periods indicated.
Three Months Ended December 31, ------------------------------- 1997 1996 ---- ---- $ % $ % --- --- ---- ------ (dollars in thousands) Revenue $5,837 100.0% $5,606 100.0% Costs of revenues 5,135 88.0 4,908 87.5 General and administrative expenses 710 12.2 651 11.6 Interest expense 103 1.8 74 1.3 ------ ----- ------ ----- Net income (loss) (69) (1.2) (18) (0.3)
Revenue for the three months ended December 31, 1997, was $5,837,376 compared to $5,606,100 for the three months ended December 31, 1996, resulting in a $231,276 or 4% increase. The increase was primarily due to increased performance under government contracts for the three months ended December 31, 1997 compared to the three months ended December 31, 1996. Cost of revenues increased $226,636 from $4,908,274 to $5,134,910, a 5% increase. Cost of revenues as a percent of sales increased from 87.5% to 88.0%. The change was the result of increased production activity and performance under government contracts, coupled with a change in the mix of contracts in process. General and administrative expenses increased from $651,297 to $710,076, a $58,779 or 9% increase. The increase was primarily the result of increased research and development activity in the first quarter of fiscal 1998. Interest expense of $74,461 for the three months ended December 31, 1996 increased 39% to $103,143 for the three months ended December 31, 1997 as additional working capital was required to support the continued growth. Interest as a percent of revenues increased from 1.3% to 1.8%. The income tax benefit increase was due to the increased loss and an effective rate change from 36% to 38%. Net income decreased from a loss of $17,932 to a loss of $68,753, with net income as a percentage of revenue decreasing from (0.3%) to (1.2%). 1997 Compared to 1996 The following table sets forth, for the periods indicated, the percentage relationship of certain items to total revenue for the periods indicated. 76 82
Year Ended September 30, ----------------------- 1997 1996 1995 ---- ---- ---- $ % $ % $ % ------- ------- ------- ------- ------- ---- (dollars in thousands) Revenue $23,953 100.0% $21,655 100.0% $16,562 100.0% Costs of revenues 20,762 86.7 18,607 85.9 13,733 82.9 General and administrative expenses 2,654 11.1 2,343 10.8 2,331 14.1 Interest expense 345 1.4 232 1.1 91 0.5 Income tax 72 0.3 145 0.7 90 0.5 Net income 120 0.5 327 1.5 317 1.9
Revenue increased by 10.6% to $23,953,070 in the fiscal year ended September 30, 1997, from $21,654,578 in the fiscal year ended September 30, 1996. The primary reason for such increase was due to $1.3 million of first time international sales and the award of a new manufacturing contract which accounted for an increase in revenue of $1.6 million. These revenue gains were offset by a $1.4 million decrease which STR sustained in its fiscal year ended September 30, 1997 under an ESM contract. Cost of revenues as a percentage of revenue increased by 0.8% to 86.7% in the fiscal year ended September 30, 1997 compared to 85.9% in the prior fiscal year, thereby reducing STR's gross profit margin to 13.3% from 14.1% in the prior year. The primary reason for this reduction in gross profit margin was the losses STR sustained in two contracts of approximately $200,000 each and losses sustained in starting up STR's international business. These losses were offset in part, however, by better than anticipated margins under an ESM contract. The decreased gross margin trend over the three year period is the result of contract losses on two international contracts with the government of Turkey, two loss contracts for palmtop computers and a $4.0 million production contract with a bid at a 10% gross margin. The loss on the international contracts was the result of underestimated costs as well as unplanned technical problems. The palmtop computer losses were the result of development costs exceeding the cost targets. Management expects that margins will improve as a result of the absence of these loss contracts and since the production contract with the low margin has been completed and similar contracts are not anticipated. For its fiscal year ended in 1997, STR's general and administrative expenses also increased by $311,194 to 11.1% of revenue compared to 10.8% of revenue in the prior fiscal year. This increase primarily resulted from the addition of management personnel and participation in two international trade shows. STR's interest expense also increased by $112,677 to $345,086 in the fiscal year ended September 30, 1997 from $232,409 in the prior fiscal year or to 1.4% of revenue in 1997 compared to 1.1% of revenue in 1996. This increase resulted primarily from several contracts undertaken on a shipped product basis with no progress payments, thereby resulting in STR having to increase its borrowings under its line of credit to obtain working capital. In addition, the declining revenue generated under a major contract from which prompt payment was historically made also caused STR to increase its reliance on its line of credit thereby increasing its interest expense. Notwithstanding the growth in revenue, because STR's cost of revenues, selling, general and administrative expenses and interest expense expressed as a percentage of revenue were increasing, STR's net income after taxes declined to $119,880 for the fiscal year ended September 30, 1997 compared to $326,655 in the prior year or by 63.3%. As a percentage of revenue for 1997, STR's net income percentage was 0.5% compared to 1.5% in the prior fiscal year. 77 83 1996 Compared to 1995 For the fiscal year ended September 30, 1995, STR generated $21,654,578 in revenue, a $5,092,738 increase or 31%, compared to $16,561,840 in the prior year. The increase principally resulted from increased activities under several contracts along with obtaining additional contracts. Costs of revenues as a percentage of revenue, however, increased by 3% from 82.9% in the fiscal year 1995 to 85.9% in fiscal 1996. In 1996, STR was able, until the end of the fiscal year, to avoid any material increase in its general and administrative expenses associated with the revenue increase. Therefore, as a percentage of revenue, these expenses decreased to 10.8% from 14.1%. The growth in revenue required an increase in working capital. STR primarily relied upon its line of credit for this purpose. Therefore, STR's interest expense increased by $141,703 from $90,706 in 1995 to $232,409 in 1996, or by 156.2%. For 1996, net income increased to $326,655 from $317,032 in the prior fiscal year. As a percentage of revenue, STR's net income in 1996 decreased to 1.5% from 1.9% in the prior year. In part, this reduction was caused by an increase in the effective tax rate STR incurred in 1996 compared to 1995. LIQUIDITY AND CAPITAL RESOURCES During the fiscal year ended September 30, 1997 and the quarter ended December 31, 1997, net cash used in operating activities was $906,620 and $252,969, respectively. This negative cash flow from operations was primarily due to an increase in accounts receivable resulting from a slow down in cash collections from customers as a result of a change in the mix of STR's contracts. STR has recently secured several international contracts and secured other contracts which do not provide for significant progress payments unlike STR's historical cost plus contracts. These contracts, coupled with STR's overall increase in contract volume and revenue growth, has negatively impacted cash flow. This increase in accounts receivable was offset by an increase in accounts payable as STR has negotiated extended credit terms with many of its vendors in order to generate the working capital required to operate STR's business. STR's growth has also required investments in test equipment and computer networks. Capital expenditures of $462,211 for the fiscal year ended September 30, 1997 exceeded depreciation expense of $359,679 by $102,532. Capital expenditures for fiscal 1998 are planned to exceed depreciation by a similar amount. STR has one significant expenditure planned for fiscal 1998 for improving the capability of the indoor antenna range in the approximate amount of $150,000. STR continues to rely on its line of credit as a means of providing working capital. During the fiscal year ended September 30, 1997 and the quarter ended December 31, 1997, net proceeds provided under the line of credit were $1,583,600 and $297,523, respectively. STR anticipates it will, from time to time, continue to rely upon its $4 million revolving bank line of credit for obtaining working capital. This line of credit is scheduled to remain in effect until June 30, 1998. STR intends to obtain a renewal or extension of the line of credit after this date. Interest is charged on advances made under this line at the bank's prime rate (8.5% as of January 31, 1998) plus 1.5%. Advances to STR under this credit facility are limited by an availability formula based upon accounts receivable. STR has the right to borrow up to 90% against government receivables, 80% against non-government receivables and 50% against unbilled governmental receivables up to a maximum of $700,000. These provisions permitted borrowings of up to $4.5 million at December 31, 1997 and STR had outstanding borrowings of $4.2 million under the line of credit on such date. STR's accounts receivable, inventory and equipment secure the STR lines of credit. STR also maintains a separate $750,000 line of credit for financing bid bonds. 78 84 The line of credit also contains various covenants relating to dividend restrictions, working capital, net worth, earnings and debt-to-equity ratios. STR was not in compliance with the net worth and the debt-to-equity covenants at September 30, 1997. In December 1997, the events of non-compliance were waived by the bank for September 30, 1997, and the covenants were amended. Management anticipates that it will be able to comply with these amended covenants through the term of the agreement. The growth in STR's revenues over the past three years coupled with modest levels of profits has caused STR to increase its reliance on its line of credit and negotiate expanded and extended credit terms with many of its vendors in order to generate the working capital required to operate STR's business. On January 30, 1998, STR completed a $3,783,000 private placement. The proceeds from this placement enabled STR to reduce its outstanding balance on its line of credit and accelerate its vendor payments. STR anticipates the capital raised from the private placement will reduce STR's interest expense and provide STR with more favorable pricing from its vendors. STR believes that its internally generated funds coupled with advances under its lines of credit will provide STR with sufficient working capital for the short term future inclusive of any reasonable levels of working capital which DEI requires for its business. STR may pursue additional or replacement financing over the long term. STR currently believes that such debt will be available at current market rates. After the consummation of the Merger, the companies anticipate an estimated pre-tax restructuring charge of approximately $1,000,000 ($620,000, net of taxes). The charge is expected to relate to costs associated with reengineering the combined companies' processes, policies and procedures. Costs are expected to be incurred for external consultants, for personnel terminations and for relocation and moving. Other costs are expected to be incurred to realign products, services and facilities around the combined companies' core businesses. It is anticipated that the restructuring will commence shortly after the Merger. YEAR 2000 STR's management and financial contract system utilizes software designed, developed and supported by Breuer and Company ("Breuer"). Breuer has informed STR that the system is not affected by the "Year 2000" problem. STR management anticipates that any costs incurred to remediate any "Year 2000" problem will not be material. NEW ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 129, "Disclosure of Information about Capital Structure," for fiscal years beginning after December 15, 1997. The provisions of SFAS No. 129 established standards for disclosing information about an entity's capital structure. STR believes that the adoption of this standard will not have a material effect on STR's current disclosure requirements. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," for fiscal years beginning after December 15, 1997. The provisions of SFAS No. 130 establish standards for reporting and display of comprehensive income and its components in the financial statements. This statement requires all items that are required to be recognized under accounting standards as components of comprehensive income be reported in the financial statements and displayed with the same prominence as other financial statements. The provisions of SFAS No. 131 establish standards for the way that enterprises report information about operating segments in annual financial statements and require that selected information about operating segments in interim financial statements be reported. It also establishes standards for related disclosure about products and services, geographic areas, and major customers. STR is currently reviewing these new standards of disclosure for adoption in 1999. 79 85 MANAGEMENT DIRECTORS The names, ages and positions of STR's directors and executive officers are as set forth below. Information set forth below concerning age, occupation(s) and other directorships has been furnished by the individuals named.
DIRECTOR NAME AGE PRINCIPAL OCCUPATION SINCE - ---- --- -------------------- ----- S. R. Perrino 63 Chairman, President & Chief Executive Officer 1972 S. Kent Rockwell 53 Vice Chairman 1987 Charles Bernard 66 Consultant 1992 Admiral James B. Busey, IV 65 Consultant 1993 John D. Sanders 59 Investor/Consultant 1996
S. R. Perrino has been Chairman of the Board and has served as President and CEO of STR since 1972. From 1967 to 1974, Mr. Perrino worked as a consultant to the U.S. Navy for threat warning systems, and to various companies including STR, Systems Dynamic, Inc., and System Consultants. From 1960 through 1967, Mr. Perrino served as Director of Marketing/Project Engineer and was one of the original founders of Radiation Systems, Inc. S. Kent Rockwell has been a director of STR since 1987. He is former Chairman of the Board, President and Chief Executive Officer of Astrotech International Corporation. He is currently a director of ITEQ, Inc. Mr. Rockwell is Chairman of Appalachian Timber Services, Inc., and Chairman and President of Rockwell Venture Capital, Inc. Charles Bernard, Ph.D., has been a director of STR since 1990. Prior to his retirement, Dr. Bernard served in a number of Government positions. He was Technical Director of the Naval Weapons Laboratory in Dahlgren, VA and the Naval Ordinance Laboratory in White Oak, MD. He was Director of Land Warfare on the staff of the Under Secretary of Defense for Research, Development and Acquisition. He founded the Columbia Bay Company and co-founded K&B Engineering Associates in 1995. In addition to serving on the STR board, Dr. Bernard has been on the board of directors of the Naval Weapons Laboratory, Naval Ordinance Laboratory, the Naval Surface Weapons Center, Columbia Bay Company, and K&B Engineering Associates. Admiral James B. Busey IV, USN (Ret.) has been a director of STR since 1992. Admiral Busey served in the U.S. Navy for 37 years in a variety of aviation and command positions. He held the position as Commander in Chief of U.S. Naval Forces in Europe, and Commander In Chief of Allied Forces in southern Europe for two years prior to his retirement in 1989. Admiral Busey served as Administrator of the Federal Aviation Administration from June 1989 until December 1991. He served as the Deputy Secretary of Transportation until June 1992. He also served as Acting Secretary for several months during this period. He served as the International President and CEO of the Armed Forces Communications and Electronics Association from October 1992 until April 1996. He continues to serve on the boards of the Flight Safety Foundation and the National Aeronautic Association in addition to several corporate boards, including Texas Instruments, Inc., Curtiss Wright Corporation, and The MITRE Corporation. John D. Sanders, Ph.D., has been a director of STR since 1996. He was previously a director of STR from 1987 to 1991. He serves as a business consultant to emerging technology companies. He was Chairman and Chief Executive Officer of Tech News, Inc., a news publisher, from 1988 to 1996, prior to its sale to the Washington Post Company. In addition, Dr. Sanders has been a Registered Representative of Wachtel & Co., Inc. a Washington D.C.-based stock brokerage firm, since 1968. Dr. Sanders serves on the boards of Hadron Inc., ITC Learning Corp. and DEI. 80 86 COMPENSATION OF DIRECTORS STR pays directors who are not full-time employees of STR $5,000 per year, and pays non-employee members $1,000 for each special meeting they attend. Each non-employee director has been granted a stock option for 10,000 shares in connection with his service on the Board. Mr. Rockwell and Mr. Busey have exercised their options. EXECUTIVE OFFICERS The following is a description of the officers of STR who are expected to be appointed as executive officers of DEI following the Merger.
EMPLOYEE NAME AGE PRINCIPAL OCCUPATION SINCE - ------------- --- -------------------- ------ S. R. Perrino 63 Chairman, President & Chief Executive Officer 1972 Robert R. Bower 61 Senior Vice President-Finance, CFO, Secretary 1985 Donald Reiser 71 Senior Vice President-Research and Development 1982
Mr. Perrino's background is described under "Information About STR -- Management -- Directors." Robert R. Bower currently serves as Senior Vice President-Finance and Chief Financial Officer. He has served in this capacity for STR since 1985. He has served as Corporate Secretary since 1989. Prior to joining STR, Mr. Bower served as Director of Financial Planning and Analysis at Fairchild Industries, Inc. from 1983 to 1985, and held several financial management positions at Rockwell International Corporation from 1962 to 1982. Donald Reiser currently serves as Senior Vice President of Research and Development. Mr. Reiser has served in a management capacity for STR since 1982. From 1964 to 1982, Mr. Reiser held various positions with the U.S. Central Intelligence Agency, including that of Deputy Director for the Office of Research and Development. He was the Vice President for Engineering for Aero Geo Astro Corporation from 1960 to 1964. From 1950 through 1960, he held various engineering position with E-Systems, Litton Industries and the ARMA Corporation. SUMMARY COMPENSATION TABLE The following table provides a summary of compensation paid or accrued by STR during fiscal 1997 to those executive officers of STR who are expected to serve as executive officers of DEI following the consummation of the Merger (the "STR Named Officers").
LONG-TERM COMPENSATION ------------ SECURITIES ANNUAL COMPENSATION UNDERLYING NAME AND PRINCIPAL FISCAL ------------------- OPTIONS/ ALL OTHER POSITION YEAR SALARY SARS COMPENSATION (1) -------- ---- ------ ---------- ---------------- S. R. Perrino President and CEO 1997 $179,267 -0- $7,273 Robert Bower Sr. Vice President 1997 $107,420 6,000 $4,953 Donald Reiser Sr. Vice President 1997 $134,194 -0- $8,159
81 87 (1) Detail of amounts reported in the "All Other Compensation" column is provided in the table below.
LIFE CONTRIBUTION TO ESOP OFFICER'S NAME INSURANCE COMPANY 401(K) ALLOCATION -------------- --------- -------------- ---------- S. R. Perrino $1,755 $3,000 $2,518 Robert Bower 786 2,508 1,659 Donald Reiser 3,023 3,000 2,136
OPTIONS The following table sets forth information concerning stock option grants in fiscal 1997 to the STR Named Officers. OPTION/SAR GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS -------------------------------------- NUMBER OF PERCENT OF SECURITIES TOTAL UNDERLYING OPTIONS/SARS OPTIONS/SARS GRANTED TO EXERCISE GRANTED EMPLOYEES IN PRICE EXPIRATION NAME (#) FISCAL YEAR ($/SHARE) DATE - ---- ----------------- -------------- --------- ---------- S. R. Perrino 0 0 0 0 Robert Bower 6,000(a) 75% $8.69 12/09/06 Donald Reiser 0 0 0 0
(a) Options vest at the rate of 20% on each of the first five anniversary dates of grant. After the Merger, the options will become exercisable for 15,480 shares of DEI Common Stock. The following table provides information concerning unexercised stock options held as of the end of fiscal 1997 by the STR Named Officers. There were no options granted to or exercised by the STR Named Officers during fiscal year 1997. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT FISCAL YEAR-END FISCAL YEAR-END ----------------------------------------------- ------------------------------------------ NAME EXERCISABLE UNEXERCISABLE EXERCISABLE(a) UNEXERCISABLE ---- ---------- ------------- ------------- ------------- S. Perrino 0 0 $0 $0 R. Bower 0 6,000 0 0 D. Reiser 0 0 0 0
(a) The value of unexercised in-the-money options was calculated using the most recent appraisal value of STR's Common Stock at September 30, 1997. 82 88 RELATED PARTY TRANSACTIONS STR's principal facilities in Newington, Virginia are leased from two partnerships in which STR's executive officers are partners. Approximately, 54,500 square feet of space is leased from Research Development Properties, a partnership in which S. R. Perrino, Donald Reiser, and Robert Bower, each hold a one-fourteenth interest. S. R. Perrino is also a fifty percent partner in Terminal Real Estate Company. This partnership leases approximately 12,500 square feet of space to STR. Both leases have been in place for several years, expire in December 1998 and carry a rental rate of $6.35 a square foot, on a triple net basis. STR believes that both leases described above are at fair and reasonable rates and in no event exceed the rates which would apply under leases between STR and totally unrelated lessors. The two partnerships have agreed, to sell the properties underlying the leases to unrelated purchasers. STR anticipates any such sales will as a condition require the renegotiation of the leases. STR is of the opinion that any such renegotiation will not have a material adverse effect on STR. PRINCIPAL STOCKHOLDERS OF STR AND SECURITY OWNERSHIP OF STR MANAGEMENT The following table sets forth certain information with respect to the beneficial ownership of shares of STR Common Stock, as of January 31, 1998, by each person who is known by STR to have been the beneficial owner of 5% or more of the shares of STR Common Stock outstanding as of such date, by each director, each STR Named Officer and by all directors and executive officers as a group. Unless otherwise noted, each stockholder exercises sole voting and investment power with respect to the shares beneficially owned.
NAME OF NUMBER OF PERCENT OF NUMBER OF DEI PERCENT OF BENEFICIAL OWNER SHARES(1) CLASS(2) SHARES AFTER MERGER(1) CLASS (2) - ------------------------- ------------ ---------- -------------------- -------- S. R. Perrino 314,980(3) 23.8 815,148 20.6 Donald Reiser 90,821(4) 6.9 234,318 5.9 Robert Bower 10,707(5) * 27,624 * S. Kent Rockwell 389,998 29.4 1,006,194 25.4 John D. Sanders 15,876(6) 1.2 69,460 1.8 Charles Bernard 10,000 * 25,800 * Admiral James Busey, IV 10,000 * 25,800 * All directors and executive officers as a group (7 persons) 850,420(7) 64.1 2,222,583(7) 56.2
* Less than one percent (1) The column sets forth shares of STR Common Stock which are deemed to be "beneficially owned" by the persons named in the table under Rule 13d-3 of the Commission, including shares of STR Common Stock that may be acquired upon the exercise of stock options or warrants that are currently exercisable or become exercisable within 60 days after January 31, 1998 as follows: Mr. Bower -- 1,200; Dr. Sanders -- 10,000; Mr. Bernard -- 10,000; and all directors and executive officers as a group -- 21,200. The options will be converted at the Effective Time into options to purchase the following numbers of shares of DEI Common Stock: Mr. Bower -- 3,096; Dr. Sanders -- 25,800; Mr. Bernard -- 25,800; and all directors and executive officers as a group -- 54,696. (2) For purposes of calculating the percentage of STR Common Stock beneficially owned, the shares issuable to such person upon exercise of stock options or warrants that are currently exercisable or become exercisable within the next 60 days are considered outstanding. 83 89 (3) Includes 26,104 shares in STR deferred compensation plans held for the benefit of Mr. Perrino for which he exercises voting control for certain corporate events. Mr. Perrino also holds 2,500 shares of DEI Common Stock. (4) Includes 15,199 shares in STR deferred compensation plans held for the benefit of Mr. Reiser for which he exercises voting control for certain corporate events. (5) Includes 7,507 shares in STR deferred compensation plans held for the benefit of Mr. Bower for which he exercises voting control for certain corporate events. (6) Dr. Sanders also owns 26,250 shares of DEI Common Stock and options to purchase an additional 3,000 shares, 2,250 of which are currently exercisable. (7) Includes the shares described in notes (1), (3), (4), (5) and (6). INFORMATION ABOUT MERGER SUB Merger Sub, a recently formed Virginia corporation, is a wholly owned subsidiary of DEI. Merger Sub was organized solely to effect the proposed Merger and has not engaged in any activities other than those relating to its formation and capitalization and the Merger. The principal office of Merger Sub is located at 300 Parkland Plaza, Ann Arbor, Michigan. DESCRIPTION OF DEI CAPITAL STOCK DEI CAPITAL STOCK The authorized capital stock of DEI presently consists of 2,000,000 shares of DEI Common Stock, par value $0.01 per share. All of the outstanding shares of DEI Common Stock are duly authorized, validly issued, fully paid and nonassessable. The shares of DEI Common Stock to be issued pursuant to the Merger will be, when issued, duly authorized, validly issued, fully paid and nonassessable. Holders of DEI Common Stock are entitled to such dividends as may be declared by the Board of Directors of DEI out of the assets legally available for that purpose and are entitled to one vote per share on all matters submitted to a vote of the stockholders of DEI. The holders of shares of DEI Common Stock do not have cumulative voting rights or preemptive rights. Therefore, the holders of more than 50% of the shares voting for the election of directors can elect all the directors, and the remaining holders will not be able to elect any directors. Shares of DEI Common Stock received by affiliates of STR may be resold by them only in transactions permitted under Rule 145 promulgated under the Securities Act. See "The Merger and Related Matters -- Federal Securities Law Consequences." LIMITATION OF DEI DIRECTOR LIABILITY As permitted by the DGCL, DEI's Certificate of Incorporation provides that directors of DEI shall not be personally liable to DEI or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to DEI or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under Section 174 of the DGCL, relating to prohibited dividends or distributions or the repurchase or redemption of stock; or (iv) for any transactions from which the director derives an improper personal benefit. 84 90 INDEMNIFICATION OF DIRECTORS AND OFFICERS OF DEI Section 145 of the DGCL sets forth the conditions and limitations governing the indemnification of officers, directors and other persons. DEI's Bylaws provide that DEI shall indemnify its directors and officers against all expense, liability and loss (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts to be paid in settlement) reasonably incurred or suffered by such person in connection with any pending, threatened or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that the director or officer is or was serving as a director or officer. Paragraph 42(a) of DEI's Bylaws state that the indemnification of its directors and officers shall be to the fullest extent authorized by the DGCL. Paragraph 42(e) of DEI's Bylaws also permit DEI to maintain insurance, at its expense, to protect itself and any director, officer, employee or agent of DEI or another corporation, partnership, joint venture, trust or other enterprise against any expense, liability or loss, whether or not DEI would have the power to indemnify such person against such expense, liability or loss under the DGCL. COMPARISON OF RIGHTS OF STR STOCKHOLDERS WITH RIGHTS OF DEI STOCKHOLDERS The following is a summary of the material differences between the rights of holders of DEI Common Stock and STR Common Stock. Because STR is organized under the VSCA and DEI is organized under the DGCL, these differences arise from various provisions of the corporate laws of such states as well as from various differences in the articles of incorporation and bylaws of STR and the certificate of incorporation and bylaws of DEI. The following summary contains all material information relative to such differences, but does not purport to be a complete statement of the rights of holders of shares of DEI Common Stock under the DGCL, DEI's certificate of incorporation and DEI's bylaws, or a comprehensive comparison with the rights of the holders of shares of STR Common Stock under the VSCA, STR's articles of incorporation, and STR's bylaws, or a complete description of the specific provisions referred to herein. The identification of specific differences is not meant to indicate that other significant differences do not exist. This summary is qualified in its entirety by reference to the governing law and the governing documents of each of DEI and STR. DEI and STR do not believe that any of the differences described below, individually or in the aggregate, constitute a material risk to the STR stockholders. DIVIDENDS Under the VSCA, a corporation's board of directors may declare distributions to shareholders if, after the distribution, the corporation can pay its debts as they generally become due or if the corporation's total assets exceed its total liabilities. Under the DGCL, a corporation's directors may declare and pay dividends either (i) out of surplus or (ii) if there is no surplus, out of net profits generated in the fiscal year in which the dividend is declared and/or the preceding fiscal year. Surplus generally means that part of the consideration received for shares of capital stock in excess of the aggregate par value of such shares. ANTI-TAKEOVER MEASURES Both the VSCA and the DGCL contain provisions which are intended to protect corporations organized thereunder from unwanted takeovers or control acquisitions. Under the VSCA, unless voting rights are granted by the shareholders to an acquiror in a "control share acquisition" (as defined under the VSCA), the acquiror does not receive voting rights for its shares. Only Virginia corporations which have more than 300 shareholders are subject to the provisions regarding control share acquisitions. If the shareholders of a Virginia corporation grant voting rights in a control share acquisition in which shares having a majority of votes are acquired, shareholders obtain dissenters rights and can demand fair value for their shares. STR is not currently subject to these provisions. The DGCL does not restrict control acquisitions of corporations organized under the DGCL. Instead, the DGCL restricts a corporation's right to engage in a business combination with any interested stockholder within a period 85 91 of three years from the date that such stockholder became an interested stockholder. In general, an interested stockholder is a stockholder who holds 15% or more of the outstanding voting stock of a Delaware corporation; provided, however, if such stockholder holds 85% of the outstanding stock, the prohibition against a business combination does not apply. The restriction on business combinations does not apply to corporations, such as DEI, which do not have a class of voting securities which is listed on a national securities exchange or an inter-dealer quotation system of a registered national securities association (such as the Nasdaq Stock Market) or held by more than 2,000 record holders. Following the Merger, DEI intends to apply for listing of the DEI Common Stock on the Nasdaq Stock Market's SmallCap Market. If such application is approved, DEI will become subject to the restriction on business combinations in the DGCL. DISSENTERS' APPRAISAL RIGHTS The VSCA and DGCL contain provisions entitling dissenting holders of shares of a corporation who comply with certain procedures to receive payment of the "fair value" of their shares in connection with certain transactions. Significant differences between the dissenters' appraisal rights provisions contained in the VSCA and those contained in the DGCL include the following: (i) dissenters' rights under the VSCA are available in connection with the disposition of all or substantially all of a corporation's property, while appraisal rights under the DGCL are not available with respect to dispositions of a corporation's assets unless the corporation's certificate of incorporation grants such rights (DEI's certificate of incorporation contains no such provision); (ii) the VSCA provides for dissenters' rights in the event of the consummation of a statutory share exchange (defined as an acquisition by a corporation of all of the outstanding shares of one or more classes or series of another corporation) where a corporation's shares are to be acquired and such corporation's shareholders are entitled to vote thereon, while the DGCL contains no provisions permitting statutory share exchanges; and (iii) the DGCL permits the exercise of appraisal rights only by stockholders of record of a corporation, while the VSCA allows the assertion of dissenters' rights by beneficial owners of shares with the consent of the holder of record of such shares. STOCKHOLDER ACTIONS Under the DGCL, special meetings of stockholders may be called by the board of directors or by any such persons authorized by a corporation's certificate of incorporation or bylaws. DEI's bylaws provide that a special meeting shall be called at the request of a majority of the shares of DEI Common Stock and may be called at any time by DEI's president. The VSCA provision is similar to that contained in the DGCL except that it specifies that either a corporation's president or its chairman of the board, in addition to its board of directors, may call a special meeting of stockholders. STR's bylaws provide that a special meeting shall be called at the request of the holders of 10% of the outstanding shares of STR Common Stock. Pursuant to Section 228 of the DGCL, any action required to be taken by the stockholders at any annual or special meeting of such stockholders, or any action which may be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action so taken, is signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and is delivered to the corporation by delivery to its registered office in Delaware, its principal place of business or an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Under the VSCA, stockholders may take action for which a stockholder vote is required by unanimous written consent. The consents must be delivered to the corporation's secretary. Any unanimous consent has the same effect as a unanimous vote. Pursuant to the DGCL, approval of holders of a majority of a corporation's shares is required for amendments to the corporation's certificate of incorporation and for certain other corporate transactions, such as mergers, consolidations and sales of assets. The VSCA provides that such actions may be taken only with the approval of holders 86 92 of more than two-thirds of a corporation's shares unless the corporation's articles of incorporation provide for a greater or less (but not less than a majority) vote and except that certain amendments to a corporation's articles of incorporation may be adopted without shareholder action, including changing each authorized issued and unissued share of an outstanding class into a greater number of whole shares if the corporation has only shares of that class outstanding. CONFLICT OF INTEREST TRANSACTIONS WITH DIRECTORS The DGCL and the VSCA contain provisions which shift to the holders of shares of a corporation the burden of proving that the directors have breached their fiduciary duty to the corporation by authorizing corporate transactions in which a director has an interest if the transaction is approved in a specified manner. The DGCL provides that no contract or transaction between one or more of its directors or officers or any organization in which any of them has a financial interest is void or voidable solely because the director or officer participates in the meeting of the board or committee at which the contract or transaction is authorized or solely because his votes are counted for such purpose if the contract or transaction is fair to the corporation or if the material facts as to his relationship or interest and as to the contract or transaction are disclosed or known (i) to the board of directors and the contract or transactions is authorized by a majority of the disinterested directors or (ii) to the stockholders and the contract or transaction is specifically approved by a vote of the stockholders. The VSCA provision is similar to that contained in the DGCL, except that the ability to void a transaction solely due to a director's interest may not be eliminated by a vote of a single disinterested director and any such elimination by a vote of shareholders must be approved by a majority of the disinterested shareholders, thus preventing the possibility that an interested director who is also a significant shareholder could cause shareholder approval of the transaction by voting his shares in favor thereof. INDEMNIFICATION The DGCL and the VSCA have similar provisions and limitations regarding indemnification by a corporation of its directors and officers, except that the VSCA does not permit indemnification in connection with any proceedings in which a director or officer was adjudged liable on the basis that personal benefit was improperly received by him. In addition, Delaware and Virginia corporations may provide broader indemnification than that set forth in the DGCL and the VSCA, respectively, except that Virginia corporations may not indemnify directors or officers against willful misconduct or a knowing violation of criminal law. LIABILITY OF DIRECTORS Both the DGCL and the VSCA authorize a corporation to include in its charter provisions limiting the liability of directors to the corporation or the holders of its shares. The VSCA also authorizes a corporation to include in its charter a provision limiting the liability of officers to the corporation or the holders of its shares. DEI has adopted provisions which eliminate the liability of directors to the full extent permitted under the DGCL. STR has not adopted any provisions limiting the liability of directors or officers to the company or its stockholders. The DGCL does not permit elimination of liability (i) for any breach of the director's duty of loyalty to DEI or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under Section 174 of the DGCL, relating to prohibited dividends or distributions or the repurchase or redemption of stock; or (iv) for any transactions from which the director derives an improper personal benefit. The VSCA does not permit elimination of liability for willful misconduct or a knowing violation of criminal law or of any federal or state securities law, including any claim of unlawful insider trading or manipulation of the market for any security. 87 93 LEGAL MATTERS The legality of the shares of DEI Common Stock to be issued in connection with the Merger will be passed upon for DEI by Dykema Gossett PLLC, Detroit, Michigan. EXPERTS The consolidated financial statements of DEI and its subsidiaries included in this Joint Proxy Statement/Prospectus as of July 31, 1997 and 1996 and for the three years ended July 31, 1995, 1996 and 1997 have been audited by Deloitte and Touche LLP, independent auditors, as stated in their report appearing herein (which report expresses an unqualified opinion and includes an explanatory paragraph referring to DEI's ability to continue as a going concern), and have been so included in reliance upon such report of such firm given upon their authority as experts in accounting and auditing. The financial statements of STR included herein as of September 30, 1997 and for the year ended September 30, 1997 have been audited by Coopers & Lybrand L.L.P., independent accountants, as set forth in their report thereon and included herein. Such financial statements are included herein in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. The consolidated financial statements of STR included herein as of September 30, 1995 and 1996 and for the years ended September 30, 1995 and 1996 have been audited by Ross, Langan & McKendree LLP, independent accountants, as set forth in their report thereon and included herein. Such financial statements are included herein in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. ACCOUNTANTS' REPRESENTATIVES Deloitte & Touche LLP was DEI's independent auditor for fiscal 1997. Deloitte & Touche LLP served as DEI's independent auditor since fiscal 1991. A representative of Deloitte & Touche LLP will be at the DEI Annual Meeting to answer questions from stockholders and to make a statement if the representative desires. No accountant has been chosen for fiscal 1998 due to the expected change in a majority of the DEI Board of Directors in connection with the Merger. STOCKHOLDER PROPOSALS FOR DEI'S 1998 ANNUAL MEETING The Annual Meeting of holders of shares of DEI Common Stock following the end of fiscal 1998 is expected to be held on or about March 1, 1999. Stockholder proposals intended to be presented at the such Annual Meeting of Stockholders must be received by DEI no later than October 1, 1998 if they are to be included in DEI's proxy statement relating to that meeting. Such proposals should be addressed to the Secretary at DEI's offices. 88 94 INDEX TO FINANCIAL STATEMENTS DAEDALUS ENTERPRISES, INC. AUDITED FINANCIAL STATEMENTS Report of Independent Auditors................................................................................ F-1 Consolidated Statements of Operations for the years ended July 31, 1997, 1996 and 1995......................... F-2 Consolidated Statements of Stockholders' Equity for the years ended July 31, 1997, 1996 and 1995...................................................................................F-2 Consolidated Balance Sheets as of July 31, 1997 and 1996........................................................F-4 Consolidated Statements of Cash Flows for the years ended July 31, 1997, 1996 and 1995..........................F-6 Notes to Financial Statements (July 31, 1997)...................................................................F-7 DAEDALUS ENTERPRISES, INC. UNAUDITED FINANCIAL STATEMENTS Consolidated Condensed Statements of Operations for the six months ended January 31, 1998 and 1997 (Unaudited)...................................................................F-16 Consolidated Condensed Balance Sheets at January 31, 1998 (Unaudited) and July 31, 1997.............................................................................................F-17 Consolidated Condensed Statements of Cash Flows for the six months ended January 31, 1998 and 1997 (Unaudited)...................................................................F-18 Notes to Financial Statements (January 31, 1998)............................................................. F-19 S.T. RESEARCH CORPORATION FINANCIAL STATEMENTS Report of Independent Accountants..............................................................................F-21 Balance Sheets at September 30, 1997 and December 31, 1997 (unaudited).........................................F-22 Statements of Income for the year ended September 30, 1997 and three months ended December 31, 1996 and 1997 (unaudited).....................................................F-24 Statements of Stockholders' Equity for the year ended September 30, 1997 and three months ended December 31, 1997......................................................................F-25 Statements of Cash Flows for the year ended September 30, 1997 and three months ended December 31, 1996 and 1997 (unaudited).....................................................F-26 Notes to Financial Statements..................................................................................F-28 Report of Independent Accountants..............................................................................F-39 Balance Sheets at September 30, 1996 and 1995..................................................................F-40 Statements of Income for the years ended September 30, 1996 and 1995...........................................F-42 Statements of Stockholders' Equity for the years ended September 30, 1996 and 1995.............................F-43 Statements of Cash Flows for the years ended September 30, 1996 and 1995.......................................F-44 Notes to Financial Statements..................................................................................F-45
