-----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, Utg9dOz+wycHqG2ASnaTJzjftgfdbaFmhMQzbwCpbNXjkbQ4g1ql5cA7tezay3V9 yByD5KKbJgJKOuL8gMBMjQ== 0000057201-96-000039.txt : 19961017 0000057201-96-000039.hdr.sgml : 19961017 ACCESSION NUMBER: 0000057201-96-000039 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19960330 FILED AS OF DATE: 19961016 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIANA CORP CENTRAL INDEX KEY: 0000057201 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-GROCERIES & RELATED PRODUCTS [5140] IRS NUMBER: 362448698 STATE OF INCORPORATION: DE FISCAL YEAR END: 0403 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-05486 FILM NUMBER: 96644309 BUSINESS ADDRESS: STREET 1: 8200 W BROWN DEER ROAD CITY: MILWAUKEE STATE: WI ZIP: 53223-1706 BUSINESS PHONE: 4143550037 FORMER COMPANY: FORMER CONFORMED NAME: FH INDUSTRIES CORP DATE OF NAME CHANGE: 19850814 FORMER COMPANY: FORMER CONFORMED NAME: SCOT LAD FOODS INC DATE OF NAME CHANGE: 19841202 10-K/A 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A (Amendment No. 1) [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended March 30, 1996 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission file Number 1-5486 THE DIANA CORPORATION (Exact name of registrant as specified in its charter) Delaware 36-2448698 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 8200 W. Brown Deer Road, Suite 200, Milwaukee, Wisconsin 53223 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (414) 355-0037 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock, $1.00 Par Value New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes ___ No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.[ ] At June 10, 1996, the aggregate market value of the voting stock of the registrant held by stockholders who were not affiliates of the registrant was $353,887,021. At June 10, 1996, the registrant had issued and outstanding an aggregate of 5,028,590 shares of its Common Stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement to be filed within 120 days after the end of the fiscal year covered by this report are incorporated by reference into Part III hereof. PART I ITEM 1. Business General The Diana Corporation ("Diana" or the "Company"), was incorporated in 1961 under the laws of the State of Delaware. The Company's operations are through its subsidiaries: Sattel Communications ("Sattel"), C&L Communications, Inc. ("C&L"), Valley Communications, Inc. ("Valley") and Atlanta Provision Company, Inc. ("APC"). The Company's businesses are reported in three business segments: telecommunications equipment, voice and data network installation and service; and wholesale distribution of meat and seafood. Financial information about the Company's business segments is contained in Note 14 to the Consolidated Financial Statements. The telecommunications equipment segment consists of Sattel and C&L. Sattel is a provider of central office voice and data switching equipment for communications providers worldwide. The Company increased its ownership interest in Sattel from 50% to 80% in fiscal 1996 (see Note 2 to the Consolidated Financial Statements). C&L is a distributer of telecommunications equipment for wide area and local area integrated networks to transport voice, data and video communications primarily in North America. The Company owns 100% of C&L. The voice and data network installation and service segment consists of Valley. Valley provides design, installation and service for voice and data networks primarily in California. Valley was acquired by C&L in November 1995 (see Note 2 to the Consolidated Financial Statements). C&L owns 80% of Valley. The wholesale distribution of meat and seafood segment consists of APC. APC is a wholly-owned subsidiary of Entree Corporation ("Entree"). The Company owns 81.25% of Entree. Telecommunications Equipment Segment Sattel Sattel is a provider of redundant, scaleable, central office voice and data switching equipment for communications providers worldwide. Sattel designs, develops, engineers and markets its switching systems worldwide. It outsources manufacturing, procurement of raw materials, and final assembly and test of finished systems to Sattel Technologies, Inc. ("STI"). STI has approximately a 4% effective ownership interest in Sattel. Certain software and hardware associated with adjunct and peripheral equipment used by Sattel to provide certain functions and features is licensed, or procured under OEM arrangements, from other vendors. Sattel commenced operations as a 50/50 joint venture between the Company and Sattel Technologies, Inc., a private company, in November 1994. In January 1996, Diana increased its ownership interest in Sattel from 50% to 80%. Sattel's product line consists of a series of central office switching platforms which are divided into four models; DSS-96, DSS-1000, DSS-3000 and DSS-10000. Each of these platforms is capable of providing end office, 1 tandem, international gateway or Internet access functionality either individually, simultaneously or in any combination. Sattel's switching products are based on "time-space-time" switching technology. The switch