95 INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders of Daedalus Enterprises, Inc. Ann Arbor, Michigan We have audited the accompanying consolidated balance sheets of Daedalus Enterprises, Inc. and subsidiaries as of July 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended July 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based upon 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, such consolidated financial statements present fairly, in all material respects, the financial position of Daedalus Enterprises, Inc. and subsidiaries at July 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 1997 in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note K, the Company is experiencing difficulty in generating sufficient cash flow to meet its obligations and sustain its operations, which raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note K. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/Deloitte & Touche LLP - ---------------------------- Deloitte & Touche LLP Ann Arbor, Michigan September 23, 1997 F-1 96 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JULY 31 --------------------------------------------- 1997 1996 1995 ---- ---- ---- OPERATING REVENUE Standard Products $ 2,199,756 $1,657,228 $2,339,540 Product Development 788,580 429,558 1,278,257 ----------- ---------- ---------- 2,988,336 2,086,786 3,617,797 Other Income 13,122 3,437 6,574 ----------- ---------- ---------- 3,001,458 2,090,223 3,624,371 COSTS AND EXPENSES Cost of revenue - standard products 1,342,561 1,036,539 1,179,648 Cost of revenue - product development 629,357 395,107 839,159 Research and development - Note G 101,651 469,369 586,466 Selling and administrative 931,778 947,155 1,473,252 Interest 63,800 76,638 82,619 ----------- ---------- ---------- 3,069,147 2,924,808 4,161,144 LOSS BEFORE INCOME TAXES (67,689) (834,585) (536,773) PROVISION (CREDIT) FOR INCOME TAXES - Note E (3,546) 132,000 (175,000) ----------- ---------- ---------- NET LOSS $ (64,143) $ (966,585) $ (361,773) ============ ========== ========== NET LOSS PER SHARE -BASIC - Note I $ (0.12) $ (1.85) $ (0.70) =========== ========== ========== NET LOSS PER SHARE - DILUTED - Note I $ (0.12) $ (1.85) $ (0.70) =========== ========== ========== CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ADDITIONAL COMMON PAID-IN RETAINED STOCK CAPITAL EARNINGS ----- ------- -------- STOCKHOLDERS' EQUITY BALANCES AT JULY 31, 1994 $5,115 $1,104,145 $1,720,885 Net loss (361,773) Stock issued pursuant to employee stock plans - 3,380 shares 34 8,986 Cash dividends - $.17 per share (87,320) ------ ---------- ----------
F-2 97 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES
BALANCES AT JULY 31, 1995 5,149 1,113,131 1,271,792 Net loss (966,585) Stock issued pursuant to employee stock plans - 18,011 shares 180 49,208 --------- ------------ ---------- BALANCES AT JULY 31, 1996 5,329 1,162,339 305,207 Net loss (64,143) Stock issued pursuant to employee stock plans - 1,100 shares 11 2,361 ---------- ------------ ---------- BALANCES AT JULY 31, 1997 $ 5,340 $ 1,164,700 $ 241,064 ========== ============ ==========
See Notes to Consolidated Financial Statements F-3 98 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
July 31, ----------------------------- 1997 1996 ---- ---- ASSETS - Note D CURRENT ASSETS Cash and cash equivalents $ 39,068 $ 56,768 Accounts receivable, less allowance of $2,500 - Note B 239,703 259,079 Unbilled accounts receivable - Note B 28,500 546,024 Inventories - Note A 601,462 640,213 Other current assets 18,075 7,829 ----------- ----------- TOTAL CURRENT ASSETS 926,808 1,509,913 ----------- ----------- PROPERTY AND EQUIPMENT - Note A Land 177,131 177,131 Building 1,433,898 1,433,898 Machinery and equipment 831,767 817,640 Special equipment 445,310 397,951 ----------- ----------- 2,888,106 2,826,620 Less accumulated depreciation (1,745,474) (1,606,526) ----------- ---------- 1,142,632 1,220,094 ----------- ----------- OTHER ASSETS - Note C 250 39,446 $ 2,069,690 $ 2,769,453 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Note payable to bank - Note D $ 0 $ 689,000 Accounts payable 197,563 184,524 Accrued compensation and related costs 103,369 97,936 Accrued commissions 0 1,129 Customer deposits 57,142 0 Reserve for product warranties 30,000 30,500 Other accrued liabilities 28,274 32,228 Mortgage debt - Note D 242,238 261,261 ----------- -----------
F-4 99 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES TOTAL CURRENT LIABILITIES 658,586 1,296,578 ---------- ---------- STOCKHOLDERS' EQUITY - Note F Common stock, $.01 par value Authorized - 2,000,000 shares Issued and outstanding - 534,024 shares (1996 - 532,924 shares) 5,340 5,329 Additional paid-in capital 1,164,700 1,162,339 Retained earnings 241,064 305,207 ---------- ---------- $1,411,104 $1,472,875 ---------- ---------- $2,069,690 $2,769,453 ========== ==========
See Notes to Consolidated Financial Statements. F-5 100 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended July 31, ------------------------------------- 1997 1996 1995 ---- ---- ---- OPERATING ACTIVITIES Net loss $(64,143) $(966,585) $(361,773) Adjustments to reconcile net income to net cash provided by operating activities Depreciation 138,948 180,280 168,584 Amortization of software 39,196 65,805 84,942 Provision (credit) for deferred income taxes 0 128,000 (135,000) Net book value of special equipment sold 149,842 152,451 0 Loss on disposal of property and equipment 0 0 2,553 Decrease (increase) in accounts receivable 536,900 596,881 (627,429) Decrease (increase) in inventories 38,751 (4,672) 476,096 Decrease in income taxes receivable 0 0 223,946 Decrease (increase) in deposits and other assets (10,246) 165,473 (133,392) Increase (decrease) in accounts payable and accrued liabilities 12,889 (259,768) 44,031 Increase (decrease) in customer deposits 57,142 (9,652) (146,447) -------- ---------- -------- CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 899,279 48,213 (403,889) INVESTING ACTIVITIES Purchase of property and equipment (211,328) (143,283) (134,844) -------- -------- --------- CASH USED IN INVESTING ACTIVITIES (211,328) (143,283) (134,844) FINANCING ACTIVITIES Proceeds from line of credit 1,758,000 1,967,749 2,572,000 Principal payments on line of credit (2,447,000) (1,920,749) (2,055,000) Payments on mortgage debt (19,023) (21,347) (32,671) Proceeds of stock issued pursuant to warrants, stock options and Stock Purchase Plan. 2,372 49,388 9,020 Dividends paid 0 0 (40,977) ---------- ---------- ---------- CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (705,651) 75,041 452,372 ----------- ---------- --------- Decrease in cash (17,700) (20,029) (86,361) Cash and cash equivalents at beginning of year 56,768 76,797 163,158 ----------- ---------- --------- CASH AND CASH EQUIVALENTS
F-6 101 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES AT END OF YEAR $39,068 $56,768 $76,797 ======= ======= =======
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - SIGNIFICANT ACCOUNTING POLICIES A summary of the significant accounting policies followed by Daedalus Enterprises, Inc. ("DEI") in preparation of the consolidated financial statements is set forth below. Certain reclassifications were made to the July 31, 1996 financial statements to conform with the classification used in the July 31, 1997 financial statements. PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of DEI and its wholly owned subsidiaries. Upon consolidation, all intercompany accounts, transactions, and profits are eliminated. REVENUE RECOGNITION. Revenue on major contracts is recognized using the percentage-of-completion method based upon the cost incurred as a percentage of the total estimated cost, whereby revenue and related costs are recognized throughout the performance period of the contract. If estimated total costs on any contract indicate a loss, the entire amount of the estimated loss is recognized immediately. Contract research revenue from U.S. Government agencies (see Note J) generally provides for reimbursement of costs plus fees. Revenue, fees and profits on such contracts are recognized as costs are incurred. Reimbursable contract costs (including overhead and general and administrative expenses) are subject to audit and adjustment by negotiation between DEI and U.S. Government representatives. Revenue under these contracts is recorded at amounts that are expected to be realized upon the final settlement with any adjustments to revenue reflected in the year of settlement. Some development contracts involve cost-sharing by DEI. DEI recognizes its share of these costs, which are classified as research and development expense, as incurred. CASH AND CASH EQUIVALENTS. DEI considers all highly liquid securities purchased with an original maturity date of three months or less to be cash equivalents. INVENTORIES. Inventories, principally work-in-process and purchased parts, are stated at the lower of first-in, first-out cost or market. Inventory at July 31, 1997 and 1996 included work-in-process of approximately $115,000 and $104,000, respectively, with the remainder consisting of raw materials and subassemblies. PROPERTY AND EQUIPMENT. Property and equipment is stated at cost and depreciated over the useful life by the straight-line method. Special equipment includes construction-in-progress, relating to a multispectral scanner system, in the amount of approximately $158,000 and $119,000 at July 31, 1997 and July 31, 1996, respectively. Special equipment consists of equipment manufactured by DEI and includes direct manufacturing costs and overhead. Such equipment which is used in manufacturing or research activities of DEI is normally made available for sale by DEI. Therefore, revenue from the sale of such equipment, if any, is included in revenue and the depreciated cost is included in cost of revenue. During the fiscal years ended July 31, 1997 and July 31, 1996, DEI sold one such system in each year with a cost of approximately $150,000 and $152,000, respectively. CAPITALIZED SOFTWARE. Capitalized software costs consist of costs incurred for internally developed software to be sold as part of standard products or used in customer-funded product development contracts. Capitalization begins upon the establishment of technological feasibility. The ongoing assessment of recoverability of capitalized software development costs requires considerable judgment by management with respect to certain external factors, anticipated future gross revenue, estimated economic life, and changes in hardware and software technology. Capitalized software is amortized on a product-by-product basis over the related sales on a per-unit basis with minimum amortization based on the straight-line method over an estimated five year useful life. F-7 102 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES NEW FINANCIAL ACCOUNTING STANDARDS. DEI has not completed the process of evaluating the impact that will result from adopting Statement of Financial Accounting Standards ("SFAS"), No. 130 "Comprehensive Income" ("No. 130") and No. 131 "Disclosures About Segments of an Enterprise and Related Information" ("No. 131"). SFAS No. 130 and No. 131 are effective for fiscal years beginning after December 15, 1997. DEI is, therefore, unable to determine the impact that adopting No. 130 and No. 131 will have on its financial statements when such statements are adopted. The Financial Accountings Standards Board has issued SFAS No. 128 "Earnings Per Share," which became effective for financial statements issued after December 15, 1997. The statement requires companies to present earnings per share on the face of the statement of operations in two categories called "Basic" and "Diluted" and requires restatement of all periods presented. DEI adopted SFAS No. 128 during the first quarter of 1998. NOTE B - ACCOUNTS RECEIVABLE At July 31, 1997 and 1996, respectively, accounts receivable included approximately $6,000 in each year from agencies of the United States federal government that will be paid upon the completion and audit of the cost plus fixed-fee contracts between DEI and the government agencies. Unbilled accounts receivable represent revenue recognized using the percentage-of-completion method, which are not yet billable under the terms of the contract. These amounts become billable based on contract terms either upon shipment of the items, presentation of invoices, or completion of the contract. The cost of such revenue is determined generally by separate job cost accounts and involves no deferral of costs. To prevent foreign currency transaction losses, international sales are contracted in U.S. dollars and large standard product contracts are generally secured by irrevocable letters of credit. DEI also receives substantial deposits on large sales to international customers. NOTE C - CAPITALIZED SOFTWARE There was no unamortized software at July 31, 1997. Other assets include approximately $39,000 of unamortized software at July 31, 1996. No software was capitalized in fiscal years 1997 and 1996. NOTE D - NOTE PAYABLE AND LONG-TERM DEBT On July 31, 1997, DEI had a $1,550,000 line of credit, with availability subject to a formula, bearing interest at one and one-half percent above the lending bank's prime rate (effective rate of 10%). The formula permits borrowing up to $950,000 based on the value of the real estate, with the remaining available borrowings based on 50% of the value of certain receivables specified in the line of credit agreement. As of July 31, 1997, total availability was approximately $1,000,000 pursuant to the formula. DEI had an outstanding balance of zero under this line of credit agreement at July 31, 1997 with $59,000 of the line of credit reserved for a standby letter of credit. This compares to a balance of $689,000 (effective rate of 9.75%) under the prior line of credit agreement and an additional $258,000 reserved for a standby letter of credit at July 31, 1996. DEI had a maximum balance outstanding of $689,000 and $747,000 during fiscal 1997 and 1996, respectively. The average outstanding balance and interest rate in fiscal 1997 and 1996 was $385,505 and 9.69% and $480,186 and 9.75%, respectively. DEI has a mortgage with a balance of $242,238 and $261,261 as of July 31, 1997 and 1996, respectively, bearing interest at one and one-half percent over prime (effective rate of 10% and 9.75% at July 31, 1997 and 1996, respectively). Monthly payments on the mortgage are $3,685 for both interest and principal with the mortgage F-8 103 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES being due on November 1, 2000. DEI has classified its total mortgage liability as current as the mortgage agreement is cross-collateralized and cross-defaulted with the line of credit which is a secured master demand note. Aggregate annual maturities of long-term debt based on the refinanced mortgage interest rate of 10% are as follows:
Fiscal Year Maturity ----------- -------- 1998 20,934 1999 23,125 2000 25,547 2001 172,632 ------- 242,238 =======
Interest paid on all debt was approximately $64,000, $77,000 and $83,000 in fiscal 1997, 1996 and 1995, respectively. NOTE E - INCOME TAXES The credit for income taxes in fiscal 1997 results primarily from a prior year refund related to a Foreign Sales Corporation. DEI has limited its recognition of income tax benefit due to the uncertainty of realizing the net operating loss carryforward. Provision (credit) for income taxes is made up of the following components:
1997 1996 1995 ---- ---- ---- Current $ (3,500) $ 4,000 $ (40,000) Deferred: Tax provision (benefit) 0 128,000 (135,000) ---------- -------- --------- PROVISION (CREDIT) FOR INCOME TAXES $ (3,500) $132,000 $(175,000) ========= ======== =========
A reconciliation of the provision (credit) for income taxes and the amount computed by applying the statutory federal income tax rates to earnings is as follows:
1997 1996 1995 ---- ---- ---- Federal income tax on earnings at statutory rates (35% in 1997, 1996 and 1995) $(24,000) $(292,000) $(188,000) Effect of federal tax rate difference as the result of surtax exemptions 0 0 6,000 Foreign Sales Corporation tax (benefit). 0 (2,000) (10,000) Increase in income taxes resulting from valulation allowance for net operating loss 17,000 392,000 0 Increase in income taxes resulting from nondeductible expenses 3,500 34,000 17,000 -------- --------- --------- PROVISION (CREDIT) FOR INCOME TAXES $ (3,500) $ 132,000 $(175,000) ======== ========= =========
No federal corporate tax payments were made in fiscal years 1997, 1996 and 1995. F-9 104 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES The temporary differences that give rise to deferred tax assets and liabilities at July 31, 1997 and 1996 are as follows:
DEFERRED TAX ASSET (LIABILITY) 1997 1996 ---- ---- SHORT- LONG- SHORT- LONG- TERM TERM TERM TERM ---- ---- ---- ---- Net operating loss carryforward $385,000 $379,000 Accrued personal leave $14,300 $14,000 Inventory reserve 24,700 32,000 Warranty reserve 8,700 8,900 Capitalized software (11,000) Depreciation (26,000) (34,000) Valuation allowance (50,000) (359,000) (47,000) (345,000) Other 2,300 3,100 ---------- -------- --------- -------- $ 0 $ 0 $ 0 $ 0 ========== ======== ========= ========
For the current fiscal year, DEI has limited the recognition of income tax benefit for its current operating losses due to cumulative losses realized in recent years. DEI recorded a valuation allowance of $409,000 as of July 31,1997 and $392,000 as of July 31, 1996. The increase in the valuation allowance during fiscal 1997 and 1996 was $17,000 and $392,000, respectively. At July 31, 1997, DEI had approximately $1,328,000 of net operating loss carryforward for tax purposes as follows:
Expiration Date Net Operating Loss ----------------------------------- 2009 $ 42,000 2010 506,000 2011 775,000 2012 5,000 ---------- $1,328,000 ==========
NOTE F - STOCK OPTIONS AND STOCK PURCHASE PLANS DEI reserved 100,000 shares of common stock for sale to eligible employees through payroll deductions over six-month periods pursuant to the 1983 Employee Stock Purchase Plan (the "Purchase Plan"). The purchase price is the lower of 90% of the fair market value of the stock on the first or last day of the purchase period. Under the Purchase Plan, 1,100, 1,011, and 3,079 shares were issued during fiscal 1997, 1996 and 1995 at an average price of F-10 105 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES $2.16, $2.36 and $3.56 per share, respectively. At July 31, 1997 and 1996, there were 65,568 and 66,918 shares, respectively, available for future purchase. DEI has an incentive stock option plan established in 1983 and a long-term incentive plan and a non-employee director stock option plan established in 1995 (collectively the "Plans"). The long-term incentive plan provides for the granting of options, restricted stock and/or performance awards to key employees and the non-employee director plan provides for the granting of options to outside members of the board of directors to purchase common stock of DEI at the fair value at the date of the grant. There are 64,000 and 21,000 shares of common stock reserved under the 1995 long-term incentive plan and the 1995 non-employee director stock option plan, respectively. There are 28,000 exercisable options outstanding and 3,000 stock appreciation rights outstanding under the 1983 incentive stock option plan; however, no additional options can be granted under this plan. Options granted pursuant to the Plans are generally exercisable ratably over a two to five year period and expire after ten years. Transactions under the Plans during fiscal years 1997, 1996 and 1995 were as follows:
WEIGHTED AVERAGE NUMBER OPTION OPTION OF SHARES PRICE PRICE --------- ----- ----- Outstanding July 31, 1994 71,250 $2.75 - $7.00 $4.18 Options granted to non-employee directors 12,000 $3.94 $3.94 Options exercised (950) $3.00 $3.00 Options canceled (5,100) $3.00 - $6.75 $4.10 ------- ------------- ----- Outstanding July 31, 1995 77,200 $2.75 - $7.00 $4.16 Options granted to employees 15,000 $2.75 $2.75 Options exercised (17,000) $2.75 $2.75 Options canceled (9,100) $2.75 - $6.75 $4.64 ------ ------------- ----- Outstanding July 31, 1996 66,100 $2.75 - $7.00 $3.60 Options granted to employees 16,850 $2.25 $2.25 Options canceled in connection with SARs (11,850) $5.00 - $7.00 $6.63 Options canceled (3,750) $2.75 - $3.94 $3.70 ------- ------------- ----- Outstanding July 31, 1997 67,350 $2.75 - $4.00 $3.25 ====== ============= =====
Of the outstanding options at July 31, 1997 and 1996, 54,425 and 52,350 are exercisable, respectively. Of the 67,350 shares covered by outstanding options at July 31, 1997, 3,000 were accompanied by stock appreciation rights. In addition to options granted under the Plans, non-qualified options to purchase 40,000 shares have been issued to two officers of DEI at $2.25 per share which expire on December 10, 2006, options to purchase 3,000 shares have been issued to the corporate secretary at $2.25 per share which expire on December 10, 2006 and options to purchase 2,000 shares have been issued to an employee at $4.00 per share which expire on September 1, 1999. F-11 106 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES Total shares of common stock reserved pursuant to the Purchase Plan, the Plans and the non-qualified options were 224,118. The weighted average estimated fair value of options granted during fiscal 1997 and 1996 was $1.03 and $1.49 per share, respectively. DEI applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its granted options. Accordingly, no compensation cost has been recognized for its granted options. Had compensation cost for DEI's granted options been determined based on the fair value at the grant dates consistent with the method of Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation," DEI's net loss and loss per common share for the year ended July 31, 1997 would have been increased to the pro forma amounts indicated below:
1997 1996 ---- ---- Net loss to common shareholders As reported $ 64,143 $966,585 Pro forma $ 106,175 $977,768 Net loss per share As reported $0.12 $1.85 Pro forma $0.20 $1.87
The fair value of options granted by DEI during 1997 and 1996 were estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used: no dividend yield, expected volatility of 51.1% and 83.3%, risk free rate of 6.23% and 5.78% and expected lives of five and ten years. NOTE G - CUSTOMER-FUNDED PRODUCT DEVELOPMENT DEI is engaged in customer-funded product development projects in which DEI shares a portion of the cost of developing the technology and retains all rights to the technology. DEI earned product development revenue of approximately $789,000, $430,000, and $1,278,000 while incurring related cost of revenue of approximately $661,000, $395,000, and $839,000 in fiscal years 1997, 1996 and 1995, respectively. In addition to these costs of revenue, DEI performed internal research and development of approximately $26,000 and $74,000 related to the customer-funded product development projects in fiscal years ended July 31, 1996 and July 31, 1995, respectively. There was no internal research and development performed in support of customer-funded product development projects in fiscal year 1997. NOTE H - PENSION PLAN DEI has a qualified defined contribution plan ("Pension Plan") and a 401(k) employee savings plan ("Savings Plan") covering all employees meeting age and length of service requirements. The Pension Plan provides only for Company contributions of 10% of the active participants' eligible wages. Pension expense, which is funded quarterly, was $99,000, $96,000 and $135,000 in 1997, 1996 and 1995, respectively. The Savings Plan requires no Company contributions; however, DEI may make contributions at the discretion of the Board of Directors. No contributions were made to the Savings Plan during fiscal years 1997, 1996 or 1995. DEI has no other postretirement benefits. F-12 107 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES NOTE I - EARNINGS PER SHARE DEI uses the treasury stock method to calculate diluted earnings per share. No adjustment was made to either the net loss or the number of shares outstanding for common stock equivalents in calculating earnings per share for fiscal 1997, 1996, and 1995 as such adjustments would have been antidilutive. Weighted average number of shares outstanding and earnings per share for the three years ended July 31 are computed as follows:
1997 1996 1995 ---- ---- ---- Weighted average number of shares outstanding 533,464 522,597 513,287 Additional shares using the treasury stock method 0 0 0 -------- --------- --------- AVERAGE NUMBER OF SHARES OUTSTANDING AND EQUIVALENTS 533,464 522,597 513,287 ======== ========= ========= Net loss $(64,143) $(966,585) $(361,773) ======== ========= ========= LOSS PER SHARE $ (0.12) $ (1.85) $ (0.70) ======== ========= ==========
NOTE J - SEGMENT INFORMATION DEI manufactures products for, and performs development projects in, the field broadly described as "remote sensing". Remote sensing is defined as the detection or measurement of various physical parameters of an object or system without direct contact with the object or system being observed. The principal products manufactured by DEI are airborne imaging systems which are installed in aircraft for acquisition of data on environmental parameters. A principal application of DEI's remote sensing products has been the measurement of environmental parameters in support of pollution control programs and environmental impact studies. DEI is also engaged in customer-funded projects for the development of advanced systems in the remote sensing field. Some of these projects lead to the incorporation of newly developed technology into the standard product line. These two portions of the business are conducted by the same pool of personnel using the same operating space and equipment and constitute a single industry segment. The following table sets forth information with respect to domestic and international sales of DEI's products and services: F-13 108 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES
1997 1996 1995 ---- ---- ---- International Government agencies Thailand $1,144,200 $ 0 $ 0 ========== ============ ========== Korea 1,130 0 0 ========== ============ ========== Total Asia 1,145,330 0 0 ========== ============ ========== Portugal $ 0 $ 436,400 $1,152,000 ========== ============ ========== Germany 67,735 0 39,654 ========== ============ ========== Spain 49,700 33,438 0 ========== ============ ========== Denmark 0 0 5,165 ========== ============ ========== Italy 0 55,360 1,023,896 ========== ============ ========== Sweden 0 0 34,517 ========== ============ ========== England 8,233 14,975 0 ========== ============ ========== Total Europe 125,668 540,173 2,255,232 ========== ============ ========== India $ 0 $ 0 $ 33,176 ========== ============ ========== Taiwan 0 0 10,123 ========== ============ ========== Total Other 0 0 43,299 Total Government Agencies $1,270,998 $ 540,173 $2,298,531 ========== ============ ========== Commercial Japan $ 32,800 $ 562,200 $ 0 ========== ============ ========== Sweden 21,541 208,869 0 ========== ============ ========== Australia 0 0 7,377 ========== ============ ========== Italy 3,164 61,693 0 ========== ============ ========== Germany 3,533 0 0 ========== ============ ========== Other 217 3,385 0 ========== ============ ========== Total Commercial 61,255 836,147 7,377 ---------- ------------ ---------- Total International $1,332,253 $ 1,376,320 $2,305,908 ========== ============ ========== Domestic U.S. Government agencies $1,625,433 $ 617,842 $1,228,389 Other 30,650 92,624 83,500 ---------- ------------ ---------- 1,656,083 710,466 1,311,889 ---------- ------------ ---------- $2,988,336 $ 2,086,786 $3,617,797 ========== ============ ==========
DEI's revenue each year is derived from a small number of high dollar value equipment sales and contracts with a relatively small number of customers. These customers change from year-to-year and no single customer has generated a majority of DEI's revenue during any consecutive years. Sales to major customers in each of the three years ended July 31, 1997 are as follows: F-14 109 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES
FISCAL YEAR ENDED JULY 31, ----------------- CUSTOMER DESCRIPTION 1997 1996 1995 (000) (000) (000) ----- ----- ----- Standard product customer Thailand $1,144 $ 0 $ 0 Japan 0 562 0 Portugal 0 436 1,152 Sweden 0 186 0 Italy 0 0 917 European product development customer - Italy 0 0 90 U.S. Government 1,625 618 1,228
NOTE K - GOING CONCERN MATTERS The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements during the years ended July 31, 1997, 1996 and 1995, DEI incurred losses of $64,143, $966,585 and $361,773, respectively, and has classified all of its debt as current for the years ended July 31, 1997 and 1996. These factors among others may indicate that DEI will be unable to continue as a going concern for a reasonable period of time. The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should DEI be unable to continue as a going concern. As described in Note D, since DEI's debt facility is in the form of a secured master demand note, DEI has classified the balance of its mortgage debt ($221,000 related to its mortgage) as a current liability. DEI's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms of its financing agreement, to obtain additional financing or refinancing as may be required, and ultimately to attain profitability. DEI will continue to pursue additional equity financing through discussions with potential investors possessing related technological and/or marketing capabilities. Pending the receipt of additional equity financing, DEI will continue to operate supported by its line of credit, but the lending bank has indicated that it may limit the amount which DEI is permitted to borrow under the line of credit in the absence of continued improvement in DEI's business prospects or progress toward the acquisition of a significant amount of equity capital. If DEI is unable to borrow amounts necessary to fund its operations, its financial position would be materially and adversely affected and DEI may have no choice but to cease operations if other sources of capital are not available. F-15 110 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS - UNAUDITED
Six Months Ended ---------------------- January 31, 1998 1997 ---- ---- OPERATING REVENUE Standard products $ 665,702 $1,016,511 Product development 169,224 488,180 834,926 1,504,691 Other Income 16,683 5,862 ---------- ---------- 851,609 1,510,553 COST AND EXPENSES Cost of revenue - standard products 469,800 507,604 Cost of revenue - product development 218,451 435,456 Research and development 28,589 73,172 Selling and administrative 413,439 477,221 Interest 27,340 35,370 ---------- ---------- 1,157,619 1,528,823 ---------- ---------- NET EARNINGS (LOSS) BEFORE INCOME TAXES (306,010) (18,270) ========== ========== CREDIT FOR INCOME TAXES - NOTE C 0 0 NET EARNINGS ( LOSS) $ (306,010) $ (18,270) ========== ========== NET EARNINGS (LOSS) PER SHARE - BASIC $ (0.57) $ (0.03) ========== ========== NET EARNINGS (LOSS) PER SHARE - DILUTED $ (0.57) $ (0.03) ========== ==========
The accompanying notes are an integral part of these condensed financial statements. F-16 111 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS
January 31, July 31, 1998 1997 ----------- ---------- (unaudited) ASSETS - Note D CURRENT ASSETS Cash and cash equivalents $ 18,744 $ 39,068 Accounts receivable, less allowance of $2,500 132,806 239,703 Unbilled accounts receivable 346,231 28,500 Inventories - Note B 483,190 601,462 Other current assets 21,297 18,075 ----------- ----------- TOTAL CURRENT ASSETS 1,002,268 926,808 PROPERTY AND EQUIPMENT Land 177,131 177,131 Building 1,433,898 1,433,898 Machinery and equipment 843,886 831,767 Special equipment 542,980 445,310 ----------- ----------- 2,997,805 2,888,106 Less accumulated depreciation (1,803,420) (1,745,474) ----------- ----------- 1,194,385 1,142,632 OTHER ASSETS 250 250 $ 2,196,903 $ 2,069,690 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIIABILITIES Note payable to bank - Note D $ 490,000 $ 0 Accounts payable 60,531 197,563 Accrued compensation and related costs 118,247 103,369 Customer deposits 161,065 57,142 Reserve for product warranties 28,585 30,000 Other accrued liabilities 0 28,274 Mortgage debt - Note D 232,297 242,238 ----------- ----------- TOTAL CURRENT LIABILITIES 1,090,725 658,586 STOCKHOLDERS' EQUITY Common stock $.01 par value Authorized--2,000,000 shares 5,346 5,340 Issued and outstanding--534,574 shares (July 31, 1997--534,024 shares) Additional paid-in capital 1,165,778 1,164,700 Retained earnings (64,946) 241,064 ----------- ----------- 1,106,178 1,411,104 ----------- ----------- $ 2,196,903 $ 2,069,690 =========== ===========
The accompanying notes are in integral part of these condensed financial statements. F-17 112 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
Six Months Ended January 31, 1998 1997 ---- ---- OPERATING ACTIVITIES Net earnings (loss) $ (306,010) $ (18,270) Adjustments to reconcile net income to net cash provided by operating activities Depreciation 57,946 68,725 Amortization of software 0 29,189 Net book value of special equipment sold 0 138,726 Decrease (increase) in accounts receivable (210,834) 72,308 Decrease in inventory 118,272 138,017 Increase in other assets (3,222) (5,683) Increase (decrease) in accounts payable and accrued expenses (151,843) (16,737) Decrease in customer deposits 103,923 150,073 ----------- ----------- CASH PROVIDED (USED) BY OPERATING ACTIVITIES (391,768) 556,348 INVESTING ACTIVITIES Purchase of property and equipment (109,699) (158,767) ----------- ----------- CASH USED IN INVESTING ACTIVITIES (109,699) (158,767) FINANCING ACTIVITIES Proceeds from revolving line of credit 965,000 665,000 Payments on revolving line of credit (475,000) (1,104,000) Payments on long-term debt (9,941) (9,284) Proceeds of stock issued pursuant to stock option and stock purchase plan 1,084 708 ----------- ----------- CASH PROVIDED (USED) IN FINANCING ACTIVITIES 481,143 (447,576) INCREASE (DECREASE) IN CASH (20,324) 49,995 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 39,068 56,768 ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF QUARTER $ 18,744 $ 6,773 =========== ===========
The accompanying notes are an integral part of these condensed financial statements. F-18 113 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OCTOBER 31, 1997 NOTE A - BASIS OF PRESENTATION The financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the results of operations, financial position and cash flows for the periods presented. The accompanying unaudited financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information necessary to be in conformity with generally accepted accounting principles. Reference is made to the Notes to Consolidated Financial Statements in the Annual Report to Stockholders for the year ended July 31, 1997. The results of operations for the six months ended January 31, 1998 are not necessarily indicative of the results to be expected for the full year. NOTE B -INVENTORY Inventory includes work-in-process of approximately $19,000 and $115,000 as of January 31, 1998 and July 31, 1997, respectively. The remaining inventory consists of parts and subassemblies, both purchased and manufactured, that can be used in the manufacturing process or sold as spare parts. NOTE C - INCOME TAXES DEI estimates its provision for income taxes using its estimated annual effective rate. DEI has limited the recognition of income tax benefit for its net operating loss carryforwards due to cumulative losses realized in recent years. The valuation allowance for deferred taxes is $498,000 at January 31, 1998 and $409,000 at July 31, 1997. NOTE D - REVOLVING CREDIT On January 31, 1998, DEI had a $1,550,000 line of credit with a bank, with availability subject to a formula, bearing interest at one and one-half percent above the bank's prime rate (effective rate of 10%). The formula is $950,000 based on the value of the real estate, with the remaining available borrowings based on 50% of the value of certain receivables specified in the line of credit agreement. As of January 31, 1998, total remaining availability was $401,000 based on the formula. The outstanding balance under this line of credit agreement was approximately $490,000 at January 31, 1998, with $59,000 of the line of credit agreement reserved for a standby letter of credit. This compares to an outstanding balance of zero (effective rate of 10%) at July 31, 1997 with an additional $59,000 reserved for a standby letter of credit. DEI has classified its total mortgage liability as current because the mortgage agreement is cross-collateralized and cross-defaulted with the line of credit, which is a secured master demand note. NOTE F - EARNINGS PER SHARE The computation of net earnings per share is based on the weighted average number of shares of common stock outstanding during the six month periods ended January 31, 1998 and 1997. The weighted average number of shares used in the computation was 534,392 and 533,173 for the six months ended January 31, 1998 and 1997, respectively, all of which were issued and outstanding. No adjustments were made to either net earnings (loss) or the number of shares outstanding in calculating earnings (loss) per share as such adjustments would have been antidilutive. F-19 114 DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES NOTE G - SUBSEQUENT EVENT DEI entered into a merger agreement (the "Merger") with S. T. Research Corporation ("STR"), a Virginia corporation, on December 23, 1997. Under the agreement, each outstanding share of STR would be exchanged for 2.58 newly issued shares of DEI's common stock and STR would become a wholly owned subsidiary of DEI. STR is a supplier of technology-driven solutions for communications and radar intercept equipment to the U. S. government (its principal customer) and a major supplier of threat warning systems to the surface and subsurface community. STR had revenues of approximately $24 million during its last fiscal year, and total assets of approximately $10.8 million and working capital of approximately $1.6 million at September 30, 1997. The Merger is expected to close in the second quarter of calendar 1998 and will be subject to the satisfaction of various conditions, including the approval of the Merger by the shareholders of STR and approval by DEI's stockholders of an amendment to its Certificate of Incorporation to permit the issuance of shares pursuant to the Merger. F-20 115 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors S.T. Research Corporation: We have audited the accompanying balance sheet of S.T. Research Corporation (the Company) as of September 30, 1997 and the related statements of income, stockholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with 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 audit provides 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 S.T. Research Corporation as of September 30, 1997, and the results of its operations and its cash flows for the year then ended, in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. Pittsburgh, Pennsylvania December 22, 1997, except for Note 16, as to which the date is January 30, 1998 F-21 116 S.T. RESEARCH CORPORATION BALANCE SHEETS ASSETS
December 31, September 30, 1997 1997 ---- ---- (unaudited) CURRENT ASSETS Cash and cash equivalents $ 119,524 $ 140,438 Accounts receivable 4,045,201 2,915,548 Unbilled contract costs, net (Note 3) 5,374,597 6,197,676 Inventories (Note 5) 203,311 110,902 Deferred tax assets (Note 8) 226,737 264,451 Other current assets 174,553 107,572 Prepaid income taxes 155,152 75,438 ------------ ------------- Total current assets 10,299,075 9,812,025 PROPERTY AND EQUIPMENT (Note 6) 875,532 932,302 OTHER ASSETS 83,975 60,137 ------------ ------------- TOTAL ASSETS $ 11,258,582 $ 10,804,464 ============ =============
The accompanying notes are an integral part of these financial statements. F-22 117 S.T. RESEARCH CORPORATION BALANCE SHEETS (Continued) LIABILITIES AND STOCKHOLDERS' EQUITY
December 31, September 30, 1997 1997 ---- ---- (unaudited) CURRENT LIABILITIES Note payable - line of credit (Note 7) $ 4,208,614 $ 3,911,091 Accounts payable 3,038,408 2,880,022 Accrued salaries, benefits, and related expenses 1,370,998 1,213,392 Other accrued expenses 112,225 174,073 Capital leases (Note 12) 52,055 75,891 ------------ ------------ Total current liabilities 8,782,300 8,254,469 LONG-TERM LIABILITIES Capital leases (Note 12) 8,993 13,953 ------------ ------------ TOTAL LIABILITIES 8,791,293 8,268,422 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Common stock, $.10 par value, 3,000,000 shares authorized, of which 723,792 were issued at September 30, 1997 and December 31, 1997 72,379 72,379 Additional paid-in capital 1,232,716 1,232,716 Retained earnings 1,162,194 1,230,947 ------------ ------------ Total stockholders' equity 2,467,289 2,536,042 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 11,258,582 $ 10,804,464 ============ ============
The accompanying notes are an integral part of these financial statements. F-23 118 S.T. RESEARCH CORPORATION STATEMENTS OF INCOME
Three Months Ended Year Ended December 31, September 30. --------------------- ------------- 1997 1996 1997 ---- ---- ---- (unaudited) REVENUE Contract revenue $ 5,837,376 $ 5,606,100 $ 23,953,070 ------------ ------------ ------------ COSTS AND EXPENSES Cost of revenues 5,134,910 4,908,274 20,761,886 General and administrative expenses 710,076 651,297 2,654,218 ------------ ------------ ------------ Total costs and expenses 5,844,986 5,559,571 23,416,104 ------------ ------------ ------------ INCOME (LOSS) FROM OPERATIONS (7,610) 46,529 536,966 OTHER INCOME (EXPENSES) Interest expense (103,143) (74,461) (345,086) ------------ ------------ ------------ INCOME (LOSS) BEFORE INCOME TAXES (110,753) (27,932) 191,880 INCOME TAX BENEFIT (PROVISION) (Note 8) 42,000 10,000 (72,000) ------------ ------------ ------------ NET INCOME (LOSS) ($ 68,753) ($ 17,932) $ 119,880 ============ ============ ============ PER SHARE AMOUNT Basic earnings (loss) per share ($ .09) ($ .02) $ .17 ============ ============ ============ Diluted earnings (loss) per share ($ .09) ($ .02) $ .16 ============ ============ ============ WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING Basic 723,792 723,950 723,827 Diluted 744,116 752,460 748,216
The accompanying notes are an integral part of these financial statements. F-24 119 S.T. RESEARCH COMPANY STATEMENT OF STOCKHOLDERS' EQUITY
Additional Total Common Paid-in Retained Stockholders' Stock Capital Earnings Equity ------- ---------- ----------- ------------- BALANCE, OCTOBER 1, 1996 $72,421 $1,236,306 $1,111,067 $2,419,794 Common stock repurchase (418 shares at cost) (42) (3,590) -- (3,632) Net income -- -- 119,880 119,880 ------- ---------- ---------- ---------- BALANCE, SEPTEMBER 30, 1997 72,379 1,232,716 1,230,947 2,536,042 Net loss (unaudited) -- -- (68,753) (68,753) ------- ---------- ---------- ---------- BALANCE, DECEMBER 31, 1997 (unaudited) $72,379 $1,232,716 $1,162,194 $2,467,289 ======= ========== ========== ==========
The accompanying notes are an integral part of these financial statements. F-25 120 S.T. RESEARCH CORPORATION STATEMENTS OF CASH FLOWS
Three Months Ended Year Ended December 31, September 30, ------------------- ------------- 1997 1996 1997 ---- ---- ---- (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) ($ 68,753) ($ 17,932) $ 119,880 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation 74,597 74,590 359,679 Deferred tax expense 37,714 -- 11,000 Cash provided by assets and liabilities: Accounts receivable (1,129,653) (227,821) (649,410) Unbilled contract costs 823,079 174,415 (1,812,266) Inventories (92,409) 190,153 130,461 Other current assets (66,981) 2,161 (59,121) Prepaid income taxes (79,714) -- (75,438) Other assets (4,993) (11,573) (12,687) Accounts payable 158,386 582,834 1,579,559 Accrued expenses 95,758 (552,470) (457,223) Income taxes payable -- (52,500) (50,500) Other -- -- 9,446 ----------- ----------- ----------- Net cash provided by (used in) operating activities (252,969) 161,857 (906,620) ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Capitalized acquisition costs (18,845) -- -- Acquisitions of property and equipment (17,827) (232,680) (462,211) Net cash used in investing activities (36,672) (232,680) (462,211)
The accompanying notes are an integral part of these financial statements. F-26 121 STATEMENTS OF CASH FLOWS (Continued)
Three Month Ended Year Ended December 31, September 30, ------------ ------------- 1997 1996 1997 ---- ---- ---- (unaudited) CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds under line of credit $297,523 $ 82,867 $1,583,600 Principal payments on capital lease obligations (28,796) (26,341) (111,907) Repurchase of common stock - (3,632) (3,632) -------- -------- ---------- Net cash provided by financing activities 268,727 52,894 1,468,061 -------- -------- ---------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (20,914) (17,929) 99,230 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 140,438 41,208 41,208 -------- -------- ---------- CASH AND CASH EQUIVALENTS, END OF PERIOD $119,524 $ 23,279 $ 140,438 ======== ======== ========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash payments for interest $ 99,580 $ 69,545 $ 310,457 ======== ======== ========== Cash payments for income taxes $ - $ 42,500 $ 186,938 ======== ======== ==========
The accompanying notes are an integral part of these financial statements. F-27 122 S.T. RESEARCH CORPORATION NOTES TO FINANCIAL. STATEMENTS NOTE 1 - STR AND ITS SIGNIFICANT ACCOUNTING POLICIES: Business Activities: S.T. Research Corporation ("STR") designs, develops, manufactures, and markets reconnaissance systems and related products primarily through U.S. Government contracts. Revenue Recognition: The estimated revenue of performance under Government fixed-price and cost-type contracts, including customer funded research and development, is recognized under the percentage of completion method of accounting whereunder the estimated revenue is determined on the basis of completion to date (the total contract amount multiplied by percent of performance to date less revenue value recognized in previous periods) and general and administrative expenses are expensed as incurred. Revenues under cost-reimbursement contracts are recorded as costs are incurred and include estimated earned fees in the proportion that costs incurred to date bear to total estimated costs. The fees under certain Government contracts may be increased or decreased in accordance with cost or performance incentive provisions which measure actual performance against established targets or other criteria. Such incentive fee awards or penalties, which historically are not material, are included in revenue at the time the amounts can be determined reasonably. Anticipated losses are recognized at the time they become known. Inventories: Inventories are stated at the lower of cost or market, determined on the first-in, first-out basis. Property and Equipment: Furniture and equipment are recorded at cost and are depreciated over estimated useful lives ranging from three to eight years using straight-line and accelerated methods. Leasehold improvements are amortized over the life of the improvement using the straight-line method. Amortization of leasehold improvements and capital lease obligations are included in depreciation expense. The cost and accumulated depreciation or amortization of assets sold or retired are removed from the respective accounts and any gain or loss is reflected in other income (expenses). STR reviews long-lived assets for impairment whenever events indicate that the carrying amount of an asset may not be recoverable and recognizes an impairment loss under certain circumstances in the amount by which the carrying value exceeds the fair value of the asset. Cash and Cash Equivalents: For purposes of the statement of cash flows, STR considers all unrestricted highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. F-28 123 NOTES TO FINANCIAL STATEMENTS, Continued NOTE 1 - STR AND ITS SIGNIFICANT ACCOUNTING POLICIES (continued): Income Taxes: STR accounts for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities have been established for the temporary differences between financial statement and tax basis of assets and liabilities existing at the balance sheet date using expected tax rates. A valuation allowance is recorded to reduce a deferred tax asset to that portion that is expected to more likely than not be realized. Use of Estimates: The preparation of financial statements 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 revenue and expenses during the reporting periods. Accordingly, actual results could differ from those estimates. Operating Cycle: In accordance with industry practice, STR classifies as current assets amounts relating to long-term contracts which may have terms extending beyond one year but are expected to be realized during the normal operating cycle of STR. The liabilities in the accompanying balance sheets which have been classified as current liabilities are those expected to be satisfied by the use of assets classified as current assets. At September 30, 1997, substantially all contracts will be completed within the next twelve months. Therefore, substantially all current assets and current liabilities are expected to be liquidated in the next twelve months. Earnings Per Share: Effective December 31, 1997, STR adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." This Statement requires the discussion of basic and diluted earnings per share and revises the method required to calculate these amounts under previous standards. Basic earnings per share is computed using the weighted average number of common shares outstanding during each period. Diluted earnings per share is computed using the weighted average number of common and common equivalent shares outstanding during each period. Earnings per share data for periods prior to the three months ended December 31, 1997 have been restated to reflect adoption of this Statement.
Three Months Three Months Year Ended Ended December Ended December September 31, 1997 31, 1996 30, 1997 -------- -------- -------- Net income (loss) $ (68,753) $ (17,932) $ 119,880 Weighted average shares outstanding - basic 723,792 723,950 723,827 Basic earnings (loss) per share $ (.09) $ (.02) $ .17 Effect of dilutive securities: Shares issuable upon exercise of stock options 20,324 28,510 24,389 --------- --------- --------- Weighted average shares
F-29 124 NOTES TO FINANCIAL STATEMENTS, Continued
outstanding - diluted 744,116 752,460 748,216 Diluted earning (loss) per share $ (.09) $ (.02) $ .16
Unaudited Financial Statements: The unaudited balance sheet as of December 31, 1997, and the unaudited statements of income, changes in stockholders' equity and cash flows for the three months ended December 31, 1997 and 1996, in the opinion of management, have been prepared on the same basis as the audited financial statements and include all significant adjustments (consisting primarily of normal recurring adjustments) considered necessary for a fair presentation of the results of these interim periods. Operating results for the three-month period ended December 31, 1997, are not necessarily indicative of the results for the entire year. F-30 125 NOTES TO FINANCIAL STATEMENTS, Continued NOTE 2 - CASH HELD IN TRUST - RESTRICTED: On January 1, 1990, STR established a health and disability benefit plan pursuant to the Employee Retirement Income Security Act of 1974 for employees and their dependents. STR funds the plan by making monthly contributions to a trust established and administered by an independent third party. The monthly contribution is based on a predetermined rate for each enrolled employee. The excess contributions over claims are maintained in trust to cover future claims of the enrolled employees. STR may terminate the trust at any time, for any reason, by resolution of its Board of Directors, and upon written notice to the enrolled employees. Distribution of trust assets shall be determined by STR. STR maintains individual claim and aggregate stop loss coverage. STR records a liability in the financial statements for known claims outstanding and an estimate, based on prior experience, of incurred but not reported claims in excess of amounts remaining in the trust fund. The trust cash account had a zero balance as of September 30, 1997. STR accrued a liability of $143,688 at September 30, 1997 under its health and disability plan. NOTE 3 - UNBILLED CONTRACT COSTS, NET: Net unbilled contract costs consist of the following at September 30, 1997: Unbilled costs and accrued profit on contracts in progress $ 12,128,273 Progress payments (5,930,597) ------------- Total $ 6,197,676 =============
Unbilled costs and accrued profit on contracts in progress comprise principally amounts of revenue recognized on contracts for which billings had not been presented to the contractor because the amounts were not billable at the balance sheet date. It is anticipated such unbilled amounts receivable at September 30, 1997, will be billed over the next 270 days as products and/or services are delivered. Retainages, which approximate $70,000 at September 30, 1997, will be billed and collected as contracts are finalized with the contractor. As of September 30, 1997, there are no significant unrecovered costs or estimated profits subject to future negotiation. Receivables under certain Government contracts are based on provisional rates that permit recovery of overhead not exceeding certain limits. These overhead rates are subject to audit on an annual basis by the Defense Contract Audit Agency (DCAA). When final determination and approval of the allowable rates have been made, receivables may be adjusted accordingly. In management's opinion, any adjustments will not be material. The DCAA has completed their audit of the rates through September 30, 1996. NOTE 4 - RESEARCH AND DEVELOPMENT: Research and development costs are included in general and administrative expenses in the statement of income and are expensed until product feasibility is established. The amount of net research and development costs expensed during 1997 was $516,830. No research and development costs were capitalized in 1997. F-31 126 NOTES TO FINANCIAL STATEMENTS, Continued NOTE 5 - INVENTORIES: Inventories consist of the following at December 31 and September 30, 1997:
December 31 September 30 ----------- ------------ (unaudited) Materials $ 199,686 $ 107,277 Work-in-process 3,625 3,625 ----------- ------------ Total $ 203,311 $ 110,902 =========== ============
NOTE 6 - PROPERTY AND EQUIPMENT: Property and equipment are summarized as follows at September 30, 1997: Furniture and fixtures $ 95,814 Machinery and equipment 1,942,415 Leasehold improvements 316,824 Equipment capitalized under capital leases 328,350 ------------ Subtotal 2,683,403 Less accumulated depreciation (1,751,101) ------------ Total $ 932,302 ============
Depreciation expense was approximately $360,000 for the year ended September 30, 1997. NOTE 7 - NOTE PAYABLE - LINE OF CREDIT: Effective July 31, 1997, STR's bank loan agreement (bank agreement) was amended and extended to June 30, 1998. The amended agreement provides a maximum available line of credit of $4,000,000. However, the total borrowing base generally cannot exceed the sum of 90 percent of qualified Government accounts receivable, 80 percent of qualified non-Government accounts receivable and 50 percent of qualified unbilled Government accounts receivable up to a maximum of $700,000. On October 23, 1997, the bank amended STR's bank agreement to allow an over-advance of $500,000 through January 31, 1998. The over-advance will allow STR to drawdown $500,000 in excess of its existing $4,000,000 line of credit. The bank agreement amendment establishes the interest rate at the bank's prime (8.5 percent at September 30, 1997) plus 1.5 percent. The amendment also contains various covenants as to dividend restrictions, working capital, net worth, earnings and debt-to-equity ratios. STR was not in compliance with the net worth and the debt-to-equity covenants at September 30, 1997. In December 1997, the events of non-compliance were waived by the bank for September 30, 1997, and the covenants were amended. Management anticipates that it will be able to comply with these amended covenants through the term of the agreement. F-32 127 NOTE 7 - NOTE PAYABLE - LINE OF CREDIT (continued): On July 29, 1997, STR established an additional line of credit (line of credit) for the sole purpose of bid bond financing. The line of credit provides for additional financing of $750,000, bears interest at the bank's prime rate plus 2 percent and expires on June 30, 1998. Bid bonds of approximately $65,000 have been applied to the line of credit as of September 30, 1997. STR's accounts receivable, inventory and equipment are pledged as collateral against the bank agreement and the line of credit. The bid bond financing line of credit and over-advance are personally guaranteed by STR's president. NOTE 8 - INCOME TAXES: STR's components of income tax expense are as follows for the year ended September 30, 1997:
Federal State Total ------- ----- ----- Current tax expense $ 51,000 $ 10,000 $ 61,000 Deferred tax expense 10,000 1,000 11,000 ---------- ----------- ---------- Income tax expense $ 61,000 $ 11,000 $ 72,000 ========== =========== ==========
STR's deferred tax assets by tax jurisdiction is as follows at September 30, 1997:
Amount ------ Federal $ 220,500 State 43,951 ----------- Total $ 264,451 ===========
Deferred tax assets consist of the following at September 30, 1997: Deferred compensation $ 111,227 Accrued vacation 134,641 Other, net 18,583 ----------- $ 264,451 ===========
F-33 128 NOTES TO FINANCIAL STATEMENTS, Continued NOTE 8 - INCOME TAXES (continued): Income taxes at statutory rates are reconciled to STR's actual provision as follows:
Percent of Pretax Amount Income ------ ------ Tax at federal statutory rate $ 65,000 34% State income taxes, net of federal tax benefit 11,000 6 Other (4,000) (2) -------- -- Provision for income taxes $ 72,000 38% ======== ==
No valuation allowance was established at September 30, 1997, in view of STR's ability to carry back deferred tax assets to recover taxes paid in previous years. NOTE 9 - EMPLOYEE BENEFIT PLANS: STR's employee benefit plan (the Plan) consists of three segments. The Plan is comprised of a nonleveraged Employee Stock Ownership Plan (ESOP), a 401(k) plan and a profit sharing plan. Eligible employees must have attained 21 years of age, and have completed 500 hours of service during the eligibility computation period. Contributions to the Plan are at the sole discretion of the Board of Directors. Company contributions to the ESOP totaled $118,000 in 1997. The total number of ESOP shares at September 30, 1997, all of which are allocated, is 240,547. At termination or retirement, the Plan will repurchase the participant's vested number of allocated shares for cash at the then fair market value of STR's stock. At December 31, 1996, the fair market value of STR's common stock, as determined by an independent appraisal, was $8.07 per share. There were no purchases of STR's common stock by the ESOP in 1997. Eligible employees may elect to participate in STR's 401(k) plan. In 1997, STR matched 40 percent of the first 5 percent of employee contributions, which amounted to $112,000. STR did not make a contribution to the profit sharing plan in 1997. F-34 129 NOTES TO FINANCIAL STATEMENTS, Continued NOTE 10 - STOCK OPTIONS: STR currently has two stock option plans (1991 Option Plan and 1996 Option Plan). Under the 1991 Option Plan, the option terms are for five years and are fully vested upon grant. Under the 1996 Option Plan, the option terms are for ten years with a five-year vesting period for employees and immediate vesting for directors. Stock option activity is summarized as follows:
1991 Weighted Average 1996 Weighted Average Option Plan Exercise Price Option Plan Exercise Price ----------- -------------- ----------- -------------- Balance at October 1, 1996 44,000 $ 3.06 6,000 $ 8.69 Granted -- -- 18,000 $ 8.62 Expired (4,000) $ 3.93 -- -- Forfeited (10,000) $ 4.08 -- -- ------- ------ Balance at September 30, 1997 30,000 $ 2.60 24,000 $ 8.64 ======= ======
The weighted average grant date fair value of options granted during 1997 was $11.87 per share. The Black-Scholes model was used to estimate the fair value of the options. Significant assumptions include a risk-free interest rate of 7.5 percent and an expected life equal to the term of the options. The following summarizes information about stock options outstanding at September 30, 1997:
Number Range of Weighted Average Outstanding Exercise Prices Remaining Life ----------- --------------- -------------- 1991 Option Plan 30,000 $1.94 to $3.93 3.3 years 1996 Option Plan 24,000 $8.07 to $8.69 9.1 years ------ 54,000 ======
F-35 130 NOTES TO FINANCIAL STATEMENTS, Continued NOTE 10 - STOCK OPTIONS (Continued): STR does not recognize compensation costs for its stock option plan in the determination of net income. Had compensation cost been determined based on the fair value at the grant dates for awards under the plan, STR's net income and earnings per share would have been reduced to the pro forma amounts indicated below at September 30, 1997:
Basic Diluted Earnings Earnings Net income Per Share Per Share ---------- --------- --------- As reported $ 119,880 $ .17 $ .16 Pro forma $ 114,080 $ .16 $ .15
NOTE 11 - CONCENTRATIONS OF CREDIT RISK: As of September 30, 1997, STR had funds on deposit in excess of the federally insured amount with NationsBank. Approximately 95 percent of STR's revenues are generated from contracts with U.S. Government agencies or U.S. Government contractors. NOTE 12 - LEASE COMMITMENTS: Operating Leases: The facilities at STR's principal location have been leased from partnerships (related party) in which certain officers and employees of STR are partners. The risk and rewards associated with the facilities and the obligations imposed by the partnerships' debt reside with the partnerships. In 1993, STR entered into a letter agreement to extend the lease commitment for its principal location. The terms of the letter agreement extended the lease through December 31, 1998, with an option to renew the lease for an additional five years, and provided for minimum lease payments of $347,000 a year. The landlord may cancel the lease by providing 180 days written notice and a cash payment of $250,000 to STR. STR also has an additional facility lease agreement for three years with an unrelated third party. The terms of the lease provide for annual minimum lease payments of $30,713 and an annual escalation of three percent. In connection with an acquisition (Note 14), STR assumed a lease of a corporation for a facility used in the corporation's operations. The terms of the lease provide for annual minimum lease payments of $84,744 plus operating expenses through April 30, 1998. It also contains an option to extend for five years. STR leases various equipment under noncancellable operating leases. F-36 131 NOTES TO FINANCIAL STATEMENTS (continued) NOTE 12 - LEASE COMMITMENTS (Continued): There were no amounts unpaid on these leases at September 30, 1997. Rent expense for the year ended September 30, 1997 was $759,295, which included $418,784 associated with leases from related parties. As of September 30, 1997, minimum rental payments under operating leases for facilities and equipment are as follows:
Related Party Third Party ------------- ----------- 1998 $418,784 $384,392 1999 104,696 179,193 2000 -- 64,345 2001 -- 36,133 2002 -- 4,724 -------- -------- Total $523,480 $668,787 ======== ========
STR subleases a portion of its facility at its principal location. As of September 30, 1997, minimum rentals to be received under the sublease are as follows:
Amount ------ 1998 $36,648 1999 18,774 ---- ------- Total $55,422 =======
Capital Leases: At September 30, 1997, STR was obligated on capital leases for equipment having an aggregate book value of $328,350. The following schedule illustrates the future minimum lease payments:
Years Ending September 30, Amount -------------------------- ------ 1998 $ 81,898 1999 14,597 ---------- Subtotal 96,495 Less amount representing interest (6,651) ---------- Present value of minimum lease obligations 89,844 Less current portion (75,891) ---------- Capital leases payable - long-term portion $ 13,953 ==========
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS: Based on existing rates, economic conditions and the short maturities, the carrying amounts of all the financial instruments at September 30, 1997 are reasonable estimates of their fair values. STR's financial instruments F-37 132 NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued): include cash and cash equivalents, accounts receivable, the note payable - line of credit, accounts payable and the capital lease obligations. NOTE 14 - ACQUISITIONS: On January 17, 1997, STR acquired a division of a corporation for an aggregate purchase price of $110,150 plus liabilities assumed of $53,855. The acquisition was accounted for as a purchase and was included with operations from the acquisition date through September 30, 1997. Pro forma results of operations would not differ significantly from STR's historical operating results. The total purchase price of $164,005 was allocated as follows: Property and equipment $141,375 Prepaid expenses and deposits 22,630 -------- Total $164,005 ========
NOTE 15 - NEW ACCOUNTING PRONOUNCEMENTS: In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 129, "Disclosure of Information about Capital Structure," for fiscal years beginning after December 15, 1997. The provisions of SFAS No. 129 established standards for disclosing information about an entity's capital structure. STR believes that the adoption of this standard will not have a material effect on STR's current disclosure requirements. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," for fiscal years beginning after December 15, 1997. The provisions of SFAS No. 130 establish standards for reporting and display of comprehensive income and its components in the financial statements. This statement requires all items that are required to be recognized under accounting standards as components of comprehensive income be reported in the financial statements and displayed with the same prominence as other financial statements. The provisions of SFAS No. 131 establish standards for the way that enterprises report information about operating segments in annual financial statements and require that selected information about operating segments in interim financial statements be reported. It also establishes standards for related disclosure about products and services, geographic areas, and major customers. STR is currently reviewing these new standards of disclosure for adoption in 1999. NOTE 16 - SUBSEQUENT EVENTS: On November 11, 1997, STR announced it had reached an agreement in principle to merge with Daedalus Enterprises, Inc. ("Daedalus"). Daedalus is a publicly traded company. Under the agreement, STR will become a wholly owned subsidiary of Daedalus. An agreement and plan of merger was executed on December 23, 1997, wherein each of STR's shares issued and outstanding, other than dissenter's shares, will be converted on the effective date of the merger into the right to receive 2.58 Daedalus shares of common stock. The merger, which is subject to regulatory approval, is expected to be finalized during the second quarter of calendar 1998. On January 30, 1998, STR completed a private placement of securities, whereby STR issued 582,000 shares of common stock. The common stock was issued for cash of $6.50 per share for aggregate proceeds of $3,783,000. F-38 133 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors S.T. Research Corporation Newington, Virginia We have audited the accompanying balance sheets of S.T. Research Corporation as of September 30, 1996 and 1995, and the related statements of income, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of STR'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 present fairly, in all material respects, the financial position of S.T. Research Corporation as of September 30, 1996 and 1995, and the results of its operations and cash flows for the years then ended in conformity with generally accepted accounting principles. ROSS, LANGAN & MCKENDREE, L.L.P. McLean, VA November 20, 1996 F-39 134 S.T. RESEARCH CORPORATION BALANCE SHEETS ASSETS
September 30, ------------------------------ (Restated - Note 15) 1996 1995 ---- ---- CURRENT ASSETS Cash and cash equivalents (Note 1) $ 41,208 $ 184,785 Cash held in trust - restricted (Note 2) 9,446 7,942 Accounts receivable 2,266,138 1,026,201 Unbilled contract costs, net (Note 3) 4,385,410 3,343,609 Inventories - at cost (Note 5) 241,363 41,034 Deferred tax asset (Note 8) 275,451 252,427 Other current assets 48,451 42,210 ---------- ---------- Total current assets 7,267,467 4,898,208 ---------- ---------- PROPERTY AND EQUIPMENT (Note 6) 829,770 707,839 ---------- ---------- OTHER ASSETS Deposits 47,450 36,090 ---------- ---------- TOTAL ASSETS $8,144,687 $5,642,137 ========== ==========
The accompanying notes are an integral part of these financial statements. F-40 135 S.T. RESEARCH CORPORATION BALANCE SHEETS (Continued) LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, ------------------------------- (Restated - Note 15) 1996 1995 ---- ---- CURRENT LIABILITIES Note payable - line of credit (Note 7) $2,327,491 $ 321,282 Accounts payable 1,300,463 1,677,549 Accrued salaries, benefits, and related expenses 1,629,551 1,043,727 Other accrued expenses 215,137 173,435 Capital leases (Note 13) 111,907 80,707 Income taxes payable 50,500 101,600 ---------- ---------- Total current liabilities 5,635,049 3,398,300 LONG-TERM LIABILITIES Capital leases (Note 13) 89,844 150,698 ---------- ---------- TOTAL LIABILITIES 5,724,893 3,548,998 ---------- ---------- COMMITMENTS AND CONTINGENCIES -- -- STOCKHOLDERS' EQUITY Common stock, $.10 par value, 3,000,000 shares authorized, of which 724,204 were issued at September 30, 1996 and 1995 72,421 72,421 Additional paid-in capital 1,236,306 1,236,306 Retained earnings 1,111,067 784,412 ---------- ---------- Total stockholders' equity 2,419,794 2,093,139 ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $8,144,687 $5,642,137 ========== ==========
The accompanying notes are an integral part of these financial statements. F-41 136 S.T. RESEARCH CORPORATION STATEMENTS OF INCOME FOR THE YEARS ENDED
September 30, -------------------------------------- (Restated - Note 15) 1996 1995 ---- ---- REVENUE Contract revenue $ 21,654,578 $ 16,561,840 ------------ ------------ COSTS AND EXPENSES Cost of revenues 18,607,490 13,732,783 General and administrative expenses 2,343,024 2,331,319 ------------ ------------ Total costs and expenses 20,950,514 16,064,102 ------------ ------------ INCOME FROM OPERATIONS 704,064 497,738 OTHER INCOME (EXPENSES) Interest expense (232,409) (90,706) ------------ ------------ INCOME BEFORE INCOME TAXES 471,655 407,032 INCOME TAX PROVISION (Note 8) 145,000 90,000 ------------ ------------ NET INCOME $ 326,655 $ 317,032 ============ ============ PER SHARE AMOUNT Basic earnings per share $ .45 $ .44 ============ ============ Diluted earnings per share $ .42 $ .42 ============ ============ WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING Basic 724,204 719,743 Diluted 769,507 575,149
The accompanying notes are an integral part of these financial statements. F-42 137 S.T. RESEARCH CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 1996 AND 1995
Total Additional Retained Stockholders' Common Paid-in Earnings Equity Stock Capital (Restated - Note 15) (Restated - Note 15) ----- ------- -------------------- -------------------- BALANCE, OCTOBER 1, 1994 $ 71,350 $1,187,377 $ 467,380 $1,726,107 Sale of common stock (Note 9) 1,071 48,929 -- 50,000 Net income -- -- 317,032 317,032 ---------- ---------- ---------- ---------- BALANCE, SEPTEMBER 30, 1995 72,421 1,236,306 784,412 2,093,139 Net income -- -- 326,655 326,655 ---------- ---------- ---------- ---------- BALANCE, SEPTEMBER 30, 1996 $ 72,421 $1,236,306 $1,111,067 $2,419,794 ========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements. F-43 138 S.T. RESEARCH CORPORATION STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
September 30, ----------------------------------- (Restated - Note 15) 1996 1995 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 326,655 $ 317,032 ----------- ----------- Adjustments to reconcile net income to net cash provided by (used in) operating activities: (Gain) loss on disposition of property and equipment (1,275) 4,846 Depreciation 281,355 190,120 Deferred tax expense (23,024) (34,927) Changes in assets and liabilities (Increase) decrease in cash held in trust (1,504) 126 Increase in accounts receivable (2,281,738) (969,183) (Increase) decrease in inventories (200,329) 47,214 Increase in other current assets (6,241) (3,222) Increase in deposits (11,360) (2,652) Increase (decrease) in accounts payable (377,085) 1,056,464 Increase in accrued expenses 627,526 70,464 Increase (decrease) in income taxes payable (51,100) 98,222 ----------- ----------- Total adjustments (2,044,775) 457,472 ----------- ----------- Net cash provided by (used in) operating activities (1,718,120) 774,504 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Acquisitions of property and equipment (349,728) (400,537) Proceeds from disposition of property and equipment 4,100 -- ----------- ----------- Net cash used in investing activities (345,628) (400,537) ----------- -----------
The accompanying notes are an integral part of these financial statements. F-44 139 S.T. RESEARCH CORPORATION STATEMENTS OF CASH FLOWS (Continued) FOR THE YEARS ENDED
September 30, ---------------------------------- (Restated - Note 15) 1996 1995 ---- ---- CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds (payments) under line of credit $ 2,006,209 ($ 538,073) Principal payments on capital lease obligations (86,038) (36,156) Issuance of common stock -- 50,000 ----------- ----------- Net cash provided by (used in) financing activities 1,920,171 (524,229) ----------- ----------- NET DECREASE IN CASH AND CASH EQUIVALENTS (143,577) (150,262) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 184,785 335,047 ----------- ----------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 41,208 $ 184,785 =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash payments for interest $ 224,906 $ 93,904 =========== =========== Cash payments for income taxes $ 219,123 $ 15,900 =========== ===========
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING TRANSACTIONS: DEI incurred capital lease obligations of $56,383 in 1996 and $271,968 in 1995 in conjunction with fixed asset leases. The accompanying notes are an integral part of these financial statements. F-45 140 NOTES TO FINANCIAL STATEMENTS NOTE 1 - STR AND ITS SIGNIFICANT ACCOUNTING POLICIES: Business Activities: S. T. Research Corporation ("STR") designs, develops, manufactures, and markets reconnaissance systems and related products primarily through U.S. Government contracts. Revenue Recognition: Revenue under Government fixed-price and cost-type contracts, including customer funded research and development, is recognized using the percentage of completion method. Revenue recognized in the current period is calculated by multiplying the completion percentage by the total contract value, less revenue recognized in previous periods. The completion percentage is the ratio of the total costs incurred to date to the total anticipated costs. Revenue under cost-reimbursement contracts are recorded as costs are incurred and include estimated earned fees in the proportion that costs incurred to date bear to total estimated costs. The fees under certain Government contracts may be increased or decreased in accordance with cost or performance incentive provisions which measure actual performance against established targets or other criteria. Such incentive fee awards or penalties, which historically are not material, are included in revenue at the time the amounts can be determined reasonably. Anticipated losses are recognized at the time they become known. Inventories: Inventories are stated at the lower of cost or market, determined on the first-in, first-out basis. Property and Equipment: Property and equipment are recorded at cost and are depreciated over estimated useful lives ranging from three to eight years using straight-line and accelerated methods. Leasehold improvements are amortized over the life of the improvement using the straight-line method. Amortization of leasehold improvements and capital lease obligations are included in depreciation expense. The cost and accumulated depreciation or amortization of assets sold or retired are removed from the respective accounts and any gain or loss is reflected in other income (expenses). Cash and Cash Equivalents: For purposes of the statement of cash flows, STR considers all unrestricted highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Income Taxes: STR accounts for income taxes in accordance with Statement of Financial Accounting Standard (SFAS) No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities have been established for the temporary differences between financial statement and tax basis of assets and liabilities existing at the balance sheet date using expected tax rates. A valuation allowance is recorded to reduce a deferred tax asset to that portion that is expected to more likely than not be realized. F-46 141 NOTES TO FINANCIAL STATEMENTS F-47 142 NOTE 1 - STR AND ITS SIGNIFICANT ACCOUNTING POLICIES (continued): Use of Estimates: The preparation of financial statements 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 revenue and expenses during the reporting periods. Accordingly, actual results could differ from those estimates. Operating Cycle: In accordance with industry practice, STR classifies as current assets amounts relating to long-term contracts which may have terms extending beyond one year but are expected to be realized during the normal operating cycle of STR. The liabilities in the accompanying balance sheets which have been classified as current liabilities are those expected to be satisfied by the use of assets classified as current assets. Earnings Per Share: Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earning Per Share." This Statement requires the discussion of basic and diluted earnings per share and revises the method required to calculate these amounts under previous standards. Basic earnings per share is computed using the weighted average number of common shares outstanding during each period. Diluted earnings per share is computed using the weighted average number of common and common equivalent shares outstanding during each period. Earnings per share data for periods prior to December 31, 1997 have been restated to reflect adoption of this Statement. The following summary is presented for the years ended:
September 30, ----------------------- 1996 1995 ---- ---- Net Income $326,655 $317,032 Weighted average shares outstanding - basic 734,204 719,743 Basic earnings per share $ .45 $ .44 Effect of dilutive securities: Shares issuable upon exercise of stock options 29,083 18,217 Shares issuable upon exercise of warrants 16,220 19,189 Weighted Average Shares outstanding - diluted 769,507 757,149 Diluted earnings per share $ .42 $ .42
NOTE 2 - CASH HELD IN TRUST - RESTRICTED: On January 1, 1990, STR established a health and disability benefit plan pursuant to the Employee Retirement Income Security Act of 1974 for employees and their dependents. STR funds the plan by making monthly contributions to a trust established and administered by an independent third party. The monthly contribution is F-48 143 based on a predetermined rate for each enrolled employee. The excess contributions over claims are maintained in trust to cover future claims of the enrolled employees. STR may terminate the trust at any time, for any reason, by resolution of its Board of Directors, and upon written notice to the enrolled employees. Distribution of trust assets shall be determined by STR. STR maintains individual claim and aggregate stop loss coverage. STR records a liability in the financial statements for known claims outstanding and an estimate, based on prior experience, of incurred but not reported claims in excess of amounts remaining in the trust fund. The trust cash account had a balance of $9,446 and $7,942 at September 30, 1996 and 1995, respectively. STR accrued a liability of $155,410 at September 30, 1996 and $142,969 at September 30, 1995 under its health and disability plan. F-49 144 NOTE 3 - UNBILLED CONTRACT COSTS, NET: Net unbilled contract costs consist of the following:
September 30, --------------------------- 1996 1995 ---- ---- Unbilled costs and accrued profit on contracts in progress $ 10,680,854 $ 10,900,698 Progress payments (6,295,444) (7,557,089) ------------ ------------ Total $ 4,385,410 $ 3,343,609 ============ ============
Unbilled costs and accrued profit on contracts in progress represent revenue recognized in excess of billings at the balance sheet date. It is anticipated that such unbilled amounts receivable will be billed over the next 270 days as the products and/or services are delivered. Retainages, which approximate $120,000 and $88,000 at September 30, 1996 and 1995, respectively, will be billed and collected as contracts are finalized. As of September 30, 1996 and 1995, there were no significant unrecovered costs or estimated profits subject to future negotiations. Receivables under certain government contracts are based on provisional rates that permit recovery of overhead not exceeding certain limits. These overhead rates are subject to audit on an annual basis by the Defense Contract Audit Agency (DCAA). When final determination and approval of the allowable rates have been made, receivables may be adjusted accordingly. In management's opinion, any adjustments will not be material. NOTE 4 - RESEARCH AND DEVELOPMENT: Research and development costs are included in general and administrative expenses in the statement of income and are expensed until product feasibility is established. The amount of research and development costs expensed totaled $817,100 and $683,400 for 1996 and 1995, respectively. No research and development costs were capitalized in 1996 and 1995. NOTE 5 - INVENTORIES: Inventories consist of the following:
September 30, ------------------------------- 1996 1995 ---- ---- Materials $139,226 $ - Work-in-process 102,137 41,034 -------- ------ Total $241,363 $41,034 ======== =======
F-50 145 NOTE 6 - PROPERTY AND EQUIPMENT: Property and equipment are summarized as follows:
September 30, --------------------------- 1996 1995 ---- ---- Furniture and fixtures $113,214 $94,958 Machinery and equipment 1,744,578 1,659,320 Leasehold improvements 295,658 249,075 Equipment capitalized under capital leases 328,350 253,551 ----------- ---------- Subtotal 2,481,800 2,256,904 Less accumulated depreciation (1,652,030) (1,549,065) ----------- ---------- Total $ 829,770 $ 707,839 =========== ==========
Depreciation expense for the years ended September 30, 1996 and 1995 was $281,355 and $190,120, respectively. NOTE 7 - NOTE PAYABLE - LINE OF CREDIT: STR's bank loan agreement has been amended and extended to April 30, 1997. The amended agreement provides a maximum available line of credit of $3,000,000. However, the total borrowing base generally cannot exceed the sum of 90 percent of qualified government accounts receivable, 80 percent of qualified non-government accounts receivable and 50 percent of qualified unbilled government accounts receivable up to a maximum of $700,000. The amendment establishes the interest rate at the bank's prime plus 1.5 percent. The amendment also contains various covenants as to working capital, net worth, interest coverage and a debt-to-equity ratio. STR was in compliance with these covenants at September 30, 1996. The line of credit is secured by STR's accounts receivable and equipment and is personally guaranteed by STR's president. F-51 146 NOTE 8 - INCOME TAXES: STR's components of income tax expense from continuing operations are as follows:
September 30, 1996 ------------------------------------- Federal State Total ------- ----- ----- Current tax expense $ 134,500 $ 33,500 $ 168,000 Deferred tax benefit (19,000) (4,000) (23,000) --------- --------- --------- Income tax expense $ 115,500 $ 29,500 $ 145,000 ========= ========= =========
(Restated - Note 15) September 30, 1995 ---------------------------------------- Federal State Total ------- ----- ----- Current tax expense $ 95,000 $ 30,000 $ 125,000 Deferred tax benefit (31,000) (4,000) (35,000) --------- --------- --------- Income tax expense $ 64,000 $ 26,000 $ 90,000 ========= ========= =========
STR's deferred tax assets by tax jurisdiction are as follows:
September 30, ------------------------------------ (Restated - Note 15) 1996 1995 ---- ---- Federal $230,500 $212,000 State 44,951 40,427 -------- -------- Total $275,451 $252,427 ======== ========
Deferred tax assets consist of the following:
September 30, --------------------------------- (Restated - Note 15) 1996 1995 ---- ---- Deferred compensation $101,786 $ 88,235 Accrued vacation 158,141 120,628 Tax credits - 15,500 Other, net 15,524 28,064 -------- -------- Total $275,451 $252,427 ======== ========
F-52 147 NOTE 8 - INCOME TAXES (continued): Income taxes at statutory rates are reconciled to STR's actual provision as follows:
Year Ending September 30, ----------------------------------------------------------- (Restated - Note 15) 1996 1995 ---- ---- Percent of Percent of Pretax Pretax Amount Income Amount Income ------ ------ ------ ------ Tax at federal statutory rate $160,000 34% $138,000 34% State income taxes, net of federal tax benefit 28,000 6 24,000 6 Research and development credit benefit (37,000) (8) (63,000) (16) Other (6,000) (1) (9,000) (2) -------- -- ------- Provision for income taxes $145,000 31% $90,000 22% ======== == ======= ==
At September 30, 1995, STR had $15,500 of available research and development credits. During 1996, STR generated an additional $21,625 of research and development credits. All the available credits were applied in 1996. No valuation allowance was established at September 30, 1996 and 1995. NOTE 9 - EMPLOYEE BENEFIT PLANS: STR's employee benefit plan (the Plan) consists of three segments. The Plan is comprised of a nonleveraged Employee Stock Ownership Plan (ESOP), a 401(k) plan and a profit sharing plan. Eligible employees must have attained 21 years of age, and have completed 500 hours of service during the eligibility computation period. Contributions to the Plan are at the sole discretion of the Board of Directors. During 1995, the ESOP purchased 10,706 shares of STR's common stock for an average purchase price of $4.67 per share. The purchase price per share was based on an independent appraisal of STR's common stock. The total purchases were $50,000 in 1995. There were no purchases in 1996. The total number of ESOP shares at September 30, 1996, all of which are allocated, is 240,547. At December 31, 1995, the fair market value of STR's common stock, as determined by an independent appraisal, was $8.69 per share. Company contributions totaled $105,000 in 1996 and $27,232 in 1995. At termination or retirement, the Plan will repurchase the participant's vested number of allocated shares for cash at the then fair market value of STR's stock. Eligible employees may elect to participate in STR's 401(k) plan. During 1996, STR elected to match 50 percent of the first 5 percent of the employee contribution. STR elected to match 45 percent of the total employee contribution in 1995. Company contributions to the 401(k) plan totaled $95,000 in 1996 and $97,769 in 1995. STR did not contribute to the profit sharing plan in either 1996 or 1995. NOTE 10 - STOCK OPTIONS: STR has established a stock option plan in order that Board members and certain key employees may purchase shares of common stock. Outstanding options are as follows: F-53 148
Shares Option Outstanding Price ----------- ----- Balance at October 1, 1994 44,000 Granted - Revoked - ------ Balance at September 30, 1995 44,000 Granted 6,000 $8.69 per share Revoked - ------ Balance at September 30, 1996 50,000 ====== Year exercisable: Shares ------ 1997 10,000 $3.93 per share 1998 4,000 $4.30 per share 1999 - 2000 - 2001-2006 36,000 $1.94 - $8.69 per share ------ Total 50,000 ======
NOTE 11 - STOCK WARRANTS: On July 13, 1989, STR executed a loan agreement with MetCap. The loan has been repaid, but under the terms of the original agreement, MetCap obtained a stock purchase warrant to acquire 20,000 shares of STR's stock. A subsequent amendment and anti-dilution provisions of the agreement have resulted in MetCap holding warrants for 31,394 shares at $1.73 per share as of September 30, 1995. The warrants were redeemed for $18,000 during 1996. NOTE 12 - CONCENTRATIONS OF CREDIT RISK: As of September 30, 1996 and 1995, STR had funds on deposit in excess of the federally insured amount with NationsBank. Approximately 95 percent of STR's revenues are generated from contracts with U.S. Government agencies or U.S. Government contractors. F-54 149 NOTE 13 - LEASE COMMITMENTS: Operating Leases: The facilities at STR's principal location have been leased from partnerships in which certain officers and employees of STR are partners. The risk and rewards associated with the facilities and the obligations imposed by the partnerships' debt reside with the partnerships. In 1993, STR entered into a good faith letter agreement to extend the lease commitment for its principal facilities. The terms of the letter agreement extended the lease through December 31, 1998 with an option to renew the lease for an additional five years, and provided for minimum lease payments of $347,000 a year. As of the report date, STR had not entered into the formal lease agreement. The landlord may cancel the lease by providing 180 days written notice, and a cash payment of $250,000 to STR. STR also leases various equipment under non-cancellable operating leases. There were no amounts unpaid on this lease at September 30, 1996 and 1995. Total sublease income was $26,922 for 1996 and $26,300 for 1995. Total rent expense was $510,642 and $567,350 for 1996 and 1995, respectively. As of September 30, 1996, minimum rental payments under operating leases for facilities and equipment are as follows:
Years Ending September 30, Amount -------------------------- ------ 1997 $ 489,957 1998 443,636 1999 121,781 2000 4,567 ---------- Total $1,059,941 ==========
As of September 30, 1996, minimum rentals to be received under subleases are as follows:
Years Ending September 30, Amount -------------------------- ------ 1997 $ 34,500 1998 36,648 1999 18,774 Total $ 89,922 ==========
F-55 150 NOTE 13 - LEASE COMMITMENTS (continued): Capital Leases At September 30, 1996, STR was obligated on capital leases for equipment having an aggregate book value of $328,350. The following schedule illustrates the future minimum lease payments:
Years Ending September 30, Amount -------------------------- ------ 1997 $132,977 1998 81,898 1999 14,597 -------- Subtotal 229,472 Less amount representing interest (27,721) -------- Present value of minimum lease obligations 201,751 Less current portion (111,907) -------- Capital leases payable - long-term portion $ 89,844 ========
NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENT: Based on existing rates, economic conditions, and the short maturities, the carrying amounts of all the financial instruments at September 30, 1996 and 1995 are reasonable estimates of their fair value. STR's financial instruments include cash and cash equivalents, cash held in trust, accounts receivable, the note payable - line of credit, accounts payable and the capital lease obligations. NOTE 15 - PRIOR PERIOD RESTATEMENT: The income tax provision, income taxes payable and the deferred tax asset was incorrectly computed for the year ended September 30, 1995. As a result, the 1995 financial statements have been restated. The adjustment to the income tax provision increased net income and retained earnings for the year ended September 30, 1995 by $10,000 over the amount previously reported. NOTE 16 - SUBSEQUENT EVENTS: On November 13, 1996, STR entered into a letter of intent agreement to purchase the business and assets, including the assumption of lease agreements, of a division of a major corporation. Final settlement on the purchase is anticipated to occur in early 1997. On December 9, 1996, the Board of Directors ratified actions taken by STR's management to form a Virginia corporation primarily to develop and protect its commercial line of communication services. It is anticipated that all business activities of the new corporation will be consolidated within STR as a communications division. F-56 151 NOTE 17 - NEW ACCOUNTING PRONOUNCEMENTS: In March 1995, the Financial Accounting Standards Board (FASB) issued 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," for fiscal years beginning after December 15, 1995. The provisions of SFAS No. 121 establish standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. In October 1995, the FASB issued SFAS No.123, "Accounting for Stock-Based Compensation," SFAS No.123 is effective for fiscal years beginning after December 15, 1995 and establishes financial accounting and reporting standards for stock-based employee compensation plans. STR believes the adoption of these standards in 1997 will not have a material impact on STR's current disclosure requirements F-57 152 ANNEX A AGREEMENT AND PLAN OF MERGER This Agreement and Plan of Merger (the "Agreement") is made as of December 23, 1997, by and among Daedalus Enterprises, Inc., a Delaware corporation ("DEI"), DEI Merger Sub, Inc., a Virginia corporation and wholly owned subsidiary of DEI ("Merger Sub"), and S. T. Research Corporation, a Virginia corporation ("STR"). DEI, Merger Sub and STR may be referred to individually as a "Party" or collectively as the "Parties". W I T N E S S E T H WHEREAS, STR, Merger Sub and DEI desire that Merger Sub merge with and into STR (the "Merger"), with STR being the surviving corporation of the Merger; WHEREAS, DEI, Merger Sub and STR desire to make certain representations, warranties, covenants and agreements in connection with the Merger; and WHEREAS, the Merger is intended to constitute a tax-free reorganization as described in Section 368 of the Code. NOW, THEREFORE, subject to the terms and conditions of this Agreement and the Articles of Merger to be filed in the Commonwealth of Virginia in order to effectuate the Merger, and in consideration of the premises and the mutual covenants and agreements hereinafter set forth, the Parties hereby agree as follows: 1. DEFINITIONS. For purposes of this Agreement, the following capitalized terms will have the following meanings: "Acquisition Proposal" has the meaning set forth in Section 5.7. "Affiliate" has the meaning set forth in Rule 12b-2 of the regulations promulgated under the Exchange Act. "Agreement" has the meaning set forth in the Preamble to this Agreement. "Articles of Merger" means the Articles of Merger to be filed with the Virginia State Corporation Commission setting forth the terms of the Merger. "Balance Sheet" has the meaning set forth in Section 4.1(h). "Certificate" has the meaning set forth in Section 3.1(a). "Closing" has the meaning set forth in Section 8.1. "Closing Date" has the meaning set forth in Section 8.1. "Code" means the Internal Revenue Code of 1986, as amended. A-1 153 "Constituent Corporations" has the meaning set forth in Section 2.1(b). "DEI" has the meaning set forth in the Preamble to this Agreement. "DEI Amended Certificate" means the Amended and Restated Certificate of Incorporation of DEI in the form attached as Exhibit 5.2. "DEI Balance Sheet" has the meaning set forth in Section 4.2(o). "DEI Common Stock" means the common stock, $.01 par value, of DEI. "DEI License Agreement" has the meaning set forth in Section 4.2(l). "DEI SEC Documents" has the meaning set forth in Section 4.2(d). "DEI Share" means any share of DEI Common Stock. "DEI Subsidiaries" has the meaning set forth in Section 4.2(b). "DGCL" means the Delaware General Corporation Law. "Dissenters' Shares" has the meaning set forth in Section 3.1(e). "Effective Time" has the meaning set forth in Section 2.2(a). "Employee Benefit Plan" means any (a) nonqualified deferred compensation or retirement plan or arrangement which is an Employee Pension Benefit Plan, (b) qualified defined contribution retirement plan or arrangement which is an Employee Pension Benefit Plan, (c) qualified defined benefit retirement plan or arrangement which is an Employee Pension Benefit Plan (including any Multiemployer Plan), (d) Employee Welfare Benefit Plan, including medical, dental, disability and other welfare benefits plan, and material fringe benefit plan or program, (e) employee, severance and termination agreements and arrangements, and (f) all plans, programs and arrangements with respect to stock options, restricted stock, phantom stock and other stock-based or stock-related compensation. "Employee Pension Benefit Plan" has the meaning set forth in Section 3(2) of ERISA. "Employee Welfare Benefit Plan" has the meaning set forth in Section 3(1) of ERISA. "Employment Agreement" means an employment agreement in the form attached hereto as Exhibit 8.2(a)(iii). "Environmental, Health, and Safety Laws" means the Comprehensive Environmental Response, Compensation and Liability Act of 1980, the Resource Conservation and Recovery Act of 1976, and the Occupational Safety and Health Act of 1970, each as amended, together with all A-2 154 other laws (including rules, regulations, codes, plans, injunctions, judgments, orders, decrees, rulings, and charges thereunder) of federal, state, local, and foreign governments (and all agencies thereof) concerning pollution or protection of the environment, public health and safety, or employee health and safety, including laws relating to emissions, discharges, releases, or threatened releases of pollutants, contaminants, or chemical, industrial, hazardous, or toxic materials or wastes into ambient air, surface water, ground water, or lands or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport, or handling of pollutants, contaminants, or chemical, industrial, hazardous, or toxic materials or wastes. "ERISA" means the Employee Retirement Income Security Act of 1974 (including any amendments thereof, and the regulations and published interpretations thereunder). "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Exchange Agent" means American Stock Transfer and Trust Company. "Financial Statements" has the meaning set forth in Section 4.1(f). "GAAP" means United States generally accepted accounting principles, as in effect from time to time. "Higher Offer" has the meaning set forth in Section 5.7. "Intellectual Property Rights" means all of the right, title and interest of the party in and to (a) all inventions (whether patentable or unpatentable and whether or not reduced to practice), all improvements thereto, and all patents, patent applications, and patent disclosures, together with all reissuances, continuations, continuations-in-part, revisions, extensions, and reexaminations thereof, (b) all trademarks, service marks, trade dress, logos, trade names, and corporate names, together with all translations, adaptations, derivations, and combinations thereof and including all goodwill associated therewith, and all applications, registrations, and renewals in connection therewith, (c) all copyrightable works, all copyrights, and all applications, registrations, and renewals in connection therewith, (d) all mask works and all applications, registrations, and renewals in connection therewith, (e) all trade secrets and confidential business information (including ideas, research and development, know-how, formulas, compositions, manufacturing and production processes and techniques, technical data, designs, drawings, specifications, customer and supplier lists, pricing and cost information, and business and marketing plans and proposals), (f) all computer software (including data and related documentation), (g) all other proprietary rights, and (h) all copies and tangible embodiments thereof (in whatever form or medium). "Knowledge" means present actual knowledge, without independent investigation. "Liability" means any liability (whether asserted or unasserted, whether absolute or contingent, whether accrued or unaccrued, whether liquidated or unliquidated, and whether due or to become due), including any liability for Taxes. A-3 155 "License Agreement" has the meaning set forth in Section 4.1(l). "Merger" has the meaning set forth in the first recital to this Agreement. "Merger Consideration" has the meaning set forth in Section 3.1(a). "Merger Sub" has the meaning set forth in the Preamble to this Agreement. "Multiemployer Plan" has the meaning set forth in Section 3(37) of ERISA. "Ordinary Course of Business" means the ordinary course of business consistent with current and past custom and practice (including with respect to quantity and frequency). "Party" and "Parties" have the meaning set forth in the Preamble of this Agreement. "Person" means an individual, a partnership, a corporation, an association, a joint stock company, a trust, a joint venture, an unincorporated organization or association, or a governmental entity (or any department, agency, or political subdivision thereof). "SEC" means the U.S. Securities and Exchange Commission. "Securities Act" means the Securities Act of 1933, as amended. "Security Interest" means any mortgage, pledge, lien, encumbrance, charge, or other security interest, other than (a) mechanic's, materialmen's and similar liens, (b) liens for Taxes not yet due and payable or for Taxes that the taxpayer is contesting in good faith through appropriate proceedings, (c) purchase money liens and liens securing rental payments under capital lease arrangements, and (d) other liens arising in the Ordinary Course of Business and not incurred in connection with the borrowing of money. "STR" has the meaning set forth in the Preamble to this Agreement. "STR Share" means any share of STR common stock, $.10 par value. "Subject Company" has the meaning set forth in Section 5.11. "Surviving Corporation" has the meaning set forth in Section 2.1(a). "Tax" means any federal, state, local, or foreign income, gross receipts, license, payroll, employment, excise, severance, stamp, occupation, premium, windfall profits, environmental (including taxes under Code Section 59A), customs duties, capital stock, franchise, profits, withholding, social security (or similar), unemployment, disability, real property, personal property, sales, use, transfer, registration, value added, alternative or add-on minimum, estimated, or other tax of any kind whatsoever, including any interest, penalty, or addition thereto, whether disputed or not. A-4 156 "VSCA" means the Virginia Stock Corporation Act. 2. MERGER. 2.1 The Merger. (a) Subject to the terms and conditions of this Agreement, the Articles of Merger, the DGCL and the VSCA, at the Effective Time (as defined in Section 2.2(a) below) (i) Merger Sub will be merged with and into STR and (ii) the separate corporate existence of Merger Sub will cease and STR will continue as the "Surviving Corporation". (b) At the Effective Time (i) the Surviving Corporation will continue its corporate existence under the laws of the Commonwealth of Virginia and will possess all of the rights, privileges, immunities, powers, franchises and purposes of STR and Merger Sub immediately prior to the Merger (STR and Merger Sub will sometimes be referred to in this Agreement as the "Constituent Corporations"), (ii) all property of the Constituent Corporations will be the property of the Surviving Corporation and (iii) the Surviving Corporation will, by operation of law, assume all of the liabilities and obligations of the Constituent Corporations. (c) The Articles of Incorporation of STR in effect at and as of the Effective Time will remain the Articles of Incorporation of the Surviving Corporation without any modification or amendment in the Merger. (d) The Bylaws of STR in effect at and as of the Effective Time will remain the Bylaws of the Surviving Corporation without any modification or amendment in the Merger. (e) The existing directors and officers of STR in office immediately prior to the Effective Time will remain the directors and officers of the Surviving Corporation until their successors shall have been duly elected or appointed and qualified or until their earlier death, resignation or removal in accordance with the Surviving Corporation's Articles of Incorporation, bylaws and applicable law. 2.2 Effectiveness of the Merger. (a) The Articles of Merger will be filed with the Virginia State Corporation Commission on the day of the Closing or as soon thereafter as is practicable. The Merger will become effective at the time at which the Articles of Merger are filed with the Virginia State Corporation Commission, or at such later time as is agreed upon by the Parties and specified in the Articles of Merger (the "Effective Time"). (b) If, at any time after the Effective Time, the Surviving Corporation will consider or be advised that any further deeds, assignments or other things are necessary or desirable to vest, perfect or confirm, of record or otherwise, in the Surviving Corporation, the title to any property or rights of the Constituent Corporations acquired or to be acquired by reason or as a result of, the Merger, the Constituent Corporations and their officers and directors, on behalf of the Constituent A-5 157 Corporations, to the extent permitted by law, will execute and deliver all such deeds and assignments and do all things necessary or desirable to vest, perfect or confirm title to such property or rights in the Surviving Corporation and otherwise to carry out the purpose of this Agreement, and the officers and directors of the Surviving Corporation are fully authorized in the name of the Constituent Corporations or otherwise to take any and all such actions. 3. MERGER CONSIDERATION. 3.1 Merger Consideration and Conversion of Shares. At the Effective Time, by virtue of the Merger and without any action on the part of any holder thereof: (a) Each STR Share issued and outstanding at the Effective Time, other than Dissenters' Shares (as defined in Section 3.1(e)), shall be converted into the right to receive 2.58 DEI Shares in accordance with Section 3.2 (the "Merger Consideration"). At the Effective Time, each STR Share shall cease to be outstanding, shall automatically be canceled and retired and shall cease to exist. Each holder of a stock certificate which immediately prior to the Effective Time represented outstanding STR Shares (a "Certificate") shall cease to have any rights with respect thereto except the right to receive, without interest, the Merger Consideration upon the surrender of such Certificate in accordance with Section 3.2. No transfers of the STR Shares shall be made on the stock transfer books of STR at or after the Effective Time. (b) Each STR Share issued and held by STR immediately prior to the Effective Time, if any, shall cease to be outstanding, shall automatically be canceled and retired without payment of any consideration therefor and shall cease to exist. (c) DEI Shares issued and outstanding immediately prior to the Effective Time shall remain outstanding and shall be unaffected by the Merger. Outstanding certificates representing DEI Shares will continue to represent the number of shares of common stock of DEI following the Effective Time and need not be exchanged for new certificates of DEI by any holders thereof. (d) Each share of common Stock of Merger Sub issued and outstanding immediately prior to the Effective Time shall be converted into the same number of shares of common stock of the Surviving Corporation. (e) Notwithstanding anything in this Agreement to the contrary, the STR Shares which are issued and outstanding immediately prior to the Effective Time and which are held by shareholders who do not vote in favor of the approval and adoption of this Agreement and who comply with all of the relevant provisions of Sections 13.1-729 through 13.1-741 of the VSCA (the "Dissenters' Shares") shall not be converted into or be exchangeable for the right to receive the Merger Consideration. Dissenters' Shares shall, from and after the Effective Time, no longer be outstanding and shall be canceled and retired and shall cease to exist, and each holder of Dissenters' Shares shall thereafter cease to have any rights with respect to such Shares except the right, if any, to receive payment pursuant to the relevant provisions of Sections 13.1-729 through 13.1-741 of the VSCA. If any holder of STR Shares shall fail to perfect or shall have effectively withdrawn or lost A-6 158 the right to dissent, the STR Shares held thereby shall thereupon be treated as though converted into the Merger Consideration pursuant to Section 3.1(a) and such shares shall be deemed not to be Dissenters' Shares. Any Merger Consideration otherwise to have been paid to holders of Dissenters' Shares shall be retained by DEI. (f) Any option outstanding at the Effective Time to purchase DEI Shares shall be unaffected by the Merger unless the terms of the agreement evidencing such option provide otherwise. Each and every option outstanding at the Effective Time to purchase STR Shares shall automatically, at the Effective Time, become an option to purchase a number of DEI Shares equal to the product of (i) the number of STR Shares for which the option is exercisable, multiplied by (ii) the Merger Consideration to be exchanged for each STR Share in the Merger. The terms of options to purchase STR Shares shall not otherwise be affected or modified as a result of the Merger. 3.2 Exchange of Certificates; Transmittal Letter. (a) Promptly after the Effective Time, DEI shall mail or cause to be mailed to each holder of record (other than STR and holders of Dissenters' Shares) of a Certificate or Certificates (i) a form of letter of transmittal (which shall specify that delivery shall be effected, and risk of loss and title to the Certificates shall pass, only upon proper delivery of the Certificates to the Exchange Agent) and (ii) instructions for use in effecting the surrender of the Certificates for payment therefor. Upon surrender of Certificates for cancellation to the Exchange Agent, together with such letter of transmittal duly executed and any other required documents, the holder of such Certificates shall be entitled to receive for each of the Shares represented by such Certificates the Merger Consideration and the Certificates so surrendered shall forthwith be canceled. Until so surrendered, such Certificates shall represent solely the right to receive the Merger Consideration as contemplated by Section 3.1(a) with respect to each of the STR Shares represented thereby. (b) No dividends or other distributions that are declared after the Effective Time on DEI Shares and payable to the holders of record thereof after the Effective Time will be paid to persons entitled by reason of the Merger to receive DEI Shares until such persons surrender their Certificates. Upon such surrender, there shall be paid to the person in whose name the DEI Shares are issued any dividends or other distributions having a record date after the Effective Time and payable with respect to such DEI Shares between the Effective Time and the time of such surrender. After such surrender there shall be paid to the person in whose name the DEI Shares are issued any dividends or other distributions on such DEI Shares which shall have a record date after the Effective Time and prior to such surrender and a payment date after such surrender and such payment shall be made on such payment date. In no event shall the persons entitled to receive such dividends or other distributions be entitled to receive interest on such dividends or other distributions. Notwithstanding the foregoing, neither the Exchange Agent nor any Party hereto shall be liable to any holder of STR Shares for any DEI Shares or dividends thereon delivered to a public official pursuant to any applicable abandoned property, escheat or similar law. The Exchange Agent shall not be entitled to vote or exercise any rights of ownership with respect to the DEI Shares held by it from time to time hereunder, except that it shall receive and hold all dividends or other distributions paid or distributed with respect to such DEI Shares for the account of the persons entitled thereto. A-7 159 (c) If any certificate representing DEI Shares is to be issued in a name other than that in which the Certificate surrendered in exchange therefor is registered, it shall be a condition of such exchange that the Certificate so surrendered shall be properly endorsed and otherwise in proper form for transfer and that the person requesting such exchange shall pay to the Exchange Agent any transfer or other taxes required by reason of the issuance of certificates for such DEI Shares in a name other than that of the registered holder of the Certificate surrendered, or shall establish to the satisfaction of the Exchange Agent that such tax has been paid or is not applicable. (d) If a Certificate is lost or destroyed, the registered owner thereof shall be entitled to receive the Merger Consideration to which such registered owner would otherwise be entitled on the surrender of such Certificate by presenting an affidavit to DEI or the Exchange Agent attesting to the loss or destruction of such Certificate. DEI or the Exchange Agent may require such registered owner, as a condition precedent to receiving the Merger Consideration, to furnish DEI or the Exchange Agent with a bond or agreement of indemnity, in such form and amount and with such sureties, or without sureties, as DEI or the Exchange Agent may direct or approve. (e) No certificates or scrip representing a fraction of a DEI Share shall be issued upon the surrender of Certificates for exchange pursuant to this Section. In lieu of any such fractional shares, each holder of STR Shares shall be entitled to receive a cash payment in an amount equal to the product of (i) the fractional interest of a DEI Share to which such holder would have been entitled (computed based upon the aggregate number of STR Shares owned by such holder and the aggregate number of DEI Shares to which such holder is entitled) and (ii) the average of the published bid and asked prices per DEI Share for the trading day immediately prior to the Effective Time. 4. REPRESENTATIONS AND WARRANTIES. 4.1 Representations and Warranties of STR. STR represents and warrants to DEI and Merger Sub as follows: (a) Authorization of Transaction. STR has full corporate power and authority to execute and deliver this Agreement and, subject to obtaining the necessary approval of its shareholders, to consummate the transactions contemplated hereby and thereby and perform its obligations hereunder and thereunder. This Agreement constitutes the valid and legally binding obligation of STR enforceable in accordance with its terms and conditions. Except for the filing of the Articles of Merger with the Virginia State Corporation Commission, STR is not required to give any notice to, make any filing with, or obtain any authorization, consent, or approval of any government or governmental agency in order to consummate the transactions contemplated by this Agreement. (b) Organization and Qualification. (i) STR is a corporation duly organized, validly existing, and in good standing under the laws of the Commonwealth of Virginia. STR is duly authorized to conduct its business and is in good standing as a foreign corporation under the laws of each jurisdiction where the failure to be so authorized and in good standing, in the aggregate for all such failures, could reasonably be expected to have a material adverse effect on STR. Such A-8 160 jurisdictions are listed on Schedule 4.1(b)(i). STR has all licenses, permits, and authorizations necessary to carry on the business in which it is engaged and to own and use the properties owned and used by it. Schedule 4.1(b)(i) also lists the directors and officers of STR. STR has delivered to DEI correct and complete copies of the Articles of Incorporation and Bylaws of STR (as amended to the date hereof). STR is not in violation of any provision of its Articles of Incorporation or Bylaws. (ii) Except as set forth in Schedule 4.1(b)(ii), STR does not own and has never owned, directly or indirectly, a 50% or greater interest in the outstanding voting securities of any Person. (c) Noncontravention. Neither the execution and the delivery of this Agreement nor the consummation of the transactions contemplated hereby or thereby, will (i) violate any constitution, statute, regulation, rule, injunction, judgment, order, decree, ruling, charge, or other restriction of any government, governmental agency, or court to which STR is subject or any provision of its Articles of Incorporation or Bylaws, (ii) except as set forth in Schedule 4.1(c), result in a breach of, constitute a default under, result in the acceleration of, create in any party the right to accelerate, terminate, modify, or cancel, or require any notice under any agreement, contract, lease, license, instrument, or other arrangement to which STR is a party or by which it is bound or to which any of its assets is subject or (iii) result in the imposition of any Security Interest upon any of STR's assets. (d) Capitalization. The entire authorized capital stock of STR consists of 3,000,000 shares of STR Common Stock, of which 723,786 shares are issued and outstanding, and 140 shares of STR's preferred stock, none of which are issued and outstanding. Each of the holders of STR Shares owns the STR Shares free and clear of any restrictions on transfer (other than any restrictions under the Securities Act and state securities laws). All of the issued and outstanding STR Shares have been duly authorized, are validly issued, fully paid, and nonassessable, and are held of record by the shareholders and in the amounts listed in Schedule 4.1(d) to this Agreement. Except as set forth on Schedule 4.1(d), STR has no outstanding subscriptions, warrants, options, rights, convertible securities or other agreements or commitments obligating STR to issue any additional shares. STR holds 418 of its authorized shares in treasury. (e) Equity Interests. Except as set forth in Schedule 4.1(e), STR does not control, directly or indirectly, or have any direct or indirect equity participation in any corporation, partnership, trust, or other business association. (f) Financial Statements. Attached as Schedule 4.1(f) are the following financial statements of STR (collectively the "Financial Statements"): (i) an audited balance sheet as of September 30, 1997 and 1996 and related statements of operations, stockholders' equity and cash flows for the fiscal years ended September 30, 1997, 1996 and 1995 for STR. The Financial Statements have been prepared in accordance with GAAP and present fairly the financial condition of STR as of such dates and the results of operations of STR for such periods. The Financial Statements are correct and complete, to the extent required by GAAP, and are consistent with the books and records of STR (which books and records are correct and complete). A-9 161 (g) Subsequent Events. Except as set forth in Schedule 4.1(g), since September 30, 1997, STR has not: (i) issued, sold, purchased or redeemed any shares of its capital stock; granted any stock options or made any other commitment to issue or sell shares of its capital stock; amended its Articles of Incorporation or Bylaws; or declared, set aside or made any payment or distribution upon its capital stock; (ii) incurred any liability or obligation under agreements or otherwise, except current liabilities entered into or incurred in the Ordinary Course of Business; issued any notes or other corporate debt securities; or waived any of its rights; (iii) mortgaged, pledged or subjected to any lien any asset or, except in the Ordinary Course of Business, entered into any lease of real property, machinery, equipment or buildings, or sold or transferred any intangible asset; (iv) effected any increases in salary, wage or other compensation of any kind, whether current or deferred, to any officer, employee, agent, broker or consultant, other than routine increases in the Ordinary Course of Business; entered into any salary, wage or other compensation agreement with a term of one year or longer with any employee or made any contribution to any trust or plan for the benefit of employees except as required by the terms thereof as now in effect; (v) entered into any material transaction other than in the Ordinary Course of Business; (vi) suffered any damage, destruction or loss to any of its properties or assets (whether or not covered by insurance); (vii) suffered any adverse changes which in the aggregate have had or are reasonably likely to have a material adverse effect on the business, financial condition or prospects of STR; or (viii) become (A) subject to any outstanding injunction, judgment, order, decree, ruling or charge or (B) a party or, to the Knowledge of STR, is threatened to be made a party, to any action, suit, proceeding, hearing, or investigation of, in or before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction of before any arbitrator. (h) Undisclosed Liabilities. STR does not have any Liability, except for (i) Liabilities set forth on the audited balance sheet of STR as of September 30, 1997 (the "Balance Sheet") and (ii) Liabilities which have arisen after September 30, 1997 in the Ordinary Course of Business (none of which liabilities resulted from, arose out of, relate to, is in the nature of, or was caused by any breach of contract, breach of warranty, tort, infringement, violation of law or provisions in the Articles of Incorporation or bylaws of STR providing for indemnification of directors, officers or employees). A-10 162 (i) Legal Compliance; Licenses and Authorizations. (i) STR has complied in all material respects with all applicable laws, statutes, rules, regulations and orders of federal, state, local, and foreign governments (and all agencies thereof), including, without limitation, all Environmental, Health and Safety Laws, and no action, suit, proceeding, hearing, investigation, charge, complaint, claim, demand, or notice has been filed or commenced against it alleging any failure so to comply. (ii) STR holds all licenses and other permits and authorizations necessary for the operation of the business of STR as presently conducted and such licenses, permits and authorizations will be in full force and effect for the entire duration of their respective unexpired license terms, unimpaired by any acts or omissions of STR, except for such licenses, permits and authorizations with respect to which the failure of STR to hold such licenses, permits and authorizations would not have a material adverse effect on STR. There is not now pending or, to the Knowledge of STR, threatened any action by the grantor of any such license, permit or authorization to revoke, cancel or refuse to renew any such license, permit or authorization. (j) Tax Returns and Taxes. (i) STR has filed all federal, state, local and other Tax returns and reports which are required to be filed; (ii) STR has paid all Taxes, interest, penalties, assessments and deficiencies due or assessed pursuant to such returns; (iii) STR has not received any notice of assessment of additional Taxes or executed or filed with any taxing authority any agreement extending the period of assessment of any Taxes; (iv) there are no claims, examinations, proceedings or proposed deficiencies for Taxes pending or, to the Knowledge of STR, threatened against STR; (v) STR is current in the payment of all withholding and other employee taxes which are due and payable; (vi) there are no Tax liens on any of the assets or properties of STR; (vii) the accruals for Taxes contained in the Balance Sheet are adequate to cover all liabilities for Taxes of STR for all periods ending on or before the date of such statement; (viii) all Taxes for periods beginning after the date of such statement up to the Closing have been paid or are adequately reserved against on the books of STR; (ix) STR has not been audited by the Internal Revenue Service, has not received any notice of an audit and has not been threatened with an audit. (k) Litigation. None of STR or any director or officer of STR is (i) subject to any outstanding injunction, judgment, order, decree, ruling, or charge or (ii) a party or, to the Knowledge of STR, threatened to be made a party to any action, suit, proceeding, hearing, or investigation of, in, or before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator. No director or officer of STR has any reason to believe that any such action, suit, proceeding, hearing, or investigation may be brought or threatened against STR. (l) Intellectual Property. Except as set forth in Schedule 4.1(l), STR does not hold, own or use any domestic or foreign patents and registered trademarks, tradenames and service marks, or patent, trademark, tradename and service mark applications filed in connection with the business of STR. Set forth on Schedule 4.1(l) is a correct and complete list of all license and other agreements allowing STR to use intellectual property rights of third parties in the United States or foreign countries entered into by STR or affecting the business of STR (the "License Agreements"). A-11 163 Except as set forth on Schedule 4.1(l), (y) STR has and owns all right, title and interest in and to all of the Intellectual Property Rights (including the exclusive right to use, sell, license or dispose of such rights and to bring actions for infringement thereof) which are required or necessary for STR to conduct its business in the normal course in accordance with past practice, free and clear of any claims, liens, licenses or encumbrances and (z) no Person has a right to receive a royalty or similar payment in respect of any of the Intellectual Property Rights. STR has no Knowledge of and has not received any notice of any infringements of, or claims or assertions of infringement of, any of the Intellectual Property Rights, and STR has not taken or omitted to take any action which would have the effect of waiving any of its rights relating to any of the Intellectual Property Rights. There have been no claims and, to the Knowledge of STR, there is no basis for any claim challenging the scope, validity or enforceability of any of the Intellectual Property Rights which are material to the conduct of STR's business. The manufacture, sale or use of any products now or heretofore manufactured or sold by STR did not and does not infringe (nor has any claim been made that any such action infringes) the intellectual property rights of others. Each of the License Agreements is in full force and effect and there has occurred no default which is continuing in respect of any License Agreement. (m) Tangible Assets. STR owns or leases all buildings, machinery, equipment, and other tangible assets used in the conduct of its business as presently conducted, free and clear of all liens and encumbrances except as set forth on Schedule 4.1(m). Each such tangible asset is in good operating condition and repair (subject to normal wear and tear) and is suitable for the purposes for which it presently is used. (n) Contracts. Except as set forth on Schedule 4.1(n), STR is not a party to any outstanding: (i) written contract (or collective bargaining agreement) with any labor union or representative of employees; (ii) written or oral commitment, contract, or agreement involving an obligation or liability on the part of STR of more than $10,000 (excluding orders for the purchase of standard products and services from STR accepted in the Ordinary Course of Business and providing for prevailing prices and customary conditions of sale); (iii) written or oral lease of real property or personal property; (iv) written or oral agreement, contract or commitment containing any covenant limiting the freedom of STR to engage in any line of business or compete with any Person; (v) written or oral employment, consulting, sales representative, agency or distributor agreement that is not cancelable by STR pursuant to its stated terms on notice of not longer than three months and without liability, penalty or premium; A-12 164 (vi) any profit sharing, stock option, stock purchase, stock appreciation, deferred compensation, severance or other plan or arrangement for the benefit of its current or former directors, officers and employees; (vii) written or oral agreement or contract relating to any indebtedness or the mortgaging, pledging or the placing of a lien on any of the properties or assets of STR which is not reflected in the Financial Statements; (viii) guaranty of any obligation; (ix) loans to or from officers, directors or affiliates; (x) any agreement with any shareholder of STR or any of its affiliates; or (xi) any other written or oral agreement which is material to the operations or business prospects of STR. STR has delivered to DEI a correct and complete copy of each written agreement listed in Schedule 4.1(n) (as amended to date) and a written summary setting forth the terms and conditions of each oral agreement referred to in Schedule 4.1(n). With respect to each such agreement: (A) the agreement is legal, valid, binding, enforceable, and in full force and effect, (B) the agreement will continue to be legal, valid, binding, enforceable, and in full force and effect on identical terms following the consummation of the transactions contemplated by this Agreement; (C) no party is in breach or default, and no event has occurred which with notice or lapse of time could constitute a breach or default, or permit termination, modification, or acceleration, under the agreement and (D) no party has repudiated any provision of the agreement. Except as set forth in Schedule 4.1(n), no contract or agreement described in Schedule 4.1(n) requires the consent of any party to the execution of this Agreement or the consummation of the transactions contemplated by this Agreement. (o) Notes and Accounts Receivable. Except as set forth in Schedule 4.1(o), all notes and accounts receivable of STR are reflected properly on its books and records, are subject to no known setoffs or counterclaims, are current and collectible, subject only to the reserve for bad debts set forth on the face of the Balance Sheet (rather than in any notes thereto) as adjusted for the passage of time through the Closing Date in accordance with the past custom and practice of STR. (p) Inventories. (i) All inventory of STR, including, without limitation, raw materials, work in process, finished goods, returned products, goods in transit and all other materials used or consumed in their business and reflected on the Balance Sheet: (A) was acquired and has been maintained in the Ordinary Course of Business; (B) is of good and merchantable quality; (C) consists substantially of a quality, quantity and condition usable, leasable or saleable in the Ordinary Course of Business; (D) is valued at reasonable amounts based on the Ordinary Course of Business during the past six months; and (E) is not subject to any write-down or write-off. (ii) STR is not under any Liability or obligation with respect to the return of inventory in the possession of wholesalers, retailers or other customers. (iii) All inventory has been valued on the Balance Sheet and on STR's records and books of account at the lower of cost (determined on a first in, first out A-13 165 basis) or market value on a basis consistent with that reflected in the Financial Statements. (iv) Obsolete inventory and inventory of below-standard quality has been written down to amounts not in excess of realizable market value. (v) All of the work-in-process, raw materials and supplies inventory can be used or consumed in the Ordinary Course of Business and are not in amounts in excess of normal requirements. (vi) Since the date of the Balance Sheet, there has been no change in the amount of inventory except changes as a result of the purchase and sale of, or adjustment to, inventory in the Ordinary Course of Business, including, but not limited to, established seasonal patterns. (q) Insurance. Set forth on Schedule 4.1(q) is a complete and correct list of all policies of insurance of STR, indicating for each policy the carrier, risks insured against, coverage limits, deductible amounts, premium rate, expiration date, all outstanding claims thereunder and whether the terms of such policy provide for retrospective premium adjustments. All such policies are outstanding and in full force and effect. (r) [reserved] (s) Payments. STR has not directly or indirectly, nor has any agent, representative or employee of STR, directly or indirectly, paid or delivered any fee, commission or other sum of money or item or property, however characterized, to any finder, agent, government official or other party, in the United States or any other country, which is in any manner related to the operations of STR and which is, or may be with the passage of time or discovery, illegal under any federal, state or local law (including, without limitation, the U.S. Foreign Corrupt Practices Act) or any other country having jurisdiction. STR has not participated, directly or indirectly, in any boycotts or other similar practices affecting any of its actual or potential customers and STR has at all times done business in an open and ethical manner. (t) Employee Benefits. (i) Schedule 4.1(t) to this Agreement lists each Employee Benefit Plan that STR maintains or to which it contributes. (A) Each such Employee Benefit Plan (and each related trust, insurance contract, or fund) complies in form and in operation in all material respects with its underlying documents, the applicable requirements of ERISA, the Code, and other applicable laws. (B) All applicable disclosure and filing requirements have been timely satisfied in all material respects with respect to each such Employee Benefit Plan. The requirements of Part 6 of Subtitle B of Title I of ERISA and of Code Section 4980B have been met with respect to each such Employee Benefit Plan which is an Employee Welfare Benefit Plan. (C) All premiums or other payments for all periods ending on or before the Closing Date have been paid with respect to each such Employee Benefit Plan which is an Employee Welfare Benefit Plan. A-14 166 (D) With respect to each such Employee Benefit Plan, STR has delivered to DEI correct and complete copies of the plan documents and summary plan descriptions, the most recent Form 5500 Annual Report, if applicable, and all related insurance contracts, or trust or other funding agreements which, if applicable, implement each such Employee Benefit Plan. (ii) STR does not contribute to, has never contributed to, nor has ever been required to contribute to any Multiemployer Plan, and has no Liability (including withdrawal Liability) under any Multiemployer Plan. (iii) STR does not maintain, has never maintained, does not contribute, has never contributed, nor has ever been required to contribute to any Employee Welfare Benefit Plan providing medical, health, or life insurance or other welfare-type benefits for current or future retired or terminated employees, their spouses, or their dependents (other than in accordance with Code Section 4980B). (iv) There is no litigation, disputed claim (other than routine claims for benefits), governmental proceeding, audit, inquiry or investigation pending or, to the Knowledge of STR, threatened with respect to any such Employee Benefit Plan, its related assets or trusts, or any fiduciary, administrator or sponsor of such Employee Benefit Plan. (v) Except as disclosed in Schedule 4.1(t), with respect to each Employee Pension Benefit Plan: (A) each such plan which is intended to qualify as a tax-qualified retirement plan under Code Section 401(a) has received a favorable determination letter(s) from the Internal Revenue Service (copies of which have been delivered to DEI) as to qualification of such plan covering the period from its adoption through the Closing Date; all amendments required to maintain such qualification have been timely adopted; nothing has occurred, whether by action or failure to act, which has resulted in or could cause the loss of such qualification (whether or not eligible for review under the Internal Revenue Service's Closing Agreement Program, Voluntary Compliance Resolution program or any similar governmental agency program); and each trust thereunder is exempt from tax pursuant to Code Section 501(a); (B) no event has occurred and no condition exists relating to any such plan that would subject STR or DEI to any tax under Code Sections 4972 or 4979, or to any Liability under ERISA Section 502; and (C) neither any such plan nor any other Person has engaged in a "prohibited transaction" (as defined in ERISA Section 406 or Code Section 4975) with respect to such Plan, for which no individual or class exemption exists. (u) Insider Interests. Except as set forth on Schedule 4.1(u), (i) no officer or director of STR, nor any shareholder of STR, has any interest in any property, real or personal, tangible or intangible, used in or pertaining to the business of STR, and (ii) no such person has any business relationship with STR, except as an officer, employee, director or shareholder thereof. A-15 167 (v) Brokers' Fees. STR has no Liability or obligation to pay any fees or commissions to any broker, finder, or agent with respect to the transactions contemplated by this Agreement. (w) Form S-4 Registration Statement. None of the information supplied or to be supplied by STR for inclusion or incorporation by reference in the Form S-4 registration statement (including the joint proxy statement contained therein) to be filed with the SEC pursuant to Section 5.10 hereof will, on the date the joint proxy statement (including any amendment or supplement thereto) is first mailed to stockholders and at the time of the meeting of STR's stockholders and the time of the meeting of DEI's stockholders to approve this Agreement, or, in the case of the Form S-4 registration statement, at the time it becomes effective under the Securities Act and at the Effective Time, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein not misleading. (x) Anti-Takeover Statutes. No "fair price", "moratorium", "control share acquisition", "business combination", or other similar anti-takeover statute or regulation is applicable to the Merger or the transactions contemplated thereby. 4.2 Representations and Warranties of DEI. DEI and Merger Sub represent and warrant to STR as follows: (a) Authorization of Transaction. DEI has full corporate power and authority to execute and deliver this Agreement and each Employment Agreement being executed and delivered by DEI and, subject to obtaining the approval of its stockholders, to consummate the transactions contemplated hereby and thereby and to perform its obligations hereunder and thereunder. This Agreement and each Employment Agreement to which DEI is a party constitutes the valid and legally binding obligation of DEI enforceable in accordance with its terms and conditions. Except for the filing of the Articles of Merger with the Virginia State Corporation Commission, DEI is not required to give any notice to, make any filing with, or obtain any authorization, consent, or approval of any government or governmental agency in order to consummate the transactions contemplated by this Agreement. (b) Organization and Qualification. (i) DEI is a corporation duly organized, validly existing, and in good standing under the laws of the State of Delaware. DEI is duly authorized to conduct its business and is in good standing as a foreign corporation under the laws of each jurisdiction where the failure to be so authorized and in good standing, in the aggregate for all such failures, could reasonably be expected to have a material adverse effect on the business of DEI and the DEI Subsidiaries, taken as a whole. Such jurisdictions are listed on Schedule 4.2(b)(i). DEI has all licenses, permits, and authorizations necessary to carry on the business in which it is engaged and to own and use the properties owned and used by it. DEI has delivered to STR correct and complete copies of the Certificate of Incorporation and Bylaws of DEI (as amended to the date hereof). DEI is not in violation of any provision of its Certificate of Incorporation or Bylaws. (ii) The DEI SEC Documents set forth the name and jurisdiction of incorporation of each Person in which DEI directly or indirectly owns a 50% or greater interest in A-16 168 the outstanding voting securities thereof (the "DEI Subsidiaries"). DEI owns all of the issued and outstanding securities of each DEI Subsidiary free and clear of all liens, charges, encumbrances and other rights of third parties, and all such securities have been duly and validly issued and are fully paid and non-assessable. Each DEI Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of its respective state or jurisdiction of incorporation, each has the corporate power to own or lease its properties and to carry on its business as presently conducted, and each is duly authorized to do business as a foreign corporation and is in good standing in all jurisdictions where the failure to so qualify would have a material adverse effect on the business of DEI and the DEI Subsidiaries, taken as a whole. None of the DEI Subsidiaries is in violation of any provision of its charter or bylaws. Merger Sub was formed solely for the purpose of the Merger and to engage in the transactions contemplated thereby, is 100% owned by DEI and has not done any business, incurred any liabilities or obligations or entered into any contracts other than this Agreement. (c) Noncontravention. Neither the execution and the delivery of this Agreement or the Employment Agreements to which it will be a party, nor the consummation of the transactions contemplated hereby or thereby, will (i) violate any constitution, statute, regulation, rule, injunction, judgment, order, decree, ruling, charge, or other restriction of any government, governmental agency, or court to which DEI is subject or any provision of its Certificate of Incorporation or bylaws, (ii) result in a breach of, constitute a default under, result in the acceleration of, create in any party the right to accelerate, terminate, modify, or cancel, or require any notice under any agreement, contract, lease, license, instrument, or other arrangement to which DEI is a party or by which it is bound or to which any of its assets is subject or (iii) result in the imposition of any Security Interest upon DEI's assets. (d) DEI SEC Documents; Options and Warrants. DEI has delivered to STR true and complete copies of its Form 10-K for the year ended July 31, 1997 and all other documents that DEI has filed with the SEC since such date pursuant to the Exchange Act (the "DEI SEC Documents"). Such reports are complete and correct in all material respects. The financial statements included in such Form 10-K have been prepared in accordance with GAAP and present fairly the consolidated financial condition of DEI and the DEI Subsidiaries as of such dates and the consolidated results of operations of DEI and the DEI Subsidiaries for such periods. The Financial Statements are correct and complete, to the extent required by GAAP, and are consistent with the books and records of DEI and the DEI Subsidiaries (which books and records are correct and complete). Except as set forth on Schedule 4.2(d), DEI has no outstanding subscriptions, warrants, options, rights, convertible securities or other agreements or commitments obligating DEI to issue any additional shares. (e) Merger Consideration. The shares of DEI Common Stock to be issued and delivered pursuant to this Agreement and the Merger are duly authorized and, when issued and delivered as contemplated herein, will be duly and validly issued, fully paid and non-assessable. (f) Equity Interests. Except for the DEI Subsidiaries, DEI does not control, directly or indirectly, or have any direct or indirect equity participation in any corporation, partnership, trust, or other business association. A-17 169 (g) Subsequent Events. Except as set forth in the DEI SEC Documents or Schedule 4.2(g), or as otherwise contemplated by this Agreement, since July 31, 1997, neither DEI nor any DEI Subsidiary has: (i) issued, sold, purchased or redeemed any shares of its capital stock; granted any stock options or made any other commitment to issue or sell shares of its capital stock; amended its Certificate of Incorporation or Bylaws; or declared, set aside or made any payment or distribution upon its capital stock; (ii) incurred any liability or obligation under agreements or otherwise, except current liabilities entered into or incurred in the Ordinary Course of Business; issued any notes or other corporate debt securities; or waived any of its rights; (iii) mortgaged, pledged or subjected to any lien any asset or, except in the Ordinary Course of Business, entered into any lease of real property, machinery, equipment or buildings, or sold or transferred any intangible asset; (iv) effected any increases in salary, wage or other compensation of any kind, whether current or deferred, to any officer, employee, agent, broker or consultant, other than routine increases in the Ordinary Course of Business; entered into any salary, wage or other compensation agreement with a term of one year or longer with any employee or made any contribution to any trust or plan for the benefit of employees except as required by the terms thereof as now in effect; (v) entered into any material transaction other than in the Ordinary Course of Business; (vi) suffered any damage, destruction or loss to any of its properties or assets (whether or not covered by insurance); (vii) suffered any adverse changes which in the aggregate have had or are reasonably likely to have a material adverse effect on the business, financial condition or prospects of DEI and the DEI Subsidiaries, taken as a whole; or (viii) become (A) subject to any outstanding injunction, judgment, order, decree, ruling or charge or (B) a party or, to the Knowledge of DEI, is threatened to be made a party, to any action, suit, proceeding, hearing, or investigation of, in or before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction of before any arbitrator, which, with respect to (A) or (B), would be required to be disclosed in a report filed by DEI under the Exchange Act. (h) Undisclosed Liabilities. Neither DEI nor any DEI Subsidiary has any Liability, except for (i) Liabilities set forth in the DEI SEC Documents and (ii) Liabilities which have arisen after the date of the current period balance sheet contained in the most recent DEI SEC Document A-18 170 in the Ordinary Course of Business (none of which liabilities resulted from, arose out of, relate to, is in the nature of, or was caused by any breach of contract, breach of warranty, tort, infringement, violation of law or provisions in the Certificate of Incorporation or bylaws of DEI or a DEI Subsidiary providing for indemnification of directors, officers or employees). (i) Legal Compliance; Licenses and Authorizations. (i) DEI and the DEI Subsidiaries have complied in all material respects with all applicable laws, statutes, rules, regulations and orders of federal, state, local, and foreign governments (and all agencies thereof), including, without limitation, all Environmental, Health and Safety Laws, and no action, suit, proceeding, hearing, investigation, charge, complaint, claim, demand, or notice has been filed or commenced against any of them alleging any failure so to comply. (ii) DEI and the DEI Subsidiaries hold all licenses and other permits and authorizations necessary for the operation of the business of DEI and the DEI Subsidiaries as presently conducted and such licenses, permits and authorizations will be in full force and effect for the entire duration of their respective unexpired license terms, unimpaired by any acts or omissions of DEI or a DEI Subsidiary, except for such licenses, permits and authorizations with respect to which the failure of DEI or a DEI Subsidiary to hold such licenses, permits and authorizations would not have a material adverse effect on DEI and the DEI Subsidiaries, taken as a whole. There is not now pending or, to the Knowledge of DEI, threatened any action by the grantor of any such license, permit or authorization to revoke, cancel or refuse to renew any such license, permit or authorization. (j) Tax Returns and Taxes. Except as set forth in Schedule 4.2(j), (i) DEI and the DEI Subsidiaries have filed all federal, state, local and other Tax returns and reports which are required to be filed; (ii) DEI and the DEI Subsidiaries have paid all Taxes, interest, penalties, assessments and deficiencies due or assessed pursuant to such returns; (iii) DEI and the DEI Subsidiaries have not received any notice of assessment of additional Taxes or executed or filed with any taxing authority any agreement extending the period of assessment of any Taxes; (iv) there are no claims, examinations, proceedings or proposed deficiencies for Taxes pending or, to the Knowledge of DEI, threatened against DEI or a DEI Subsidiary; (v) DEI and the DEI Subsidiaries are current in the payment of all withholding and other employee taxes which are due and payable; (vi) there are no Tax liens on any of the assets or properties of DEI or a DEI Subsidiary; (vii) the accruals for Taxes set forth in the current period balance sheet contained in the most recent DEI SEC Document are adequate to cover all liabilities for Taxes of DEI and the DEI Subsidiaries for all periods ending on or before the date of such statement; (viii) all Taxes for periods beginning after the date of such statement up to the date hereof and the Closing have been paid or are adequately reserved against on the books of DEI and the DEI Subsidiaries; (ix) DEI and the DEI Subsidiaries have not been audited by the Internal Revenue Service since the fiscal 1989 Tax return, have not received any notice of an audit and have not been threatened with an audit. (k) Litigation. Except as set forth in Schedule 4.2(k), none of DEI, the DEI Subsidiaries or any director or officer of DEI or the DEI Subsidiaries is (i) subject to any outstanding injunction, judgment, order, decree, ruling, or charge or (ii) a party or, to the Knowledge of DEI, A-19 171 threatened to be made a party to any action, suit, proceeding, hearing, or investigation of, in, or before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator. No director or officer of DEI or the DEI Subsidiaries has any reason to believe that any such action, suit, proceeding, hearing, or investigation may be brought or threatened against DEI or the DEI Subsidiaries. (l) Intellectual Property. Except as set forth in Schedule 4.2(l), DEI and the DEI Subsidiaries do not hold, own or use any domestic or foreign patents and registered trademarks, tradenames and service marks, or patent, trademark, tradename and service mark applications filed in connection with the business of DEI and the DEI Subsidiaries. Set forth on Schedule 4.2(l) is a correct and complete list of all license and other agreements allowing DEI and the DEI Subsidiaries to use intellectual property rights of third parties in the United States or foreign countries entered into by DEI and the DEI Subsidiaries or affecting the business of DEI and the DEI Subsidiaries (the "DEI License Agreements"). Except as set forth on Schedule 4.2(l), (y) DEI and the DEI Subsidiaries have and own all right, title and interest in and to all of the Intellectual Property Rights (including the exclusive right to use, sell, license or dispose of such rights and to bring actions for infringement thereof) which are required or necessary for DEI and the DEI Subsidiaries to conduct their business in the normal course in accordance with past practice, free and clear of any claims, liens, licenses or encumbrances and (z) no Person has a right to receive a royalty or similar payment in respect of any of the Intellectual Property Rights. Except as set forth on Schedule 4.2(l), DEI and the DEI Subsidiaries have no Knowledge of and have not received any notice of any infringements of, or claims or assertions of infringement of, any of the Intellectual Property Rights, and DEI and the DEI Subsidiaries have not taken or omitted to take any action which would have the effect of waiving any of its rights relating to any of the Intellectual Property Rights. There have been no claims and, to the Knowledge of DEI, there is no basis for any claim challenging the scope, validity or enforceability of any of the Intellectual Property Rights which are material to the conduct of the business of DEI and the DEI Subsidiaries. The manufacture, sale or use of any products now or heretofore manufactured or sold by DEI and the DEI Subsidiaries did not and does not infringe (nor has any claim been made that any such action infringes) the intellectual property rights of others. Each of the DEI License Agreements is in full force and effect and there has occurred no default which is continuing in respect of any DEI License Agreement. (m) Tangible Assets. DEI and the DEI Subsidiaries own or lease all buildings, machinery, equipment, and other tangible assets used in the conduct of their business as presently conducted, free and clear of all liens and encumbrances except as set forth on Schedule 4.2(m). Each such tangible asset is in good operating condition and repair (subject to normal wear and tear) and is suitable for the purposes for which it presently is used. (n) Contracts. All material contracts which are required to be attached to or incorporated by reference in the DEI SEC Documents have been so attached or incorporated. With respect to each such contract filed with or incorporated by reference into a DEI SEC Document: (A) the contract is legal, valid, binding and enforceable; (B) the contract will continue to be legal, valid, binding and enforceable on identical terms following the consummation of the transactions contemplated by this Agreement; (C) no party is in breach or default, and no event has occurred which with notice or lapse of time could constitute a breach or default, or permit termination, A-20 172 modification, or acceleration, under the contract and (D) no party has repudiated any provision of the contract. Except as set forth in Schedule 4.2(n), none of such contracts requires the consent of any party to the execution of this Agreement or the consummation of the transactions contemplated by this Agreement. (o) Notes and Accounts Receivable. All notes and accounts receivable of DEI and the DEI Subsidiaries are reflected properly on its books and records, are subject to no known setoffs or counterclaims, are current and collectible, subject only to the reserve for bad debts set forth on the face of the audited balance sheet (rather than in any notes thereto) filed as part of the DEI SEC Documents (the "DEI Balance Sheet") as adjusted for the passage of time through the Closing Date in accordance with the past custom and practice of DEI and the DEI Subsidiaries. (p) Inventories. (i) All inventory of DEI and the DEI Subsidiaries, including, without limitation, raw materials, work in process, finished goods, returned products, goods in transit and all other materials used or consumed in their business and reflected on the DEI Balance Sheet: (A) was acquired and has been maintained in the Ordinary Course of Business; (B) is of good and merchantable quality; (C) consists substantially of a quality, quantity and condition usable, leasable or saleable in the Ordinary Course of Business; (D) is valued (after taking into account the reserve set forth on the DEI Balance Sheet) at reasonable amounts based on the Ordinary Course of Business during the past six months; and (E) is not subject to any write-down or write-off in excess of the reserve set forth on DEI Balance Sheet. (ii) DEI and the DEI Subsidiaries are not under any Liability or obligation with respect to the return of inventory in the possession of wholesalers, retailers or other customers. (iii) All inventory has been valued on the DEI Balance Sheet and on DEI's records and books of account at the lower of cost (determined on a first in, first out basis) or market value (after taking into account the reserve set forth on the DEI Balance Sheet). (iv) Obsolete inventory and inventory of below-standard quality has been written down to amounts not in excess of realizable market value (after taking into account the reserve set forth on the DEI Balance Sheet). (v) All of the work-in-process, raw materials and supplies inventory can be used or consumed in the Ordinary Course of Business and are not in amounts in excess of normal requirements. (vi) Since the date of the DEI Balance Sheet, there has been no change in the amount of inventory except changes as a result of the purchase and sale of, or adjustment to, inventory in the Ordinary Course of Business, including, but not limited to, established seasonal patterns. (q) Insurance. Set forth on Schedule 4.2(q) is a complete and correct list of all policies of insurance of DEI and the DEI Subsidiaries, indicating for each policy the carrier, risks insured against, coverage limits, deductible amounts, premium rate, expiration date, all outstanding claims thereunder and whether the terms of such policy provide for retrospective premium adjustments. All such policies are outstanding and in full force and effect. (r) [reserved] (s) Payments. Neither DEI nor any DEI Subsidiary has directly or indirectly, nor has any agent, representative or employee of any of them, directly or indirectly, paid or delivered any fee, commission or other sum of money or item or property, however characterized, to any finder, agent, government official or other party, in the United States or any other country, which A-21 173 is in any manner related to the operations of DEI and the DEI Subsidiaries and which is, or may be with the passage of time or discovery, illegal under any federal, state or local law (including, without limitation, the U.S. Foreign Corrupt Practices Act) or any other country having jurisdiction. Neither DEI nor any DEI Subsidiary has participated, directly or indirectly, in any boycotts or other similar practices affecting any of its actual or potential customers and DEI and the DEI Subsidiaries have at all times done business in an open and ethical manner. (t) Employee Benefits. (i) Schedule 4.2(t) to this Agreement lists each Employee Benefit Plan that DEI or a DEI Subsidiary maintains or to which it contributes. (A) Each such Employee Benefit Plan (and each related trust, insurance contract, or fund) complies in form and in operation in all material respects with its underlying documents, the applicable requirements of ERISA, the Code, and other applicable laws. (B) All applicable disclosure and filing requirements have been timely satisfied in all material respects with respect to each such Employee Benefit Plan. The requirements of Part 6 of Subtitle B of Title I of ERISA and of Code Section 4980B have been met with respect to each such Employee Benefit Plan which is an Employee Welfare Benefit Plan. (C) All premiums or other payments for all periods ending on or before the Closing Date have been paid with respect to each such Employee Benefit Plan which is an Employee Welfare Benefit Plan. (D) With respect to each such Employee Benefit Plan, DEI has delivered to STR correct and complete copies of the plan documents and summary plan descriptions, the most recent Form 5500 Annual Report, if applicable, and all related insurance contracts, or trust or other funding agreements which, if applicable, implement each such Employee Benefit Plan. (ii) DEI and the DEI Subsidiaries do not contribute to, have never contributed to, nor have ever been required to contribute to any Multiemployer Plan, and have no Liability (including withdrawal Liability) under any Multiemployer Plan. (iii) DEI and the DEI Subsidiaries do not maintain, have never maintained, do not contribute, have never contributed, nor have ever been required to contribute to any Employee Welfare Benefit Plan providing medical, health, or life insurance or other welfare-type benefits for current or future retired or terminated employees, their spouses, or their dependents (other than in accordance with Code Section 4980B). (iv) There is no litigation, disputed claim (other than routine claims for benefits), governmental proceeding, audit, inquiry or investigation pending or, to the Knowledge of DEI, threatened with respect to any such Employee Benefit Plan, its related assets or trusts, or any fiduciary, administrator or sponsor of such Employee Benefit Plan. A-22 174 (v) Except as disclosed in SCHEDULE 4.2(T), with respect to each Employee Pension Benefit Plan: (A) each such plan which is intended to qualify as a tax-qualified retirement plan under Code Section 401(a) has received a favorable determination letter(s) from the Internal Revenue Service (copies of which have been delivered to STR) as to qualification of such plan covering the period from its adoption through the Closing Date; all amendments required to maintain such qualification have been timely adopted; nothing has occurred, whether by action or failure to act, which has resulted in or could cause the loss of such qualification (whether or not eligible for review under the Internal Revenue Service's Closing Agreement Program, Voluntary Compliance Resolution program or any similar governmental agency program); and each trust thereunder is exempt from tax pursuant to Code Section 501(a); (B) no event has occurred and no condition exists relating to any such plan that would subject STR or DEI to any tax under Code Sections 4972 or 4979, or to any Liability under ERISA Section 502; and (C) neither any such plan nor any other Person has engaged in a "prohibited transaction" (as defined in ERISA Section 406 or Code Section 4975) with respect to such Plan, for which no individual or class exemption exists. (u) Insider Interests. No officer or director of DEI or any DEI Subsidiary, nor any shareholder of DEI, has any interest in any property, real or personal, tangible or intangible, used in or pertaining to the business of DEI and the DEI Subsidiaries, and no such person has any business relationship with DEI or any DEI Subsidiary, except as an officer, employee, director or shareholder thereof. (v) Brokers' Fees. Except as set forth in Schedule 4.2(v), DEI and the DEI Subsidiaries have no Liability or obligation to pay any fees or commissions to any broker, finder, or agent with respect to the transactions contemplated by this Agreement. (w) Form S-4 Registration Statement. None of the information supplied or to be supplied by DEI for inclusion or incorporation by reference in the Form S-4 registration statement (including the joint proxy statement contained therein) to be filed with the SEC pursuant to Section 5.10 hereof will, on the date the joint proxy statement (including any amendment or supplement thereto) is first mailed to stockholders and at the time of the meeting of STR's stockholders and the time of the meeting of DEI's stockholders to approve this Agreement, or, in the case of the Form S-4 registration statement, at the time it becomes effective under the Securities Act and at the Effective Time, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein not misleading. (x) Anti-Takeover Statutes. No "fair price", "moratorium", "control share acquisition", "business combination", or other similar anti-takeover statute or regulation is applicable to the Merger or the transactions contemplated thereby. A-23 175 5. PRE-CLOSING COVENANTS. The Parties agree as follows with respect to the period between the execution of this Agreement and the Closing. 5.1 General. Each of the Parties will use its best efforts to take all action and to do all things necessary, proper, or advisable in order to consummate and make effective the transactions contemplated by this Agreement (including satisfaction, but not waiver, of the closing conditions set forth in Section 7 below). 5.2 Stockholder Meetings. As soon as practicable following the date hereof, each of DEI and STR, acting through its Board of Directors, will take all action necessary in accordance with its Certificate of Incorporation and Bylaws and applicable law to duly call, give notice of, convene and hold a special meeting of its stockholders for the purpose of voting, in the case of STR, upon the approval of this Agreement and the transactions contemplated hereby and, in the case of DEI, upon the approval of the DEI Amended Certificate (in the form attached hereto as Exhibit 5.2, which increases the number of authorized DEI Shares to 5,000,000 and changes DEI's name to "Sensys Technologies Inc.") and an amendment to the DEI Long-Term Incentive Plan increasing the number of shares available thereunder to 400,000. Subject to the fiduciary duties of DEI's Board of Directors and STR's Board of Directors under applicable law (as determined following consultation with counsel) and the next succeeding sentence, the Board of Directors of each of DEI and STR shall recommend and declare advisable such approval and use its best efforts to solicit votes in favor of the matters set forth above. The Board of Directors of each of DEI or STR, as the case may be, may at any time prior to the Effective Time withdraw, modify, or change any recommendation and declaration regarding this Agreement and the Merger (in the case of STR) or the approval of the DEI Amended Certificate and the amendment to the DEI Long-Term Incentive Plan (in the case of DEI), or recommend and declare advisable any other offer or proposal, if (i) such Board of Directors determines that the failure to so withdraw, modify, or change its recommendation and declaration would cause the Board of Directors to breach its fiduciary duties to DEI's or STR's stockholders, as the case may be, under applicable law as advised in writing by counsel, or (ii) another Person or group makes a Higher Offer that the Board of Directors reasonably believes, in the good faith exercise of its business judgment, is likely to lead to consummation of an agreement to acquire all of the stock of DEI or STR, as the case may be, and, notwithstanding anything contained in this Agreement to the contrary, any such withdrawal, modification, or change of recommendation shall not constitute a breach of this Agreement by DEI or STR, as the case may be; provided that neither Board of Directors may withdraw, modify or change its recommendation or declaration with respect to this Agreement or the Merger because of the trading price of DEI Shares between the date hereof and the date of the applicable stockholder meeting. 5.3 Notices and Consents. DEI and STR will give any notices to third parties, and use their best efforts to obtain any third-party authorizations, consents, or approvals required in order to consummate the transactions contemplated by this Agreement. 5.4 Operation of Business. From the date of this Agreement until the Effective Time, STR and DEI will each operate its business in the Ordinary Course of Business. STR and DEI will each use its best efforts to preserve intact its present business organization, maintain in effect all material licenses, permits and approvals of governmental authorities necessary for the conduct of its present A-24 176 business and maintain its present operations, physical facilities, working conditions and relationships with lessors, suppliers, customers, clients and employees. Each of STR and DEI agree not to engage in any practice, take any action, or enter into any transaction outside the Ordinary Course of Business without the prior written consent of DEI (in the case of STR) or STR (in the case of DEI). Without limiting the generality of the foregoing and except as otherwise specifically provided in this Agreement, from the date of this Agreement until the Effective Time, each of STR and DEI will not, without the prior written consent of the other Party: (a) amend its Articles of Incorporation or Certificate of Incorporation, as the case may be, or its Bylaws; (b) pay or declare any cash dividend, or other dividend or distribution with respect to its capital stock; (c) issue, transfer, sell or deliver, or commit to issue, transfer, sell or deliver, any shares of its capital stock (or any options, warrants or any rights thereto including, without limitation, any securities convertible into or exchangeable, with or without additional consideration, for such capital stock) except pursuant to the exercise of stock options or warrants existing on the date of this Agreement or under the conditions set forth in Schedule 5.4(c); (d) increase or reduce the number of shares of its capital stock by split-up, reverse split, reclassification or distribution of stock dividends; (e) purchase or otherwise acquire for any consideration any outstanding shares of its capital stock or securities carrying the right to acquire, or convertible into or exchangeable for such stock, with or without additional consideration; (f) acquire by merger or consolidation with, or merge or consolidate with, or purchase substantially all of the assets of, or otherwise acquire any business of any corporation, partnership, association or other business organization or division thereof, or make any investment of a capital nature either by purchase of stock or securities, contributions to capital, property transfer or otherwise, or by the purchase of any property or assets of any other individual, partnership, firm or corporation; (g) incur additional indebtedness for borrowed money except pursuant to existing lines of credit; (h) adopt or materially modify any bonus, pension, profit-sharing or other compensation plan or enter into any contract of employment with any employee which is not terminable at will without cost or other liability; (i) adopt, enter into or amend in any material respect any collective bargaining, employment, severance or termination agreement or arrangement with any person or make any change in its key management structure, including, but not limited to, the hiring of additional employees or the termination of existing employees; A-25 177 (j) discharge or satisfy any lien or encumbrance or pay any obligation or liability (whether accrued, absolute, contingent or otherwise), except current liabilities incurred in the Ordinary Course of Business; (k) mortgage, pledge or subject to lien, charge, security interest or any other encumbrance any of its assets or property; (l) transfer or lease any of its assets or property except in the Ordinary Course of Business except as set forth in Schedule 5.4(l); (m) cancel or compromise any debt or claim other than in the Ordinary Course of Business in an aggregate amount in excess of $10,000; (n) waive or release any rights, or settle any claim, in an aggregate amount which is in excess of $10,000; (o) transfer or grant any rights under any leases, licenses or other agreements, other than in the Ordinary Course of Business; (p) make or grant any general or individual wage or salary increase to any of its officers; (q) fail to pay or discharge its accounts payable, debts or liabilities when due; (r) suffer any material adverse change in its financial condition, properties or business; (s) except in the Ordinary Course of Business, make or enter into any contract, commitment or transaction which involves an expenditure in excess of $10,000, or renew, extend, amend or modify any contract, commitment or transaction involving in excess of $10,000; (t) enter into or amend any contract, agreement or other transaction with any of its officers, directors or shareholders, or any affiliate of such an officer, director or shareholder, on terms that are less favorable than could be obtained from an unrelated third party on an arm's length basis. 5.5 Full Access to and Provision of Information. Each of STR and DEI will permit the other Party and its designees to have access to all premises, properties, personnel, books, records (including Tax records), contracts, and documents of or pertaining to it and will deliver such other documentation and information which is reasonably requested in accordance with that certain Non-Disclosure Agreement, dated as of October 28, 1996, between DEI and STR. 5.6 Notice of Developments. Upon becoming aware of such facts or circumstances, each Party will give prompt written notice to the other Party of (a) the occurrence or failure to occur of any event the effect of which is that any representation and warranty made by such Party herein is A-26 178 untrue and (b) the receipt of any notice or other communication from any third party alleging that the consent of such third party is or may be required in connection with the transactions contemplated by this Agreement. To the extent such facts or circumstances would cause a Schedule to this Agreement to become incorrect or incomplete, such Schedule shall be amended and delivered promptly to the other Party (and, in any event, prior to the Closing). No disclosure by any Party pursuant to this Section 5.6, however, will be deemed to amend or supplement this Agreement or the Schedules (except to increase the number of STR Shares outstanding as stated in Section 4.1(d) and to disclose the sale of STR Shares in Schedule 4.1(g), in each case to the extent STR Shares are sold under the conditions set forth in Schedule 5.4(c)), or to prevent or cure any misrepresentation, breach of warranty, or breach of covenant, unless such misrepresentation or breach is waived in accordance with Section 11.10; provided, however, that if the Effective Time occurs notwithstanding such disclosure, the representations and warranties contained in this Agreement shall be deemed amended to include such disclosure and such misrepresentation or breach shall be deemed waived. 5.7 Exclusivity. (a) Neither DEI nor any of the DEI Subsidiaries nor any of their respective officers and directors shall, and DEI and the DEI Subsidiaries will use their best efforts to cause their employees, agents, and representatives (including, without limitation, any investment banker, attorney or accountant retained by DEI) not to, initiate, solicit, encourage or take any other action to facilitate, directly or indirectly, any inquiries or the making of any proposal with respect to a merger, consolidation, share exchange or similar transaction or series of transactions involving DEI or any of DEI Subsidiary, or any purchase of all or any significant portion of the assets of DEI (other than DEI's real estate) or any equity interest in DEI other than the transactions contemplated hereby (an "Acquisition Proposal"), or engage in any negotiations concerning, or provide any confidential information or data to, or have any discussions with, any person relating to an Acquisition Proposal; provided, however, that the Board of Directors on behalf of DEI may furnish or cause to be furnished information and may participate in such discussions and negotiations through its representatives with persons who have sought the same if (i) the failure to provide such information or participate in such negotiations and discussions would cause the members of the Board of Directors to breach its fiduciary duties to DEI's stockholders under applicable law as advised in writing by counsel or (ii) another Person or group makes a bona fide offer or proposal with respect to all DEI Shares which, based upon the identity of the Person making it and the terms thereof, the Board of Directors believes, in the good faith exercise of its business judgment, could reasonably be expected to lead to a transaction involving all DEI Shares more favorable to DEI's stockholders from a financial point of view than the transaction contemplated hereby; provided, however, that such Person must have required, as a condition to his or its highest offer or proposal (or to the making thereof), that DEI terminate this Agreement (in either case, a "Higher Offer"). DEI will notify STR immediately, orally and in writing, if any such inquiries or proposals are received by, any such information is requested from, or any such negotiations or discussions are sought to be initiated or continued with DEI and will keep STR informed, on a current basis, of the status and terms of any such proposals and status of any such negotiations or discussions. The provisions of this Section 5.7(a) shall not prohibit DEI from taking any position with respect to an Acquisition Proposal pursuant to Rules 14d-9 and 14e-2 under the Exchange Act. (b) Neither STR nor any of its officers and directors shall, and STR will use its best efforts to cause its employees, agents, and representatives (including, without limitation, any A-27 179 investment banker, attorney or accountant retained by STR) not to, initiate, solicit, encourage or take any other action to facilitate, directly or indirectly, any inquiries or the making of any Acquisition Proposal, or engage in any negotiations concerning, or provide any confidential information or data to, or have any discussions with, any person relating to an Acquisition Proposal; provided, however, that the Board of Directors on behalf of STR may furnish or cause to be furnished information and may participate in such discussions and negotiations through its representatives with persons who have sought the same if (i) the failure to provide such information or participate in such negotiations and discussions would cause the members of the Board of Directors to breach its fiduciary duties to STR's stockholders under applicable law as advised in writing by counsel or (ii) another Person or group makes a bona fide offer or proposal with respect to all STR Shares which, based upon the identity of the Person making it and the terms thereof, the Board of Directors believes, in the good faith exercise of its business judgment, could reasonably be expected to lead to a transaction involving all STR Shares more favorable to STR's stockholders from a financial point of view than the transaction contemplated hereby; provided, however, that such Person must have required, as a condition to his or its Highest Offer (or to the making thereof), that STR terminate this Agreement. STR will notify DEI immediately, orally and in writing, if any such inquiries or proposals are received by, any such information is requested from, or any such negotiations or discussions are sought to be initiated or continued with STR and will keep DEI informed, on a current basis, of the status and terms of any such proposals and status of any such negotiations or discussions. 5.8 WARN Act. STR agrees that, if requested by DEI, it shall, on behalf of DEI, issue such notices as are required under the Worker Adjustment and Retraining Notification Act of 1988 or any similarly applicable state or local law. No such notices shall be given without the prior approval of DEI. 5.9 Press Releases and Public Announcements. Neither DEI nor STR will issue any press release or make any public announcement relating to the subject matter of this Agreement or any Employment Agreement without the prior written approval of the other party, which approval shall not be unreasonably withheld. 5.10 Registration Statement. DEI and STR will, as promptly as practicable, prepare and DEI will file with the SEC a Form S-4 registration statement containing a joint proxy statement/prospectus and forms of proxy in connection with the vote of DEI's and STR's stockholders with respect to the Merger and the issuance of the DEI Shares pursuant to the Merger. DEI and STR will, and will cause their accountants and lawyers to, use their best efforts to have or cause the Form S-4 registration statement to be declared effective as promptly as practicable, including, without limitation, causing their accountants to deliver necessary or required instruments such as opinions and certificates, and will take any other action required or necessary to be taken under federal or state securities laws or otherwise in connection with the registration process. DEI and STR will use their respective best efforts to cause the joint proxy statement included as part of the Form S-4 registration statement to be mailed or delivered to stockholders of DEI and STR at the earliest practicable date and will coordinate and cooperate with respect to the timing of such meetings and shall use their best efforts to hold such meetings as soon as practicable after the date hereof. A-28 180 5.11 Affiliates of the Company and Parent. Prior to the Effective Time, DEI and STR (each of which is referred to in this Section as a "Subject Company") shall deliver to each other a list identifying all persons who, at the time this Agreement is submitted for approval to the stockholders of the Subject Company, may be deemed to be Affiliates of the Subject Company. STR shall use its best efforts to cause each person who is identified as an Affiliate in the list furnished pursuant to this Section 5.11 to deliver to DEI, on or prior to the Effective Time, a written agreement, in the form to be approved by the parties hereto, that such Affiliate will not sell, pledge, transfer or otherwise dispose of any DEI Shares issued to such Affiliate pursuant to the Merger, except pursuant to an effective registration statement or in compliance with Rule 145 or an exemption from the registration requirements of the Securities Act. 5.12. Representations and Warranties. Except as otherwise expressly provided by this Agreement, neither STR nor DEI or Merger Sub will take any action that would cause any of the representations and warranties set forth in Sections 4.1 or 4.2, as the case may be, not to be true and correct in all material respects at and as of the Effective Time; provided, that STR shall not be prohibited from selling STR Shares under the conditions set forth in Schedule 5.4(c). 5.13 Board of Directors of DEI. Effective at the Effective Time and conditional upon the consummation of the Merger, William Panschar and Charles Stanich shall have submitted their resignations as DEI Directors to the DEI Board of Directors, DEI's Board of Directors shall have resolved to increase the number of directors on the DEI Board of Directors to seven and DEI's Board of Directors shall have appointed S. R. Perrino, S. K. Rockwell, James Busey and Dr. Chuck Bernard to fill the resulting vacancies. 5.14 Amended and Restated Certificate of Incorporation of DEI. If duly approved by DEI's stockholders as contemplated by Section 5.2, DEI shall, immediately prior to the Effective Time, execute and file the DEI Amended Certificate with the Delaware Secretary of State. 6. POST-CLOSING COVENANTS. The Parties agree as follows with respect to the period following the Closing: 6.1 General. In case at any time after the Closing any further action is necessary or desirable to carry out the purposes of this Agreement or any Employment Agreement, each of the Parties will, to the extent permitted by law, take such further action (including the execution and delivery of such further instruments and documents and obtaining such further consents) as any other Party may request, all at the sole cost and expense of the requesting Party. STR acknowledges and agrees that from and after the Closing, DEI will be entitled to possession of all documents, books, records (including Tax records), agreements and financial data in STR's possession of any sort relating to STR. 6.2 Employee Benefit Plans. DEI shall maintain or cause to be maintained after the Closing all of the Employee Benefit Plans of STR and DEI until such time as it has determined that termination of any such Employee Benefit Plan is in DEI's best interest. 7. CONDITIONS TO OBLIGATIONS TO CLOSE THE MERGER. A-29 181 7.1 Conditions to Obligation of DEI and Merger Sub. The obligation of DEI and Merger Sub to consummate the transactions to be performed by them in connection with the Closing is subject to satisfaction or waiver of the following conditions prior to the Effective Time: (a) The representations and warranties set forth in Section 4.1 shall be true and correct at and as of the Closing Date. (b) STR shall have performed and complied with all of its covenants under this Agreement in all material respects through the Closing. (c) This Agreement and the Merger shall have been duly approved by the holders of the requisite number of the STR Shares in accordance with applicable law and STR's Articles of Incorporation and Bylaws, and the DEI Amended Certificate shall have been duly approved by the holders of the requisite number of the DEI Shares in accordance with applicable law and DEI's Certificate of Incorporation and Bylaws. (d) There shall be no more than 35,000 Dissenters' Shares for which written demand for payment has been made in accordance with the VSCA. (e) STR and DEI shall each have procured all of the third party consents required in order for it to consummate the transactions contemplated by this Agreement. (f) All required governmental and regulatory approvals for the Merger, including any approvals required under federal or state securities laws, shall have been received. (g) No action, suit, or proceeding shall be pending or threatened before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator wherein an unfavorable injunction, judgment, order, decree, ruling, or charge would (i) prevent consummation of any of the transactions contemplated by this Agreement, (ii) cause any of the transactions as set forth in this Agreement to be rescinded following consummation, (iii) affect adversely the right of STR to own its assets and to operate its business as it currently operates, or (iv) if determined adversely to STR or any director, officer, employee or agent of STR, have a material adverse effect on the business, financial condition or prospects of STR and no such injunction, judgment, order, decree, ruling, or charge described in (i), (ii), (iii) or (iv) shall be in effect. (h) All actions to be taken by STR in connection with the consummation of the Merger and all certificates, opinions, instruments, and other documents delivered at the Closing or required to effect the Merger shall be satisfactory in form and substance to DEI and its counsel. (i) STR shall have made, or caused to be made, all of the deliveries required by Section 8.2(b). A-30 182 (j) There shall not have occurred since the date hereof any event which has had or with the passage of time, is reasonably likely to have a material adverse effect on the condition (financial or otherwise), assets, liabilities, results of operations or prospects of STR. (k) The Form S-4 registration statement containing the joint proxy statement to be used at the DEI and STR stockholder meetings at which approval of the Merger is considered shall have become effective, no stop order suspending the effectiveness of the Form S-4 registration statement shall have been issued and no proceedings for such purpose shall have been initiated and be continuing or threatened by the SEC. DEI shall have received all state securities laws or "blue sky" permits and authorizations necessary to issue DEI Shares pursuant to the Merger as contemplated by this Agreement. (l) Each Affiliate of STR shall have executed and delivered to DEI the letters contemplated by Section 5.11, together with such other documents and instruments as DEI may reasonably request related to compliance with the Securities Act. 7.2 Conditions to Obligation of STR to Close the Merger. The obligation of STR to consummate the transactions to be performed by it in connection with the Closing is subject to satisfaction or waiver of the following conditions: (a) The representations and warranties set forth in Section 4.2 shall be true and correct at and as of the Closing Date. (b) DEI and Merger Sub shall have performed and complied with all of their covenants under this Agreement in all material respects through the Closing. (c) No action, suit, or proceeding shall be pending or threatened before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator wherein an unfavorable injunction, judgment, order, decree, ruling, or charge would (i) prevent consummation of any of the transactions contemplated by this Agreement, or (ii) cause any of the transactions contemplated by this Agreement to be rescinded following consummation, and no such injunction, judgment, order, decree, ruling, or charge described in (i) and (ii) shall be in effect. (d) DEI and Merger Sub shall have made, or caused to be made, all of the deliveries required by Section 8.2(a). (e) This Agreement and the Merger shall have been duly approved by the holders of the requisite number of the STR Shares in accordance with applicable law and STR's Articles of Incorporation and Bylaws, and the DEI Amended Certificate shall have been duly approved by the holders of the requisite number of the DEI Shares in accordance with applicable law and DEI's Certificate of Incorporation and Bylaws. (f) All required governmental and regulatory approvals for the Merger, including any approvals required under federal or state securities laws, shall have been received. A-31 183 (g) All actions to be taken by DEI and Merger Sub in connection with the consummation of the Merger and all certificates, opinions, instruments, and other documents delivered at the Closing or required to effect the Merger shall be satisfactory in form and substance to STR and its counsel. (h) There shall not have occurred since the date hereof any event which has had or with the passage of time, is reasonably likely to have a material adverse effect on the condition (financial or otherwise), assets, liabilities, results of operations or prospects of DEI and the DEI Subsidiaries, taken as a whole. (i) The Form S-4 registration statement containing the joint proxy statement to be used at the DEI and STR stockholder meetings at which approval of the Merger is considered shall have become effective, no stop order suspending the effectiveness of the Form S-4 registration statement shall have been issued and no proceedings for such purpose shall have been initiated and be continuing or threatened by the SEC. DEI shall have received all state securities laws or "blue sky" permits and authorizations necessary to issue DEI Shares pursuant to the Merger as contemplated by this Agreement. 8. CLOSING. 8.1 Time and Place. Subject to the terms and conditions of this Agreement, the closing of the transactions contemplated by this Agreement (the "Closing") will take place at such location, on such date and at such time as the Parties mutually agree at the earliest practicable time after the satisfaction or waiver of all conditions to the Merger set forth in Article 7 hereof (the "Closing Date"). 8.2 Deliveries at the Closing. (a) At the Closing, DEI will deliver or cause to be delivered to STR the following: (i) A certificate of DEI, dated the Closing Date, signed by the President and the Treasurer of DEI, to the effect that the conditions of Section 7.2 have been fulfilled; (ii) The written opinion of Dykema Gossett PLLC, counsel to DEI, dated the Closing Date, in the form attached as Exhibit 8.2(a)(ii); (iii) Employment Agreements executed by DEI, Mr. Thomas Ory and Mr. Charles Stanich; and (iv) The Articles of Merger executed by Merger Sub. (b) At the Closing, STR will deliver or cause to be delivered to DEI the following: (i) A certificate of STR, dated the Closing Date, signed by the President and the Treasurer of STR, to the effect that the conditions of Section 7.1 have been fulfilled; A-32 184 (ii) The opinion of Michaels, Wishner & Bonner, P.C., counsel to STR, dated the Closing Date, in the form attached as Exhibit 8.2(b)(ii); (iii) The Articles of Merger executed by STR; and (iv) Such other information, documents or instruments from STR as DEI may reasonably request for the purpose of effectuating the transactions contemplated by the Agreement. 9. TERMINATION. 9.1 Termination. Notwithstanding the adoption of this Agreement by DEI, Merger Sub and STR, this Agreement may be terminated, and the Merger abandoned, at any time before the Effective Time in any of the following ways: (a) by the mutual written agreement of the Parties; (b) by DEI if (i) any of the conditions set forth in Section 7.1 have not been satisfied at Closing and have not been waived by DEI, (ii) STR shall have failed to comply in any material respect with any of the covenants, conditions or agreements contained in this Agreement to be complied with or performed by STR at or prior to such date of termination and which failure to comply has not been cured within five business days following receipt by STR of written notice of such failure to comply, (iii) any representation or warranty of STR contained in this Agreement shall not be true in all material respects when made or on and as of the Effective Time as if made on and as of the Effective Time, (iv) the STR Board of Directors withdraws, modifies or changes its recommendation of this Agreement or the Merger in a manner adverse to DEI or shall have resolved to do any of the foregoing, (v) the STR Board of Directors shall have recommended to the stockholders of STR any Acquisition Proposal or resolved to do so, or (vi) DEI enters into a definitive agreement accepting a Higher Offer; (c) by STR if (i) any of the conditions set forth in Section 7.2 have not been satisfied at Closing and have not been waived by STR, (ii) DEI shall have failed to comply in any material respect with any of the covenants, conditions or agreements contained in this Agreement to be complied with or performed by DEI at or prior to such date of termination and which failure to comply has not been cured within five business days following receipt by DEI of written notice of such failure to comply, (iii) any representation or warranty of DEI contained in this Agreement shall not be true in all material respects when made or on and as of the Effective Time as if made on and as of the Effective Time, (iv) the DEI Board of Directors withdraws, modifies or changes its recommendation of this Agreement or the Merger in a manner adverse to STR or shall have resolved to do any of the foregoing, (v) the DEI Board of Directors shall have recommended to the stockholders of DEI any Acquisition Proposal or resolved to do so, or (vi) STR enters into a definitive agreement accepting a Higher Offer; or (d) by STR or DEI if the Closing Date does not occur on or before May 31, 1998; provided, that the right to terminate this Agreement under this paragraph (d) shall not be available A-33 185 to any Party whose failure to fulfill any obligations under this Agreement has been the cause of or resulted in the failure of the consummation of the Merger to occur on or before such date. A Party desiring to terminate this Agreement must give written notice of such termination to the other Parties, specifying the paragraph of this Section 9.1 pursuant to which such termination is made and the reason(s) therefor. 9.2 Effect of Termination. In the event this Agreement is terminated and the Merger abandoned (a) pursuant to Section 9.1(b)(v) or Section 9.1(c)(vi), or (b) as a result of the failure of STR's stockholders to approve the Merger, DEI shall be entitled to receive from STR all costs and out-of-pocket expenses (including reasonable attorneys', accountants and investment banking fees and expenses related to the Merger and any related financing) which DEI may have incurred in connection with the negotiation and preparation of this Agreement and related documentation, due diligence investigations undertaken with respect to STR and DEI, and the preparation, filing, printing and mailing of the Form S-4 registration statement and the joint proxy statement included therein and the response to SEC comments thereon. In the event this Agreement is terminated and the Merger abandoned (x) pursuant to Section 9.1(c)(v) or Section 9.1(b)(vi), or (y) as a result of the failure of DEI's stockholders to approve the Merger, STR shall be entitled to receive from DEI all costs and out-of-pocket expenses (including reasonable attorneys', accountants and investment banking fees and expenses related to the Merger and any related financing) which STR may have incurred in connection with the negotiation and preparation of this Agreement and related documentation, due diligence investigations undertaken with respect to STR and DEI, and the preparation, filing, printing and mailing of the Form S-4 registration statement and the joint proxy statement included therein and the response to SEC comments thereon. Upon termination of this Agreement (and the Merger) pursuant to Section 9.1 for any other reason, each Party will be responsible for its out-of-pocket expenses (including professional fees and expenses) and the cost of printing the Form S-4 Registration Statement and the related joint proxy statement shall be borne equally by DEI and STR. 10. SURVIVAL OF REPRESENTATIONS. 10.1 No Survival of Representations and Warranties. The representations and warranties contained in this Agreement and in any certificate furnished or to be furnished pursuant hereto shall not survive the Closing Date. 11. MISCELLANEOUS. 11.1 Complete Agreement; Amendment. This Agreement and the Employment Agreements, including the Exhibits, the Schedules and other writings referred to in or delivered pursuant to or simultaneously with this Agreement, contain the entire understanding of the Parties with respect to the transactions contemplated by this Agreement. No representation, inducement, agreement, promise or understanding altering, modifying, taking from or adding to the terms and conditions hereof will have any force and effect unless the same is in writing and validly executed by the Parties hereto. A-34 186 11.2 Notices. All notices or other communications required or permitted hereunder will be in writing and will be deemed to have been duly given if sent by registered or certified mail, postage prepaid and return receipt requested, addressed as follows: (a) if to DEI or Merger Sub, to: Mr. Thomas R. Ory, President Daedalus Enterprises, Inc. 300 Parkland Plaza Ann Arbor, Michigan 48106 with a copy to: Mark A. Metz, Esq. Dykema Gossett PLLC 400 Renaissance Center Detroit, Michigan 48243 (b) If to STR, to: S. R. Perrino, President S. T. Research Corporation 8419 Terminal Road Newington, Virginia 22122 with a copy to: Mark Wishner, Esq. Michaels, Wishner & Bonner, P.C. Suite 900 1140 Connecticut Avenue Washington, D.C. 20036 or to such other address as will be furnished in writing by any Party, and any such notice or communication will be deemed to have been given as of the date so mailed. Any Party may send any notice, request, demand, claim, or other communication hereunder to the intended recipient at the address set forth above using any other means (including personal delivery, expedited courier, messenger service, telecopy, telex, ordinary mail, or electronic mail), but no such notice, request, demand, claim, or other communication will be deemed to have been duly given unless and until it actually is received by the intended recipient. Any Party may change the address to which notices, requests, demands, claims, and other communications hereunder are to be delivered by giving the other Party notice in the manner herein set forth. A-35 187 11.3 Expenses. Accept as otherwise provided in this Agreement, each Party will be responsible for the payment of the fees and expenses which he or it incurs for counsel, accountants, brokers and otherwise in connection with this Agreement. 11.4 Assignment. This Agreement will be binding upon and inure to the benefit of, and be enforceable by, the Parties hereto and their respective successors and assigns, provided that neither this Agreement nor any of the rights, interests or obligations under this Agreement will be assigned by STR without the prior written consent of DEI; and further provided, that DEI may assign, in its sole discretion, any or all of its rights, interests and obligations under this Agreement to any direct or indirect wholly owned subsidiary of DEI. 11.5 Counterparts. This Agreement may be executed in counterparts, all of which together will be deemed an original of this Agreement. 11.6 Governing Law. This Agreement will be governed by the laws of the State of Delaware without regard to its rules regarding choice of law. 11.7 Interpretation. The titles of the Sections have been inserted as a matter of convenience and reference only and will not control or affect the meaning or construction of this Agreement. References to Sections refer to Sections of this Agreement unless otherwise stated. Words such as "herein", "hereof", "hereby" and "hereunder", and words of similar import, unless the context requires otherwise, refer to this Agreement. As used in this Agreement, the masculine, feminine and neuter genders shall be deemed to include the others if the context requires. 11.8 Incorporation of Exhibits and Schedules. The Exhibits and Schedules identified in this Agreement are incorporated herein by reference and made a part hereof. References to this Agreement herein shall be construed as references to the Agreement with all Exhibits and Schedules. 11.9 Construction. The Parties have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement will be construed as if drafted jointly by the Parties and no presumption or burden of proof will arise favoring or disfavoring any Party by virtue of the authorship of any of the provisions of this Agreement. 11.10 Waivers. No waiver by any Party of any default, misrepresentation, or breach of warranty or covenant hereunder, whether intentional or not, will be deemed to extend to any prior or subsequent default, misrepresentation, or breach of warranty or covenant hereunder or affect in any way any rights arising by virtue of any prior or subsequent such occurrence. Any waiver of any obligation contained in this Agreement is freely, knowingly and voluntarily given by each Party, without any duress or coercion, after each Party has had opportunity to consult with its counsel and has carefully and completely read all of the terms and provisions of this Agreement. No Party will be deemed to have made any waiver unless it has been made in writing and signed by the Party to be charged with having made such waiver. A-36 188 IN WITNESS WHEREOF, the duly authorized officers of DEI and STR have hereunto set their hands and delivered this Agreement as of the date and year first above written. DAEDALUS ENTERPRISES, INC. S. T. RESEARCH CORPORATION By: /s/ Thomas R. Ory By: /s/ S. R. Perrino - --------------------------- ----------------------- Thomas R. Ory S. R. Perrino Its: President Its: President DEI MERGER SUB, INC. By: /s/ Thomas R. Ory - --------------------------- Its: President A-37 189 Schedules to the Agreement: 4.1(b)(i) Organization, qualification and corporation power 4.1(b)(ii) Subsidiaries and former subsidiaries 4.1(d) Capitalization 4.1(e) Equity interests 4.1(f) STR Financial Statements 4.1(g) Subsequent Events 4.1(k) Litigation 4.1(l) Intellectual property 4.1(m) Exceptions to tangible assets owned 4.1(n) Contracts 4.1(o) Setoffs and Counterclaims 4.1(q) Insurance 4.1(t) Employee benefits 4.1(u) Insider interests 4.2(b)(i) List of jurisdictions in which DEI is qualified as a foreign corporation 4.2(d) Options and Warrants 4.2(g) Subsequent Events 4.2(j) Taxes 4.2(k) Litigation 4.2(l) Intellectual property 4.2(m) Exceptions to tangible assets owned 4.2(n) Contracts 4.2(q) Insurance 4.2(t) Employee benefits 4.2(v) Broker fees 5.4(c) Sales 5.4(l) Asset transfer Exhibits to the Agreement: 5.2 Form of DEI Amended Certificate 8.2(a)(ii) Form of Opinion of Dykema Gossett PLLC 8.2(a)(iii) Form of Employment Agreement 8.2(b)(ii) Form of Opinion of Michaels, Wishner & Bonner, P.C. A-38 190 ANNEX B December 23, 1997 Board of Directors Daedalus Enterprises, Inc. 300 Parkland Plaza Rd. Ann Arbor, Michigan 48103 Gentlemen: We understand that Daedalus Enterprises, Inc. ("Daedalus" or the "Company") intends to enter into a strategic merger with S.T. Research Corporation ("S.T. Research") pursuant to the Agreement and Plan of Merger by and among Daedalus, DEI Merger Sub, Inc. and S.T. Research datxed December 23, 1997 (referred to as the "Agreement"). Under the proposed terms contained in the Agreement, Daedalus will exchange 2.58 shares of its common stock for each outstanding share of S.T. Research common stock (the "Consideration"). Daedalus will be the surviving entity with a new name to be determined. You have requested that Roney & Co. render an opinion to you as to whether the Consideration as proposed under the Agreement is fair, from a financial point of view, to the shareholders of Daedalus. Roney & Co. is a regional investment banking firm of recognized standing. As part of our investment banking services, we are regularly engaged in the valuation of corporate entities in connection with public offerings and merger and acquisition transactions. In arriving at the opinion as set forth below, we have, among other things: I. Reviewed the Annual Reports and related financial information for the fiscal years ended 1993 to 1997 for Daedalus; II. Reviewed the audited financial statements for the fiscal years ended 1992 to 1997 for S.T. Research; III. Reviewed 1998 budgets for both Daedalus and S.T. Research; IV. Reviewed the Agreement V. Relied upon the appraisal of Daedalus' facility prepared by Gerald Alcock Company, LLC as of June 30, 1995; VI. Relied upon the fair market value of ESOP shares of S.T. Research prepared by Corporate Finance of Washington as of December 31, 1996; VII. Researched current industry conditions and trends concerning the terms of recent comparable mergers and acquisitions as we deemed relevant; and B-1 191 Daedalus Enterprises, Inc. December 23, 1997 VIII. Conducted discussions with members of senior management of Daedalus and S.T. Research concerning their respective business and prospects and the benefits of the Agreement. In preparing our opinion, we have relied on and assumed the accuracy and completeness of all financial and other information supplied or otherwise made available to us. We have not assumed any responsibility for independent verification of such information or any independent appraisal of the information. With respect to the financial forecasts furnished to us, we have assumed, without any further independent investigations and analysis by Roney, that they have been reasonably prepared and reflect the best currently available estimates and judgment of Daedalus' and S.T. Research's management as to their respective expected future financial performance. In our analyses, we have made numerous assumptions with respect to industry performance, business and economic conditions, and other matters, many of which are beyond the control of Daedalus and S.T. Research. Any estimates contained in our analyses are not necessarily indicative of future results or value, which may be significantly more or less favorable than such estimates. Estimates of values of companies do no purport to be appraisals or necessarily reflect the price at which companies or their securities actually may be sold. No company or transaction utilized in our analyses was identical to Daedalus or the proposed transaction. Accordingly, such analyses are not based solely on arithmetic calculations, rather, they involve complex considerations and judgments concerning differences in financial and operating characteristics of the relevant companies, the timing of the relevant transactions and prospective buyer interests, as well as other factors that could affect companies to which they are being compared. None of the analyses performed by us was assigned a greater significance than any other. It should be noted that this opinion is based on economic and market conditions and other circumstances existing on, and information made available as of, the date hereof. In addition, our opinion is, in any event, limited to the fairness to Daedalus and its shareholders, from a financial point of view, of the Consideration and does not address Daedalus' underlying business decision to effect the Transaction or any other terms of the Transaction. Our opinion is directed to the Board of Directors of Daedalus and does not constitute a recommendation to the Board of Directors of Daedalus in connection with any matter relating to the Agreement and has been prepared for the use of the Board of Directors and senior management of Daedalus and will not be reproduced, summarized, described or referred to or given to any other person without our prior written consent. Notwithstanding the B-2 192 Daedalus Enterprises, Inc. December 23, 1997 foregoing, this opinion may be included in the registration statement or prospectus and proxy statement filed in connection with the Agreement, provided that this opinion will be reproduced in full, and any description of or reference to us or summary of the opinion in such registration statement or prospectus and proxy statement will be in a form acceptable to us and our counsel. On the basis of, and subject to, the foregoing, we are of the opinion that, as of the date hereof, the Consideration, as proposed by the Agreement, is fair to the shareholders of Daedalus, from a financial point of view. Sincerely, RONEY & CO. B-3 193 ANNEX C TITLE 13.1. CORPORATIONS CHAPTER 9. VIRGINIA STOCK CORPORATION ACT ARTICLE 15. DISSENTERS' RIGHTS Section 13.1-729. Definitions. In this article: "Corporation" means the issuer of the shares held by a dissenter before the corporate action, except that (i) with respect to a merger, "corporation" means the surviving domestic or foreign corporation or limited liability company by merger of that issuer, and (ii) with respect to a share exchange, "corporation" means the acquiring corporation by share exchange, rather than the issuer, if the plan of share exchange places the responsibility for dissenters' rights on the acquiring corporation. "Dissenter" means a shareholder who is entitled to dissent from corporate action under Section 13.1-730 and who exercises that right when and in the manner required by Sections 13.1-732 through 13.1-739. "Fair value," with respect to a dissenter's shares, means the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable. "Interest" means interest from the effective date of the corporate action until the date of payment, at the average rate currently paid by the corporation on its principal bank loans or, if none, at a rate that is fair and equitable under all the circumstances. "Record shareholder" means the person in whose name shares are registered in the records of a corporation or the beneficial owner of shares to the extent of the rights granted by a nominee certificate on file with a corporation. "Beneficial shareholder" means the person who is a beneficial owner of shares held by a nominee as the record shareholder. "Shareholder" means the record shareholder or the beneficial shareholder. Section 13.1-730. Right to dissent. A. A shareholder is entitled to dissent from, and obtain payment of the fair value of his shares in the event of, any of the following corporate actions: C-1 194 1. Consummation of a plan of merger to which the corporation is a party (i) if shareholder approval is required for the merger by Section 13.1-718 or the articles of incorporation and the shareholder is entitled to vote on the merger or (ii) if the corporation is a subsidiary that is merged with its parent under Section 13.1-719; 2. Consummation of a plan of share exchange to which the corporation is a party as the corporation whose shares will be acquired, if the shareholder is entitled to vote on the plan; 3. Consummation of a sale or exchange of all, or substantially all, of the property of the corporation if the shareholder was entitled to vote on the sale or exchange or if the sale or exchange was in furtherance of a dissolution on which the shareholder was entitled to vote, provided that such dissenter's rights shall not apply in the case of (i) a sale or exchange pursuant to court order, or (ii) a sale for cash pursuant to a plan by which all or substantially all of the net proceeds of the sale will be distributed to the shareholders within one year after the date of sale; 4. Any corporate action taken pursuant to a shareholder vote to the extent the articles of incorporation, bylaws, or a resolution of the board of directors provides that voting or nonvoting shareholders are entitled to dissent and obtain payment for their shares. B. A shareholder entitled to dissent and obtain payment for his shares under this article may not challenge the corporate action creating his entitlement unless the action is unlawful or fraudulent with respect to the shareholder or the corporation. C. Notwithstanding any other provision of this article, with respect to a plan of merger or share exchange or a sale or exchange of property there shall be no right of dissent in favor of holders of shares of any class or series which, at the record date fixed to determine the shareholders entitled to receive notice of and to vote at the meeting at which the plan of merger or share exchange or the sale or exchange of property is to be acted on, were (i) listed on a national securities exchange or on the National Association of Securities Dealers Automated Quotation System (NASDAQ) or (ii) held by at least 2,000 record shareholders, unless in either case: 1. The articles of incorporation of the corporation issuing such shares provide otherwise; 2. In the case of a plan of merger or share exchange, the holders of the class or series are required under the plan of merger or share exchange to accept for such shares anything except: a. Cash; b. Shares or membership interests, or shares or membership interests and cash in lieu of fractional shares (i) of the surviving or acquiring corporation or limited liability company or (ii) of any other C-2 195 corporation or limited liability company which, at the record date fixed to determine the shareholders entitled to receive notice of and to vote at the meeting at which the plan of merger or share exchange is to be acted on, were either listed subject to notice of issuance on a national securities exchange or held of record by at least 2,000 record shareholders or members; or c. A combination of cash and shares or membership interests as set forth in subdivisions 2 a and 2 b of this subsection; or 3. The transaction to be voted on is an "affiliated transaction" and is not approved by a majority of "disinterested directors" as such terms are defined in Section 13.1-725. D. The right of a dissenting shareholder to obtain payment of the fair value of his shares shall terminate upon the occurrence of any one of the following events: 1. The proposed corporate action is abandoned or rescinded; 2. A court having jurisdiction permanently enjoins or sets aside the corporate action; or 3. His demand for payment is withdrawn with the written consent of the corporation. Section 13.1-731. Dissent by nominees and beneficial owners. A. A record shareholder may assert dissenters' rights as to fewer than all the shares registered in his name only if he dissents with respect to all shares beneficially owned by any one person and notifies the corporation in writing of the name and address of each person on whose behalf he asserts dissenters' rights. The rights of a partial dissenter under this subsection are determined as if the shares as to which he dissents and his other shares were registered in the names of different shareholders. B. A beneficial shareholder may assert dissenters' rights as to shares held on his behalf only if: 1. He submits to the corporation the record shareholder's written consent to the dissent not later than the time the beneficial shareholder asserts dissenters' rights; and 2. He does so with respect to all shares of which he is the beneficial shareholder or over which he has power to direct the vote. C-3 196 Section 13.1-732. Notice of dissenters' rights. A. If proposed corporate action creating dissenters' rights under Section 13.1-730 is submitted to a vote at a shareholders' meeting, the meeting notice shall state that shareholders are or may be entitled to assert dissenters' rights under this article and be accompanied by a copy of this article. B. If corporate action creating dissenters' rights under Section 13.1-730 is taken without a vote of shareholders, the corporation, during the ten-day period after the effectuation of such corporate action, shall notify in writing all record shareholders entitled to assert dissenters' rights that the action was taken and send them the dissenters' notice described in Section 13.1-734. Section 13.1-733. Notice of intent to demand payment. A. If proposed corporate action creating dissenters' rights under Section 13.1-730 is submitted to a vote at a shareholders' meeting, a shareholder who wishes to assert dissenters' rights (i) shall deliver to the corporation before the vote is taken written notice of his intent to demand payment for his shares if the proposed action is effectuated and (ii) shall not vote such shares in favor of the proposed action. B. A shareholder who does not satisfy the requirements of subsection A of this section is not entitled to payment for his shares under this article. Section 13.1-734. Dissenters' notice. A. If proposed corporate action creating dissenters' rights under Section 13.1-730 is authorized at a shareholders' meeting, the corporation, during ten-day period after the effectuation of such corporate action, shall deliver a dissenters' notice in writing to all shareholders who satisfied the requirements of Section 13.1-733. B. The dissenters' notice shall: 1. State where the payment demand shall be sent and where and when certificates for certificated shares shall be deposited; 2. Inform holders of uncertificated shares to what extent transfer of the shares will be restricted after the payment demand is received; 3. Supply a form for demanding payment that includes the date of the first announcement to news media or to shareholders of the terms of the proposed corporate action and requires that the person asserting dissenters' rights certify whether or not he acquired beneficial ownership of the shares before or after that date; C-4 197 4. Set a date by which the corporation must receive the payment demand, which date may not be fewer than thirty nor more than sixty days after the date of delivery of the dissenters' notice; and 5. Be accompanied by a copy of this article. Section 13.1-735. Duty to demand payment. A. A shareholder sent a dissenters' notice described in Section 13.1-734 shall demand payment, certify that he acquired beneficial ownership of the shares before or after the date required to be set forth in the dissenters' notice pursuant to subdivision 3 of subsection B of Section 13.1-734, and, in the case of certificated shares, deposit his certificates in accordance with the terms of the notice. B. The shareholder who deposits his shares pursuant to subsection A of this section retains all other rights of a shareholder except to the extent that these rights are canceled or modified by the taking of the proposed corporate action. C. A shareholder who does not demand payment and deposits his share certificates where required, each by the date set in the dissenters' notice, is not entitled to payment for his shares under this article. Section 13.1-736. Share restrictions. A. The corporation may restrict the transfer of uncertificated shares from the date the demand for their payment is received. B. The person for whom dissenters' rights are asserted as to uncertificated shares retains all other rights of a shareholder except to the extent that these rights are canceled or modified by the taking of the proposed corporate action. Section 13.1-737. Payment. A. Except as provided in Section 13.1-738, within thirty days after receipt of a payment demand made pursuant to Section 13.1-735, the corporation shall pay the dissenter the amount the corporation estimates to be the fair value of his shares, plus accrued interest. The obligation of the corporation under this paragraph may be enforced (i) by the circuit court in the city or county where the corporation's principal office is located, or, if none in this Commonwealth, where its registered office is located or (ii) at the election of any dissenter residing or having its principal office in the Commonwealth, by the circuit court in the city or county where the dissenter resides or has its principal office. The court shall dispose of the complaint on an expedited basis. B. The payment shall be accompanied by: C-5 198 1. The corporation's balance sheet as of the end of a fiscal year ending not more than sixteen months before the effective date of the corporate action creating dissenters' rights, an income statement for that year, a statement of changes in shareholders' equity for that year, and the latest available interim financial statements, if any; 2. An explanation of how the corporation estimated the fair value of the shares and of how the interest was calculated; 3. A statement of the dissenters' right to demand payment under Section 13.1-739; and 4. A copy of this article. Section 13.1-738. After-acquired shares. A. A corporation may elect to withhold payment required by Section 13.1-737 from a dissenter unless he was the beneficial owner of the shares on the date of the first publication by news media or the first announcement to shareholders generally, whichever is earlier, of the terms of the proposed corporate action, as set forth in the dissenters' notice. B. To the extent the corporation elects to withhold payment under subsection A of this section, after taking the proposed corporate action, it shall estimate the fair value of the shares, plus accrued interest, and shall offer to pay this amount to each dissenter who agrees to accept it in full satisfaction of his demand. The corporation shall send with its offer an explanation of how it estimated the fair value of the shares and of how the interest was calculated, and a statement of the dissenter's right to demand payment under Section 13.1-739. Section 13.1-739. Procedure if shareholder dissatisfied with payment or offer. A. A dissenter may notify the corporation in writing of his own estimate of the fair value of his shares and amount of interest due, and demand payment of his estimate (less any payment under Section 13.1-737), or reject the corporation's offer under Section 13.1-738 and demand payment of the fair value of his shares and interest due, if the dissenter believes that the amount paid under Section 13.1-737 or offered under Section 13.1-738 is less than the fair value of his shares or that the interest due is incorrectly calculated. B. A dissenter waives his right to demand payment under this section unless he notifies the corporation of his demand in writing under subsection A of this section within thirty days after the corporation made or offered payment for his shares. C-6 199 Section 13.1-740. Court action. A. If a demand for payment under Section 13.1-739 remains unsettled, the corporation shall commence a proceeding within sixty days after receiving the payment demand and petition the circuit court in the city or county described in subsection B of this section to determine the fair value of the shares and accrued interest. If the corporation does not commence the proceeding within the sixty-day period, it shall pay each dissenter whose demand remains unsettled the amount demanded. B. The corporation shall commence the proceeding in the city or county where its principal office is located, or, if none in this Commonwealth, where its registered office is located. If the corporation is a foreign corporation without a registered office in this Commonwealth, it shall commence the proceeding in the city or county in this Commonwealth where the registered office of the domestic corporation merged with or whose shares were acquired by the foreign corporation was located. C. The corporation shall make all dissenters, whether or not residents of this Commonwealth, whose demands remain unsettled parties to the proceeding as in an action against their shares and all parties shall be served with a copy of the petition. Nonresidents may be served by registered or certified mail or by publication as provided by law. D. The corporation may join as a party to the proceeding any shareholder who claims to be a dissenter but who has not, in the opinion of the corporation, complied with the provisions of this article. If the court determines that such shareholder has not complied with the provisions of this article, he shall be dismissed as a party. E. The jurisdiction of the court in which the proceeding is commenced under subsection B of this section is plenary and exclusive. The court may appoint one or more persons as appraisers to receive evidence and recommend a decision on the question of fair value. The appraisers have the powers described in the order appointing them, or in any amendment to it. The dissenters are entitled to the same discovery rights as parties in other civil proceedings. F. Each dissenter made a party to the proceeding is entitled to judgment (i) for the amount, if any, by which the court finds the fair value of his shares, plus interest, exceeds the amount paid by the corporation or (ii) for the fair value, plus accrued interest, of his after-acquired shares for which the corporation elected to withhold payment under Section 13.1-738. Section 13.1-741. Court costs and counsel fees. A. The court in an appraisal proceeding commenced under Section 13.1-740 shall determine all costs of the proceeding, including the reasonable compensation and expenses of appraisers appointed by the court. The court shall assess the costs against the corporation, except that the court may assess costs against all or some of the dissenters, in amounts the court finds equitable, C-7 200 to the extent the court finds the dissenters did not act in good faith in demanding payment under Section 13.1-739. B. The court may also assess the reasonable fees and expenses of experts,excluding those of counsel, for the respective parties, in amounts the court finds equitable: 1. Against the corporation and in favor of any or all dissenters if the court finds the corporation did not substantially comply with the requirements of Sections 13.1-732 through 13.1-739; or 2. Against either the corporation or a dissenter, in favor of any other party, if the court finds that the party against whom the fees and expenses are assessed did not act in good faith with respect to the rights provided by this article. C. If the court finds that the services of counsel for any dissenter were of substantial benefit to other dissenters similarly situated, the court may award to these counsel reasonable fees to be paid out of the amounts awarded the dissenters who were benefited. D. In a proceeding commenced under subsection A of Section 13.1-737 the court shall assess the costs against the corporation, except that the court may assess costs against all or some of the dissenters who are parties to the proceeding, in amounts the court finds equitable, to the extent the court finds that such parties did not act in good faith in instituting the proceeding. C-8 201 ANNEX D AMENDED AND RESTATED CERTIFICATE OF INCORPORATION Daedalus Enterprises, Inc., a corporation organized and existing under the laws of the State of Delaware, hereby certifies as follows: 1. The name of the corporation is Daedalus Enterprises, Inc. Daedalus Enterprises, Inc. was originally incorporated under the same name, and the original Certificate of Incorporation of the corporation was filed with the Secretary of State of the State of Delaware on January 13, 1969. 2. Pursuant to Sections 242 and 245 of the General Corporation Law of the State of Delaware, this Amended and Restated Certificate of Incorporation restates and integrates and further amends the provisions of the Certificate of Incorporation of this corporation, and has been duly adopted in accordance with Sections 242 and 245. 3. The text of the Certificate of Incorporation as heretofore amended or supplemented is hereby restated and further amended to read in its entirety as follows: FIRST. The name of the corporation is Sensys Technologies Inc. SECOND. Its registered office in the State of Delaware is located at No. 100 West Tenth Street, in the City of Wilmington, County of New Castle. The name and address of its registered agent is The Corporation Trust Company, No. 100 West Tenth Street, Wilmington, Delaware. THIRD. The nature of the business and its purpose is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware, including, without limitation, research, development and manufacturing. FOURTH. The total number of shares of Common Stock which the corporation shall have authority to issue is five million (5,000,000) and the par value of each of such shares is $0.01, amounting to fifty thousand dollars ($50,000.00). FIFTH. [RESERVED] SIXTH. [RESERVED] SEVENTH. The corporation is to have perpetual existence. EIGHTH. The private property of the stockholders shall not be subject to the payment of corporate debts to any extent whatever. NINTH. In furtherance and not in limitation of the powers conferred by statute, the board of directors is expressly authorized: D-1 202 To make, alter or repeal the bylaws of the corporation. To authorize and cause to be executed mortgages and liens upon the real and personal property of the corporation. To set apart out of any of the funds of the corporation available for dividends a reserve or reserves for any proper purpose and to abolish any such reserve in the manner in which it was created. By resolution passed by a majority of the whole board, to designate one or more committees, each committee to consist of two or more of the directors of the corporation, which, to the extent provided in the resolution or in the bylaws of the corporation, shall have and may exercise the powers of the board of directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it. Such committee or committee shall have such name or names as may be stated in the bylaws of the corporation or as may be determined from time to time by resolution adopted by the board of directors. When and as authorized by the affirmative vote of the holders of a majority of the stock issued and outstanding having voting power given at a stockholders' meeting duly called for that purpose, or when authorized by the written consent of the holders of a majority of the voting stock issued and outstanding, to sell, lease or exchange all of the property and assets of the corporation, including its good will and its corporate franchises, upon such terms and conditions and for such consideration, which may be in whole or in part shares of stock in, and/or other securities of, any other corporation or corporations, as its board of directors shall deem expedient and for the best interests of the corporation. TENTH. Meetings of stockholders may be held outside the State of Delaware, if the bylaws so provide. The books of the corporation may be kept (subject to any provision contained in the statutes) outside the State of Delaware at such place or places as may be designated from time to time by the board of directors or in the bylaws of the corporation. Elections of directors need not be by ballot unless the bylaws of the corporation shall so provide. ELEVENTH. The corporation reserves the right to amend, alter, change or repeal any provision contained in this certificate of incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon stockholders herein are granted subject to this reservation. TWELFTH. Whenever a compromise or arrangement is proposed between this corporation and its creditors or any class of them and/or between this corporation and its stockholders or any class of them, any court of equitable jurisdiction within the State of Delaware may, on the application in a summary way of this corporation or of any creditor or stockholder thereof or on the application of any receiver or receivers appointed for this corporation under the provisions of section 291 of Title 8 of the Delaware Code or on the D-2 203 application of trustees in dissolution or of any receiver or receivers appointed for this corporation under the provisions of section 279 or Title 8 of the Delaware Code order a meeting of the creditors or class of creditors and/or of the stockholders or class of stockholders of this corporation, as the case may be, to be summoned in such manner as the said court directs. If a majority in number representing three-fourths in value of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this corporation, as the case may be, agree to any compromise or arrangement and to any reorganization of this corporation as consequence of such compromise or arrangement, the said compromise or arrangement and the said reorganization shall, if sanctioned by the court to which the said application has been made, be binding on all the creditors or class of creditors, and/or on all the stockholders or class of stockholders, of this corporation, as the case may be, and also on this corporation. THIRTEENTH: A Director of the corporation shall not be personally liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a Director, except for liability (i) for any breach of the Director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the General Corporation Law of the State of Delaware, as the same exists or hereafter may be amended, or (iv) for any transaction from which the Director derived an improper personal benefit. If the General Corporation Law of the State of Delaware hereafter is amended to authorize the further elimination or limitation of the liability of Directors, then the liability of a Director of the corporation, in addition to the limitation on personal liability provided herein, shall be limited to the fullest extent permitted by the amended Delaware General Corporation Law of the State of Delaware. Any repeal or modification of this Article THIRTEENTH by the stockholders of the corporation shall be prospective only, and shall not adversely affect any limitation on the personal liability of a Director of the corporation existing at the time of such repeal or modification. IN WITNESS WHEREOF, the undersigned corporation has executed, signed and acknowledged this Amended and Restated Certificate of Incorporation this ___ day of _______, 1998. ___________________________________ Thomas R. Ory President (authorized officer) Acknowledged: ______________________________ Lloyd A. Semple, Secretary D-3 204 ANNEX E [CORPORATE FINANCE OF WASHINGTON, INC. LETTERHEAD] December 23, 1997 Board of Directors S.T. Research Corporation Newington, Virginia You have asked our opinion of fairness from a financial point of view to the shareholders of S.T. Research Corporation ("STR") of the Agreement and Plan of Merger dated 12/23/97 between S.T. Research and Daedalus Enterprises, Inc. This Agreement provides, in part, that Daedalus will exchange 2.58 shares of its Common Stock to acquire each share of STR. In arriving at our opinion, we have analyzed: (1) the merger agreement, (2) financial information concerning the assets, operations, and prospects of S.T. Research and Daedalus as furnished by their respective managements, (3) the trading history of Daedalus' common stock, (4) the financial effects of the merger upon the Daedalus shares to be exchanged for S.T. Research shares, and (5) the market price ratios of defense electronics manufacturers. We have visited the STR facilities and have discussed with its management the operations, financial condition and prospects and the potential strategic benefits of the merger to both companies. We have relied upon the accuracy and completeness of the financial and other information provided to us by the respective managements. In brief, our analysis shows a reduction in revenues per STR share but a per share enhancement of assets, working capital, estimated EBITDA (earnings before interest, depreciation and amortization), and expected market price. In our opinion, the exchange of shares by Daedalus Enterprises, Inc. for the shares of S.T. Research Corporation pursuant to the Merger Agreement is fair from a financial point of view to S.T. Research Corporation and its stockholders. Corporate Finance of Washington, Inc. By: /s/ Peter Gavian --------------------- Peter Gavian E-1 205 PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 20. Indemnification of Directors and Officers. Section 145 of the General Corporation Law of the State of Delaware (the "DGCL") provides that a corporation may indemnify its officers, directors, employees and agents (or persons who have served, at the corporation's request, as officers, directors, employees or agents of another corporation) against the expenses, including attorneys' fees, actually and reasonably incurred by them in connection with the defense of any action by reason of being or having been directors, officers, employees or agents, if such person shall have 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 proceedings, had no reason to believe his conduct was unlawful, except that if such action shall be in the right of the corporation, no such indemnification shall be provided as to any claims, issue or matter as to which such person shall have been adjudged to have been liable to the corporation unless and only to the extent that the Court of Chancery of the State of Delaware, or any other court in which the suit was brought, shall determine upon application that in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. Item 21. Exhibits A list of exhibits included as part of this Registration Statement is set forth in the Exhibit Index which immediately precedes such exhibits and is incorporated herein by reference. Item 22. Undertakings 1. The undersigned Registrant hereby undertakes: (a) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) to include any prospectus required by Section 10(a)(3) of the Securities Act; (ii) to reflect in the prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement (notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration fee" table in the effective registration statement); (iii) to include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement. (b) That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (c) To remove from registration by means of post-effective amendment any of the foregoing securities being registered which remain unsold at the termination of the offering. 2. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the II-1 206 Registrant 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. In the event that a claim for indemnification against such liabilities (other than the payment by a Registrant of expenses incurred or paid by a director, officer or controlling person of such Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant against which such claim is asserted will, unless in the opinion of its counsel the mater has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by them is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. 3. The undersigned registrant hereby undertakes to respond to requests for information that is incorporated by reference into the prospectus pursuant to Items 4, 10(b), 11 or 14 of this Form S-4, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the registration statement through the date of responding to the request. 4. The undersigned registrant hereby undertakes to supply by means of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the registration statement when it became effective. 207 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant certifies that it has reasonable grounds to believe that it meets all requirements for filing on Form S-4 and has duly caused this Amendment No. 2 to Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Ann Arbor, State of Michigan on the date indicated below. DAEDALUS ENTERPRISES, INC. Dated: May 7, 1998 By: /s/ Thomas R. Ory -------------------------------------- Thomas R. Ory President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Amendment No. 2 to Registration Statement has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated, in the City of Ann Arbor, State of Michigan.
Signature Title Date - --------- ----- ---- /s/ Thomas R. Ory President, Chief Executive Officer and Director May 7, 1998 - --------------------------- (Principal Executive Officer) Thomas R. Ory * Vice President - Finance and Treasurer May 7, 1998 - --------------------------- (Principal Financial and Accounting Officer) Jane E. Barrett * Vice President, Chief Operating Officer and May 7, 1998 - --------------------------- Director Charles G. Stanich * Director and Chairman of the Board May 7, 1998 - --------------------------- John D. Sanders * Director May 7, 1998 - --------------------------- William S. Panschar * Director May 7, 1998 - --------------------------- Philip H. Power * By /s/ Thomas R Ory --------------------- Thomas R. Ory Attorney-in-fact
208 EXHIBIT INDEX The Commission File Number for all reports filed on Forms 10-K, 10-Q or 8-K filed by DEI is 0-8193.
Exhibit No. Description - ----------- ----------- 2.01 Agreement and Plan of Merger, dated as of December 23, 1997, by and among DEI, DEI Merger Sub and STR (included as Annex A to the Joint Proxy Statement/Prospectus which is a part of this Registration Statement). 3.01 Certificate of Incorporation of DEI, with all amendments thereto, as presently in effect (filed as exhibit 3.01 to the 1994 Form 10-K and incorporated herein by reference) 3.03 Bylaws of DEI, with all amendments thereto, as presently in effect (filed as exhibit 3.03 to the Quarterly Report on Form 10-Q for the first quarter of fiscal 1998 and incorporated herein by reference) 4.43 Real Estate Mortgage in the amount of $425,000 dated March 1, 1991, between DEI and Manufacturers National Bank, Ann Arbor (formerly filed as exhibit 4.43, Term Note, to DEI's Quarterly Report on Form 10-Q for the second quarter of fiscal 1991 and incorporated herein by reference) 4.46 First Amendment to Real Estate Mortgage dated December 23, 1991 between DEI and Manufacturers Bank, N.A. (filed as exhibit 4.46 to DEI's Quarterly Report on Form 10-Q for the second quarter of fiscal 1992 and incorporated herein by reference) 4.55 Mortgage Extension Agreement between DEI and Comerica Bank, dated October 30, 1995 (filed as exhibit 4.55 to DEI's Quarterly Report on Form 10-Q for the first quarter of fiscal 1996 and incorporated herein by reference) 4.57 Master Revolving Note and Advance Formula Agreement between DEI and Comerica Bank, both dated October 25, 1996 (filed as exhibit 4.57 to the 1996 Form 10-K and incorporated herein by reference) 5.01 Opinion of Dykema Gossett PLLC (previously filed) 8.01 Opinion of Michaels, Wishner & Bonner, P.C. (filed herewith) 10.60 1983 Incentive Stock Option Plan (filed as exhibit 10.60 to the 1994 Form 10-K and incorporated herein by reference) 10.607 Non-Qualified Stock Option Agreement with Mr. Thomas R. Ory, dated November 8, 1989 (filed as exhibit 10.607 to the 1993 Form 10-K and incorporated herein by reference) 10.608 Non-Qualified Stock Option Agreement with Mr. Charles G. Stanich, dated November 8, 1989 (filed as exhibit 10.608 to the 1993 Form 10-K and incorporated herein by reference) 10.610 Long-term Incentive Plan (filed as exhibit 10.610 to the 1994 Form 10-K and incorporated herein by reference) 10.611 Stock Option Plan for Nonemployee Directors (filed as exhibit 10.611 to the 1994 Form 10-K and incorporated herein by reference)
209 10.612 Form of Senior Officer Severance Agreement with Messrs. Ory and Stanich, dated June 21, 1995 (filed as Exhibit 10.612 to the 1995 Form 10-K and incorporated herein by reference) 10.613 Form of Incentive Stock Option Agreement Under Long-Term Incentive Plan (filed as exhibit 10.613 to DEI's Quarterly Report on Form 10-Q for the first quarter of fiscal 1997 and incorporated herein by reference) 10.614 Form on Non-Qualified Stock Option Agreement Under Long-Term Incentive Plan (filed as exhibit 10.614 to DEI's Quarterly Report on Form 10-Q for the second quarter of fiscal 1997 and incorporated herein by reference) 10.901 Teaming agreement between DEI and Coastal Environmental Services, Inc., dated March 17, 1994. (filed as exhibit 10.901 to the 1994 Form 10-K and incorporated herein by reference) 10.902 Agreement between DEI and James W. Sewall Company, dated March 25, 1994, for the development of the Airborne Digital Camera and related software for pipeline right-of-way monitoring and other applications (filed as exhibit 10.902 to the 1994 Form 10-K and incorporated herein by reference) 10.903 Teaming agreement between DEI and Pacific Meridian Resources, dated August 17, 1994 (filed as exhibit 10.903 to the 1994 Form 10-K and incorporated herein by reference) 10.904 Strategic Alliance Agreement between DEI and ERIM International, Inc., dated October 20, 1997 (filed herewith) 10.905 Cooperative Development and Service Agreement between DEI and ERIM International, Inc., dated March 26, 1998 (filed herewith) 11.01 Computation of Earnings Per Share (filed as exhibit 11.01 to the 1997 Form 10-K and incorporated herein by reference) 21.01 Subsidiaries of DEI (filed as exhibit 21.01 to the 1997 Form 10-K and incorporated herein by reference) 23.01 Consent of Deloitte & Touche LLP (filed herewith) 23.02 Consent of Coopers & Lybrand L.L.P. (filed herewith) 23.03 Consent of Ross, Langan & McKendree LLP (filed herewith) 23.04 Consent of Dykema Gossett PLLC (included in Exhibit 5.01) 23.05 Consent of Michaels, Wishner & Bonner, P.C. (included in Exhibit 8.01) 23.06 Consent of Roney & Co. (filed herewith) 23.07 Consent of Corporate Finance of Washington, Inc. (previously filed) 23.08 Consent of S. R. Perrino (previously filed) 23.09 Consent of James Busey (previously filed) 23.10 Consent of Charles Bernard (previously filed) 23.11 Consent of S. Kent Rockwell (previously filed) 23.12 Consent of Gerald Alcock Company, L.L.C. (filed herewith) 99.01 Form of Proxy to be used in soliciting holders of shares of DEI Common Stock for its Annual Meeting to be held on May 28, 1998 (previously filed) 99.02 Form of Proxy to be used in soliciting holders of shares of STR Common Stock for its Special Meeting to be held on May 28, 1998 (previously filed)
EX-8.01 2 EXHIBIT 8.01 1 Exhibit 8.01 [Michaels, Wishner & Bonner, P.C. Letterhead] May 1, 1998 S.T. Research Corporation 8419 Terminal Road Newington, VA 22122-1430 Gentlemen: You have asked us to render our opinion concerning certain federal income tax consequences of the proposed transaction described below. Facts S.T. Research Corporation ("STR") is a Virginia corporation which develops, manufactures and markets intelligence sensory and electronic reconnaissance systems primarily for the defense markets. STR has issued and outstanding one class of voting common stock (the "STR Shares"). Daedalus Enterprises, Inc. ("DEI") is a Delaware corporation primarily engaged in the design, development and manufacturing of remote sensing products generally consisting of airborne imaging systems. DEI Merger Sub, Inc. ("Merger Sub") is a Virginia corporation formed for the purpose of engaging in the transaction described below. All of the outstanding stock of Merger Sub is owned by DEI. The Proposed Transaction It is proposed that subject to the satisfaction of certain conditions, Merger Sub will be merged with and into STR in a statutory merger pursuant to the Virginia Stock Corporation Act (the "Merger"). The terms upon which the Merger will be effected are set forth in an Agreement and Plan of Merger dated as of December 23, 1997 (the "Merger Agreement") by and among Merger Sub, DEI and STR. At the time when articles of merger are filed with the Virginia State Corporation Commission, the STR Shares will be converted into shares of DEI Common Stock at the ratio set forth in the Merger Agreement, except that (i) a holder who is entitled to receive a fractional share of DEI) Common Stock will receive cash in lieu of such fractional share and (ii) a holder of STR Shares who exercises dissenters' rights under the Virginia Stock Corporation Act will receive cash in lieu of DEI Common Stock. No rulings have been sought from the Internal Revenue Service concerning the federal 2 S.T. Research Corporation May 1, 1998 Page 2 income tax consequences of the Merger. Opinion For purposes of rendering the opinions set forth below, we have made such investigation of law, and have examined such documents and made such inquiries, as we have deemed relevant or proper. Based upon the foregoing, it is our opinion that under current law, the Merger will qualify as a "tax-free" reorganization within the meaning of Sections 368(a)(1)(A) and 368(a)(2)(B) of the Internal Revenue Code of 1986, as amended (the "Code"), subject to satisfying certain nonstatutory requirements following the Merger which are described below. As a tax-free reorganization, the following federal income tax consequences will result from the Merger: (a) No gain or loss would be recognized by a holder of STR Shares upon the receipt of DEI Common Stock in exchange for his STR Shares (except for cash received in lieu of a fractional share). (b) The aggregate tax basis of the DEI Common Stock received by an STR shareholder in the Merger (including a fractional share interest, if any) would be the same as the aggregate tax basis of the STR Shares surrendered in exchange therefor. (c) The holding period of the DEI Common Stock (including a fractional share interest, if any) received by an STR shareholder in the Merger would include the holding period of the STR Shares surrendered in exchange therefor, provided, however, that the STR Shares so surrendered are held as a capital asset when the Merger becomes effective, (d) An STR shareholder who receives cash in lieu of a fractional share of DEI Common Stock in connection with the Merger would recognize gain or loss equal to the difference between the cash received and the basis of such fractional share. Such gain or loss would be capital gain or loss, provided, however, that the STR Shares are held as a capital asset at the effective time of the Merger and would be long term capital gain or loss if the STR Shares had been held for more than one year and qualify for the lower tax rate on capital gains prescribed by the Taxpayer Relief Act of 1997 if held for more than 18 months. (e) No gain or loss would be recognized by DEI, STR or Merger Sub in connection with the Merger. 3 S. T. Research Corporation May 1, 1998 Page 3 As noted above, apart from the formal requirements of the Code, the Merger must meet certain substantive non-statutory requirements developed through case law and Internal Revenue Service regulations. These non-statutory rules may change what is in form a tax-free reorganization into a taxable transaction. These non-statutory requirements generally fall into two categories - the continuity of interest requirement and the continuity of business enterprise requirement. As for the continuity of interest requirement, a substantial part of the value of the proprietary interest in the target corporation must be preserved. This generally requires a substantial portion of the consideration paid for the target stock be in the form of equity. As for the continuity of business enterprise requirement, the acquiring corporation must continue the acquired corporation's historic business or use a significant portion of the acquired corporation's historic business assets in the continued business. In the course of our representation of STR in connection with the Merger, nothing has come to our attention which would cause us to conclude that either of these requirements will not be satisfied. Moreover, the manner in which the Merger is structured, the fact that the holders of a majority of the shares of DEI Common Stock which will be issued in the Merger have indicated they have no intent to dispose of such DEI Common Stock and that the STR business, along with the DEI business, will continue to be operated subsequent to the Merger, suggest that the non-statutory requirements for tax-free treatment of the merger will be met. We understand that this opinion will be summarized in STR's proxy statement for a special meeting of its shareholders for the information of such shareholders and will be filed with the Securities and Exchange Commission as an exhibit to the Registration Statement on Form S-4 of DEI. We consent to the filing of this opinion as an Exhibit to the Registration Statement and the Prospectus which is a part thereof relative to our issuing the above opinion. Very truly yours, MICHAELS, WISHNER & BONNER, P.C. By: /s/ Mark J. Wishner -------------------------------- Mark J. Wishner EX-10.904 3 EXHIBIT 10.904 1 EXHIBIT 10.904 STRATEGIC ALLIANCE AGREEMENT This AGREEMENT, dated as of the 20th day of October, 1997 between DAEDALUS ENTERPRISES, INC., a Delaware Corporation with offices at 300 Parkland Plaza, Ann Arbor, Michigan 48103 with a mailing address of P.O. Box 1869, Ann Arbor, Michigan, 48106-1869, (hereinafter referred to as "DAEDALUS") and ERIM INTERNATIONAL, INC., a Michigan Corporation with offices at 3300 Green Road, Ann Arbor, Michigan, 48105, with a mailing address of P.O. Box 134008, Ann Arbor, Michigan, 48113-4008, (hereinafter referred to as "ERIM INT."); (hereinafter referred to collectively as the "PARTIES"). RECITALS WHEREAS, DAEDALUS has developed a prototype airborne multispectral digital camera (AMDC) incorporating off-the-shelf third party computer, camera, tape recorder and GPS components combined with a custom filter wheel and controller and special system control, data formatting, and output software, collectively referred to as the "airborne multispectral digital camera system"; and WHEREAS, the airborne multispectral digital camera system was developed under a NASA sponsored Small Business Innovation Research (SBIR) contract and the commercial rights to the airborne multispectral digital camera are owned by DAEDALUS; and WHEREAS, DAEDALUS is well established in the airborne remote sensing instrument market, and has the capabilities to perform production engineering, manufacturing, marketing, and sales of the airborne multispectral digital camera system; and WHEREAS, ERIM INT. is well established in the remote sensing R&D and applications market and has capabilities for the development, production, marketing, and sales of specialized software for image registration, geolocation, rectification, mapping, enhancement, and output; and WHEREAS, DAEDALUS and ERIM INT. believe that by working together the PARTIES can create an improved airborne multispectral digital camera system with significantly increased market appeal resulting in significant revenue and profits to the PARTIES; and WHEREAS, the PARTIES desire to define and establish between them their respective responsibilities, rights, obligations, working relationships, and remuneration; NOW THEREFORE, in consideration of the foregoing and the mutual covenants contained herein, it is agreed as follows: 2 ARTICLE 1. Relationship of the Parties ERIM INT. and DAEDALUS hereby agree to develop an Airborne Multispectral Digital Camera System according to the provisions that follow. This relationship shall be nonexcusive and both parties agree that either may enter into other similar development and sales agreements with third parties at their discretion. This Agreement shall not constitute, create, or in any way be interpreted as a joint venture, partnership, or formal business organization of any kind. The Parties will operate as independent contractors working together to achieve the objectives outlined in this agreement. ARTICLE 2. Expenses Each PARTY hereto shall bear all its own expenses incurred in connection with all efforts conducted pursuant to this Agreement, except as otherwise agreed in advance by an instrument in writing signed by a duly authorized officer of each of the Parties. ARTICLE 3. DAEDALUS Development Responsibilities DAEDALUS shall be responsible for all labor and material costs necessary to convert the prototype AMDC, as illustrated in Attachment A, to a production system for commercial sale including documentation and training materials necessary to train customers in system operation and maintenance and to provide after-sale support including warranty. This effort will be conducted on such a schedule as necessary to permit offering a complete commercial AMDC system for sale by 1 April 1998. In general, Daedalus will be responsible for all airborne components and accessories for the AMDC. ARTICLE 4. ERIM INT. Development Responsibilities ERIM INT. will be responsible for all labor and materials necessary to develop and produce a complete software system to read AMDC data tapes, coregister and resample individual images to create composite frames, geo-locate AMDC frames, and provide archive and catalog capabilities. This software system will include a graphical user interface and be built as an integrated function of ERDAS Imagine initially operating under Solaris 2.5 on a SUN work station. This work will be done in the following two increments to meet the respective schedules: 1. A basic software system will be built to permit DAEDALUS to meet its requirements for delivery of the prototype AMDC to NASA by 15 November 1997. This software system, built within the ERDAS Imagine software environment, will include the capability outlined in Work Unit I of Attachment B. ERIM INT. will provide a single seat license for this software for delivery to 2 3 NASA at no cost to DAEDALUS. This does not include the base ERDAS Imagine software that must be properly licensed and installed by NASA before delivery. 2. A software system will be built to support the sale of complete AMDC systems to commercial customers and be completed by 1 April 1998. This software system will enhance the basic system of Item 1 above with the capabilities outlined in Work Unit II of Attachment B. It will also operate in accordance with specifications established by ERIM INT. and be accompanied by an operators manual and/or help functions. ARTICLE 5. Joint Development Responsibilities of the PARTIES The PARTIES will be jointly responsible for the collection and production of sample image data from the AMDC system and software to demonstrate the capabilities of the system and to prepare advertising and sales materials to support marketing of the AMDC system. DAEDALUS will be primarily responsible for providing and operating the prototype AMDC system and arranging for aircraft services required. DAEDALUS and ERIM INT. will share costs equally for aircraft services relating to the collection, data production and preparation of materials for advertising and marketing purposes, and these costs and activities will be mutually agreed upon in advance. The PARTIES agree that the initial collection of sample AMDC data must be performed before the 15 November 1997 delivery of the prototype AMDC system to NASA. ARTICLE 6. Future Enhancements of the AMDC System It is agreed that the PARTIES intend to continue the development of the AMDC beyond its first commercial version to enhance its capabilities in both data acquisition and data processing and output products. DAEDALUS will have general responsibility for enhancement of the airborne equipment and ERIM INT. will have general responsibility for enhancement of the software system. The PARTIES will mutually agree on the enhancements to be made, the sharing of their costs, and the schedule for completion and offering of enhancements. ARTICLE 7. Product Warranty Responsibilities DAEDALUS will provide a 12-month warranty for the complete airborne portion of the AMDC system in accordance with its Standard Warranty Policy. 3 4 ERIM INT. will provide a software warranty for the data processing portion of the complete AMDC system that is mutually agreeable to DAEDALUS and ERIM INT. ERIM INT. will also prepare and offer to customers a software maintenance contract that is mutually agreeable to DAEDALUS and ERIM INT. NO WARRANTIES OF ANY KIND ARE PROVIDED BETWEEN ERIM INT. AND DAEDALUS PURSUANT TO THIS AGREEMENT. THIS INCLUDES, BUT IS NOT LIMITED TO ANY EXPRESS OR IMPLIED WARRANTIES, WARRANTIES OF MERCHANTABILITY, OR FITNESS FOR A PARTICULAR PURPOSE. ARTICLE 8. Product Pricing The selling price of the complete AMDC system will be a composite of DAEDALUS and ERIM INT. selling prices for their respective portions of the AMDC system. The respective prices will be independently determined based upon each PARTY'S pricing model. The composite price will be reviewed jointly by the PARTIES to determine its market acceptability and, if adjustment is deemed necessary, such adjustment will be made in the price of each PARTY'S portion of the system to the degree mutually agreed upon and the resultant price for each portion of the system will be the price utilized to determine revenue sharing percentage for each PARTY. ARTICLE 9. Product Ownership Title to and commercial rights to the complete airborne AMDC system shall be retained by DAEDALUS. Title to and commercial rights to the complete ground data processing software system shall be retained by ERIM INT. Ownership of future enhancements to either the airborne AMDC system or the ground data processing software in those cases where DAEDALUS and ERIM INT. work together to develop such enhancements will be agreed to on a case by case basis and documented as a written amendment to this agreement and signed by both PARTIES. ARTICLE 10. Revenue sharing All revenue from the sale of complete AMDC systems consisting of airborne hardware and control software supplied by DAEDALUS and ground data processing software (not including the basic ERDAS Imagine system) supplied by ERIM INT. will be shared in accordance with the Revenue Sharing Schedule in Attachment C. Revenue sharing will be based upon the net selling price for each AMDC system sold whether sold by DAEDALUS or ERIM INT. Net selling price shall mean the sale or lease price to third parties, less deductibles 4 5 employed in normal royalty accounting practice, such as quantity, trade or prompt payment discounts, commissions paid to independent sales agents, container and packaging costs, transportation costs, sales and use taxes, insurance, delivery expenses and charges, allowances for returns, duty, tax or government charge on manufacture, sale, turnover or delivery, provided that container and packaging costs, transportation costs, insurance costs, and delivery expenses and charges shall be deducted only if and to the extent that the same are billed and invoiced by the seller to the customer separately from the product on which net selling price is to be determined. Such deductibles shall not be construed to include manufacturing costs or manufacturing overhead. All revenue sharing payments are to be made by the selling PARTY to the other PARTY within 30 days from the time that the selling PARTY receives final payment from the customer or, in the case of installment payments, within 30 days from the time each installment payment is received by the selling PARTY. The PARTIES agree that there will be no sharing of revenues earned by DAEDALUS for development and delivery of the prototype AMDC system to NASA. ARTICLE 11. Exchange of Proprietary Information ERIM INT. will maintain ownership of its Proprietary Information and Intellectual Property related to the software developed for the ground processing system. DAEDALUS will have no claims to any Proprietary Information and Intellectual Property of ERIM INT. DAEDALUS will maintain ownership of its Proprietary Information and Intellectual Property related to the AMDC. ERIM INT. will have no claims to any Proprietary Information and Intellectual Property of DAEDALUS. The definition, exchange and protection of proprietary information under this agreement will be in accordance with the "NONDISCLOSURE AGREEMENT" between DAEDALUS and ERIM INT. dated 28 February 1997, included herein by reference. ARTICLE 12. Term and Termination The term of this Agreement shall be one year and shall be automatically renewed yearly. However, after the initial one year term either party may terminate this Agreement by giving 30 days written notice to the other. Should DAEDALUS terminate this Agreement before ERIM INT. receives the sum of $100,000 through system sales, DAEDALUS agrees to pay the difference between $100,000 and the total received to the date of termination by ERIM INT. (If ERIM INT. had received $50,000 to date then DAEDALUS would pay ERIM $50,000.) 5 6 Upon termination of this Agreement, ERIM INT. shall continue to provide the software and honor all warranties and commitments for any existing sales. In addition, should ERIM INT. terminate this Agreement, ERIM INT. will continue to provide software and honor commitments for a six (6) month period following termination to allow DAEDALUS to find suitable replacement software. This Agreement shall also terminate upon the insolvency of the other party. Insolvency shall be defined as the filing by either party under any provision of the bankruptcy laws of the United States. Such termination shall enable the surviving party to acquire exclusively the technology of the other relating to the development of the AMDC System, to the extent allowed by law. Termination shall not effect the obligations of the parties in respect to the provisions listed in Article 11, Exchange of Proprietary Information. ARTICLE 13. Assignment This Agreement may not be assigned in whole or in part by either PARTY without the prior written consent of the other PARTY; except upon the merger, consolidation, sale or other transfer of all or substantially all of the assets of either PARTY, provided that the surviving PARTY agrees to be bound in all respects by the provisions of the Agreement. ARTICLE 14. Entire Agreement This Agreement contains the entire understanding between the PARTIES hereto relating to the subject hereof. This Agreement may not be modified in any manner except by an instrument in writing signed by a duly authorized officer or representative of each of the PARTIES. ARTICLE 15. Governing Law This Agreement and any subsequent modifications thereto shall be governed by and construed in accordance with the laws of the State of Michigan. ARTICLE 16. Severability of Provisions In the event that one or more provision(s) of this Agreement are found unenforceable by law, the remaining provision(s) shall continue to have full force and effect. ARTICLE 17. Intellectual Property Infringement Indemnification DAEDALUS agrees to indemnify ERIM INT. and hold ERIM INT. harmless against any and all claims, suits, judgments, damages, costs and other charges, including attorney's fees 6 7 as are asserted by a third party claiming that technology used or developed by DAEDALUS herein, infringes upon such third party's patent, copyright, trademark, trade secret or other intellectual property right. Specifically and without limitation, DAEDALUS agrees to further indemnify and hold ERIM INT. harmless against any claims arising out of the performance by DAEDALUS or ERIM INT. under the terms of this Agreement which may be brought under US Patent No. 5,247,356 entitled "Method and Apparatus for Mapping and Measuring Land" presently held by Pictometry, Inc. To qualify for such indemnification defense ERIM INT. must: 1. give DAEDALUS prompt notice of any such claim, and 2. allow DAEDALUS to control, and fully cooperate with DAEDALUS in, the defense and all related settlement negotiations. Article 17 sets forth ERIM INT. exclusive remedy against DAEDALUS with respect to any action or claim for alleged infringement of intellectual property rights. ERIM INT. agrees to indemnify DAEDALUS and hold DAEDALUS harmless against any and all claims, suits, judgments, damages, costs or other charges, including attorney's fees that are asserted by a third party claiming that use of ERIM INT. technology infringes upon such third party's patent, copyright, trademark, trade secret or other intellectual property right. To qualify for such indemnification defense DAEDALUS must: 1. give ERIM INT. prompt notice of any such claim, and 2. allow ERIM INT. to control, and fully cooperate with DAEDALUS in, the defense and all related settlement negotiations. Article 17 sets forth DAEDALUS exclusive remedy against ERIM INT. with respect to any action or claim for alleged infringement of intellectual property rights. 7 8 IN WITNESS WHEREOF, the PARTIES have caused this Agreement to be duly executed in duplicate to become effective as of the day and year first written above. DAEDALUS ENTERPRISES, INC. ERIM INTERNATIONAL, INC. By: /s/ Thomas R. Ory By: /s/ Robert L. Henry, Jr. Thomas R. Ory Robert L. Henry, Jr. Its: President/CEO Its: Secretary and General Counsel Date: 20 Oct. 1997 Date: 10/20/97 8 EX-10.905 4 EXHIBIT 10.905 1 EXHIBIT 10.905 COOPERATIVE DEVELOPMENT AND SERVICE AGREEMENT BY AND BETWEEN ERIM INTERNATIONAL, INC. AND DAEDALUS ENTERPRISES, INC. This Agreement, dated as of the 26th day of March, 1998 (the "Effective Date") between ERIM INTERNATIONAL, INC., a Michigan corporation with offices at 1975 Green Road, Ann Arbor, Michigan 48105, ("EI") with a mailing address of P.O. Box 134008, Ann Arbor, Michigan 48113-4008, and DAEDALUS ENTERPRISES, INC., with offices at 300 Parkland Plaza, Ann Arbor, Michigan, 48106-1869 ("DAEDALUS"). RECITALS WHEREAS, EI and DAEDALUS (the "PARTIES") desire to develop and perform commercial service contract activities for third parties using an Airborne Mutispectral Digital Camera System (the "AMDC") constructed by DAEDALUS and an Image Processing System (the "IPS") developed by EI and to continue development of application specific value-added software and/or hardware techniques to further enhance the utility and attractiveness of the system to potential customers; and WHEREAS, the PARTIES desire to define and establish their respective responsibilities, rights, obligations, working relationships, and remuneration in this AGREEMENT; NOW THEREFORE, in consideration of the foregoing and the mutual covenants contained herein, it is agreed as follows: ARTICLE 1. Relationship of the PARTIES This relationship shall be nonexclusive and the PARTIES agree that either may enter into other similar development and service agreements with third parties at their discretion. This AGREEMENT shall not constitute, create, or in any way be interpreted as a joint venture, partnership, or formal business organization of any kind. The PARTIES will operate as independent contractors working together to achieve the objectives outlined in this AGREEMENT. ARTICLE 2. Expenses Except as otherwise specifically stated herein, each party shall bear all of its own expenses incurred in connection with efforts under this AGREEMENT. 2 ARTICLE 3. DAEDALUS Responsibilities a. DAEDALUS will build an AMDC which will meet the specifications contained in Attachment A hereto, and shall demonstrate by appropriate tests that said specifications are met. DAEDALUS shall also provide documentation and training materials in sufficient detail to enable system installation and operation of the AMDC by EI personnel. b. DAEDALUS shall perform the fabrication and testing of the AMDC in accordance with the following Milestones related to the EI payment schedule of Article 4 (1). Milestone 1: two (2) months from the Effective Date the following major components will have been purchased and received by DAEDALUS: - Frame grabber - AIT tape recorder - Timer card - SCSI controller card - Chassis, power and CPU for computer - Kodak CCD camera - Camera lens The computer system and camera will be integrated and testing started. At this milestone the system will be capable of capturing single frame images from the camera and recording on tape-monochrome only. Milestone 2: three (3) months from the Effective Date the following shall have occurred: - Ninety percent (90%) of all material will have been purchased and received by DAEDALUS. Most fabrication will be complete and the camera and computer will be integrated and tested. The electromechanical assembly of filters and rotation stage will be in process. DAEDALUS will certify in writing to EI that it has satisfied the Milestones specified under this Article by submitting a written invoice to EI. If DAEDALUS fails to meet either Milestone above, EI shall have the right to withhold progress payments for the fabrication of the AMDC until such Milestone is met. c. The AMDC shall be completed within four months of the Effective Date (the "Completion Date"). In the event DAEDALUS does not complete the fabrication of the AMDC within sixty (60) days of the Completion Date, EI may deduct 10% from the final progress payment. If the AMDC is not complete within ninety (90) days of the 3 Completion Date, EI may terminate this Agreement and DAEDALUS shall refund all progress payments. d. DAEDALUS will maintain the AMDC in operational condition for use on commercial service contracts and provide all labor for the maintenance of the same. For purposes of this AGREEMENT operational condition shall mean: (1) the computer, camera, tape recorder and GPS components combined with a custom filter wheel and controller and special system control, data formatting, and output software, will be kept in working order; (2) normal and customary periodic repair and maintenance of the AMDC will occur and be documented; (3) configuration control and quality assurance shall be implemented such that the nominal system performance shall be at least as good as that demonstrated during the development stage. ARTICLE 4. EI Responsibilities (1) EI shall pay DAEDALUS a total of $120,000 to fund construction of the AMDC under Section 3 of the AGREEMENT. Said sum shall be paid in four installments as follows: $30,000 at contract execution $15,000 two months after the Effective Date $15,000 three months after the Effective Date $60,000 at completion of the AMDC (2) EI will market and develop products and services that use the AMDC. EI will also make improvements to the AMDC registration software as mutually agreed upon by DAEDALUS and EI. (3) EI will be responsible for scheduling service projects but will consult with DAEDALUS when establishing such schedule, in accordance with Article 7. ARTICLE 5. Ownership Rights a. AMDC Title to and commercial rights in the complete AMDC system's intellectual property shall be retained by DAEDALUS. b. IPS Title to and commercial rights in the complete IPS system's intellectual property shall be retained by EI. 4 c. Enhancements Ownership of future enhancements to either the AMDC or the IPS in those cases where DAEDALUS and EI work together to develop such enhancements, will be agreed to on a case by case basis and documented as a written amendment to this agreement signed by both PARTIES d. AMDC (1) Title to the AMDC delivered pursuant to Article 3, shall vest jointly in DAEDALUS and EI, and each party shall be permitted to market and sell commercial service projects. The PARTIES shall divide revenues from commercial service projects in accordance with the provisions of Section 7 of this AGREEMENT. It is agreed that the AMDC shall not be sold, leased or otherwise conveyed or transferred by either party without the express written consent of the other. (2) Joint ownership of the AMDC shall not be construed as a grant, license or other transfer of any right in the proprietary information or intellectual property owned by either EI or DAEDALUS to the other. ARTICLE 6. Joint Responsibilities of the PARTIES a. It is agreed that the PARTIES intend to continue the development of the AMDC and the IPS beyond its first commercial version. DAEDALUS will have general responsibility for enhancement of the AMDC equipment and EI will have general responsibility for enhancement of the IPS. The PARTIES will mutually agree on the enhancements to be made, the sharing of their costs, and the schedule for completion. b. After completion of the AMDC, EI will share equally with DAEDALUS, all expenses, net of insurance proceeds, for parts necessary for repair and/or maintenance of the AMDC. c. Each of the PARTIES shall be responsible for insuring the AMDC with the other identified as a named insured party. DAEDALUS shall be responsible for loss or damage to the AMDC when in possession of it and EI shall be responsible for loss or damage to the AMDC when it is in possession of it. In the event of damage or loss DAEDALUS shall be responsible for making appropriate repairs or replacement within a reasonable period of time, provided the damage or loss is covered by such insurance and proceeds from the same go to DAEDALUS. ARTICLE 7. Project Coordination/Revenue Sharing Project terms: In order to coordinate the efforts of the PARTIES on individual service projects, terms relating to the schedule, personnel, Daily Use Fees, and other individual project requirements will be mutually agreed to by the PARTIES in a letter or other 5 document that incorporates this AGREEMENT by reference. Daily Use Fee: The PARTIES will agree on the number of days the AMDC will be required to perform individual service projects. For use of the AMDC for individual service projects, the party responsible for performing the project shall pay to the other the sum of $1,250 per day based on the number of days billed on such service project. Unless otherwise agreed, payment of the Daily Use Fee shall be made within thirty (30) days from receipt of payment from the project customer, but in no event later than one hundred and twenty (120) days beyond project completion. ARTICLE 8. Term and Termination a. This AGREEMENT shall begin on the Effective Date and continue until terminated as herein provided. b. After the second anniversary of the Effective Date, either party may terminate this AGREEMENT by giving thirty (30) days written notice to the other. The party terminating under this provision shall give up all rights of ownership in the AMDC and revenue derived from its use. c. The PARTIES may terminate this AGREEMENT by mutual consent and either party may purchase the other's interest in the AMDC at a price to be negotiated between the PARTIES. If a purchase cannot be negotiated within sixty (60) days from the date of mutual termination, the AMDC will be sold at a public sale and the proceeds will be split equally between the PARTIES. d. Except as may be prohibited by the bankruptcy laws of the United States, in the event either party shall become or commit an act of voluntary or involuntary bankruptcy, make an assignment for the benefit of creditors, or become insolvent, the other party may elect to cancel any unfulfilled obligations hereunder. Notwithstanding the foregoing, in the event of insolvency or bankruptcy of DAEDALUS prior to the completion of the AMDC, EI shall have the right to claim and possess the incomplete AMDC in order to protect its joint interest in the title to the AMDC. In the event insolvency or bankruptcy the solvent party shall have the right to acquire exclusively the technology of the other relating to the development of the AMDC to the extent allowed by law. e. Termination of this AGREEMENT for any reason shall not relieve a party of any outstanding obligation with regard to services sold and delivered or under contact prior to the date of termination, nor shall it effect the obligations of the PARTIES under Article 10 hereof. ARTICLE 9. Product Warranty Responsibilities OTHER THAN AS STATED IN THIS AGREEMENT, NO WARRANTIES OF ANY KIND ARE MADE BY EITHER PARTY TO THE OTHER OR FOR THE 6 BENEFIT OF THIRD PARTIES, INCLUDING SPECIFICALLY EXPRESS OR IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. ARTICLE 10. Exchange of Proprietary Information a. EI will maintain ownership of its Proprietary Information and Intellectual Property related to the IPS. DAEDALUS shall have no claim to any Proprietary Information and Intellectual Property belonging to EI. b. DAEDALUS will maintain ownership of its Proprietary Information and Intellectual Property related to the AMDC and EI shall have no claim to any Proprietary Information and Intellectual Property belonging to DAEDALUS. c. The definition, exchange and protection of Proprietary Information under this Agreement shall be governed by the "NONDISCLOSURE AGREEMENT" between the parties dated 28 February 1997, included herein by reference. ARTICLE 11. Intellectual Property Infringement Indemnification a. DAEDALUS agrees to indemnify EI and hold EI harmless against any and all claims, suits, judgments, damages, costs and other charges, including attorney's fees that are asserted by a third party claiming that the activities relating to or arising under this AGREEMENT by DAEDALUS infringes upon such third party's patent, copyright, trademark, trade secret or other intellectual property right. Specifically and without limitation, DAEDALUS agrees to further indemnify and hold EI harmless against any claims arising out of performance by DAEDALUS or EI under the terms of this AGREEMENT which may be brought under US patent No. 5,247,356 entitled "Method and Apparatus for Mapping and Measuring Land" presently held by Pictometry, Inc. To qualify for such indemnification defense EI must: (1) Give DAEDALUS notice of any such claim, and (2) Allow DAEDALUS to control, and fully cooperate with DAEDALUS in the defense and all related settlement negotiations. This Article 11 sets forth EI exclusive remedy against DAEDALUS with respect to any action or claim for alleged infringement of intellectual property rights. b. EI agrees to indemnify DAEDALUS and hold DAEDALUS harmless against any and all claims, suits, judgments, damages, costs and other charges, including attorney's fees that are asserted by a third party claiming that the activities relating to or arising under this AGREEMENT by EI infringes upon such third party's patent, copyright, trademark, trade secret or other intellectual property right 7 To qualify for such indemnification defense DAEDALUS must: (1) Give EI notice of any such claim, and (2) Allow EI to control, and fully cooperate with EI in the defense and all related settlement negotiations. This Article 11 sets forth DAEDALUS exclusive remedy against EI with respect to any action or claim for alleged infringement of intellectual property rights. ARTICLE 12. Force Majeure Neither party shall be liable for any delay or failure to perform its obligations under this Agreement if such delay or failure arises from any cause or causes beyond its reasonable control, including, but not limited to labor disputes, strikes, acts of God, lightening, shortages of materials, rationing, utility or communization failures, earthquakes, casualty, war, act of the public enemy, riots, insurrections, embargoes, blockages, actions, restrictions or orders of any government, agency or subdivision thereof. Each party shall give the other written notice within ten (10) days of such delay, and shall include in the notice the steps the party will take to alleviate the problem. ARTICLE 13. Entire AGREEMENT This AGREEMENT contains the entire understanding of the PARTIES hereto relating to the subject hereof. This AGREEMENT may not be modified in any manner except by an instrument in writing signed by a duly authorized officer or representative of each of the PARTIES. Nothing in this AGREEMENT should be construed to modify or amend the PARTIES Strategic Alliance Agreement effective 20 October 1997. ARTICLE 14. Severability of Provisions In the event that one or more provision(s) of this AGREEMENT are found unenforceable by law, the remaining provision(s) shall continue to have full force and effect. 8 IN WITNESS WHEREOF, the PARTIES have caused this AGREEMENT to be duly executed in duplicate to become effective as of the day and year first written above. ERIM INTERNATIONAL, INC. DAEDALUS ENTERPRISES, INC. By: /s/ Carlos Zorea By: /s/ Thomas R. Ory ------------------------- ------------------ Carlos Zorea Thomas R. Ory Its: Executive Vice President Its: President & COO Date: 26 March 1998 Dated: March 26, 1998 EX-23.01 5 EXHIBIT 23.01 1 EXHIBIT 23.01 INDEPENDENT AUDITOR'S CONSENT We consent to the use in this Amendment No. 2 to the Registration Statement of Daedalus Enterprises, Inc. and subsidiaries (the "Company") on Form S-4 of our report relating to the consolidated financial statements of the Company dated September 23, 1997 (which report expresses an unqualified opinion and includes an explanatory paragraph which indicates that there are matters that raise substantial doubt about the Company's ability to continue as a going concern) appearing in the Prospectus, which is part of this Registration Statement, as amended. We also consent to the reference to us under the heading "Experts" in such Prospectus. DELOITTE & TOUCHE L.L.P. Detroit, Michigan May 7, 1998 EX-23.02 6 EXHIBIT 23.02 1 EXHIBIT 23.02 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the inclusion in this Amendment No. 2 to the Registration Statement on Form S-4 of our report, dated December 22, 1997, except for Note 16, as to which the date is January 30, 1998, on our audit of the financial statements of S.T. Research Corporation as of September 30, 1997 and for the year then ended. We also consent to the reference to our firm under the caption "Experts." COOPERS & LYBRAND L.L.P. Pittsburgh, Pennsylvania May 7, 1998 EX-23.03 7 EXHIBIT 23.03 1 EXHIBIT 23.03 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our report dated November 20, 1996, with respect to the financial statements of S. T. Research Corporation included in the Proxy Statement of Deadalus Enterprises, Inc. ("DEI") that is made part of this Amendment No. 2 to the Registration Statement on Form S-4 and Prospectus of DEI for the registration of up to 3,420,527 shares of its common stock. ROSS, LANGAN & MCKENDREE, L.L.P. McLean, Virginia May 7, 1998 EX-23.06 8 EXHIBIT 23.06 1 EXHIBIT 23.06 CONSENT OF RONEY & CO. Conditioned upon the inclusion of our entire opinion letter as Annex B to the joint proxy statement/prospectus of Daedalus Enterprises, Inc. and S.T. Research Corporation, which joint proxy statement/prospectus is part of the Registration Statement on Form S-4, as amended, of Daedalus Enterprises, Inc., we hereby consent to the use of our name and to the description of our opinion letter dated December 23, 1997, under the captions "Summary -- Opinion of DEI's Financial Advisor" and "The Merger and Related Matters -- Opinion of DEI's Financial Advisor" and acknowledge that such use of our name and such description is in a form acceptable to us and our counsel. By giving such consent we do not thereby admit that we are experts with respect to any part of such Registration Statement within the meaning of the term "expert" as used in, or that we come within the category of persons whose consent is required under the Securities Act of 1933, as amended, or the rules and regulations of the Securities and Exchange Commission promulgated thereunder. RONEY & CO. EX-23.12 9 EXHIBIT 23.12 1 EXHIBIT 23.12 CONSENT OF GERALD ALCOCK COMPANY, L.L.C. We consent to the reference to our firm, to the use of our name and to the description of our appraisal report dated December 15, 1997, under the caption "The Merger And Related Matters -- Report Of Appraiser" in the joint proxy statement/prospectus of Daedalus Enterprises, Inc. and S.T. Research Corporation, which joint proxy statement/prospectus is part of the Amendment No. 2 to the Registration Statement on Form S-4 of Daedalus Enterprises, Inc. By giving such consent we do not thereby admit that we are experts with respect to any part of such Registration Statement within the meaning of the term "expert" as used in, or that we come within the category of persons whose consent is required under the Securities Act of 1933, as amended, or the rules and regulations of the Securities and Exchange Commission promulgated thereunder. GERALD ALCOCK COMPANY, L.L.C. /s/ Gerald V. Alcock ------------------------------------ By: Gerald V. Alcock, President Date: May 7, 1998 -----END PRIVACY-ENHANCED MESSAGE-----