architecture is based on a design including multiple Motorola 680X0 processors and a VMEbus structure. Sattel believes the system is modular as it is scaleable from 96 to 10,000 subscriber lines and from 96 to 4096 digital ports. Sattel also provides a product called DataNet to address the Internet and Intranet Services market. The DataNet product is a synthesis of telephone switching technology with data handling and multiplexing techniques. DataNet has capabilities for passing data over telephone circuits. The product provides the integration of modem technology into central office type switches. Sattel believes that a variety of flexible data access arrangements makes DataNet a complete, self contained voice/data platform. The DSS/Switch with DataNet provides a services platform for Internet Service Providers (ISPs) and other On-line Service Providers. Sattel believes that DataNet's capability for providing customer control, security, real time and Local Exchange Company (LEC) billing, and fraud control combine to make this product a marketable solution for the ISP market. The DataNet switch allows for customer control because it is a telephony switch and can provide public network information that allows the customer the ability to assign subscribers different levels of service, different billing options and potentially parental control features (such as blocking certain portions of the Internet based on passwords or identification). Since DataNet is a Class 5 switch, it does provide real time communications and captures both the "called" number (DNIS) as well as the "calling" number (ANI). By providing this information to the ISP, the processing of transactions can be made to be dependent upon a match between either the DNIS or ANI with the transaction type. For example, rather than using a password approach (that may be "spoofed" by a "hacker"), the DataNet customer may use the ANI from subscribers to determine whether or not a financial transaction (such as a credit card purchase) is allowed. If the ANI attempting the financial transaction is not correct, the network may disallow the transaction and capture the phone number of the party that tried to process the transaction. Sattel presently has a patent application on file with the U.S. Patent Office with respect to its DataNet product. It intends to file additional patents related to the DSS switching products and other technology as it is developed. Sattel relies to a great degree on trade secrets and tight control of its software to protect its intellectual property rights. The DataNet product has undergone successful Alpha (internal) and Beta (customer) testing at MCI's laboratory in Richardson, Texas and it has undergone successful Beta testing at the MCI Switch Center in Los Angeles, California by MCI and Concentric Network Corporation ("CNC"). The product has been shipped for production to CNC and for Beta testing to GTE. All of the tests to date have been successful, except for one minor problem that was encountered and corrected at the initial Beta testing in MCI's laboratories. Sattel has not observed any problems in a customer's production environment for this product. Sattel is not aware of any problems that the product might encounter in a production environment, however, since there is not an extended history of the product in a production environment, the possibility exists that unforeseen problems might occur. Sattel would immediately address any problems with the proper technical resources. Sattel's other products have been tested, installed and are in production both in the United 2 States and overseas. No material problems were encountered, however, minor software and equipment problems were addressed and corrected. Sattel believes its market consists of emerging telecommunications companies, Regional Bell Operating Companies, PTT's, Long Distance Carriers (IXCs), Competitive Access Providers (CAPS), Internet Service Providers and Cable TV companies. Sattel has divided its market into four segments of customers: 1. Strategic Accounts, 2. Internet Service Providers (ISP's), 3. Growth Accounts, and 4. International Accounts. Sattel has positioned its products in the medium to small end switching market of voice/data communications. This target market is less than 10,000 lines and is optimized at the 500-5,000 line size to address the Strategic and Growth accounts. In May 1996, Sattel and Concentric Network Corporation ("CNC") announced a portion of a nonbinding Memorandum of Understanding between the two companies. Under this arrangement, Sattel will supply its DataNet product and communications lines and services under a strategic supplier arrangement to approximately 21 sites across the U.S. for CNC to use in its next generation network. CNC and Sattel agreed in concept to establish a wholesale business for other ISP's to use the CNC backbone network. In addition, the Memorandum of Understanding called for Sattel to invest $10-20 million into CNC and to receive yet-to-be-determined equity interests in both CNC and the wholesale business. The equity interest in CNC will be in a form that has rights substantially similar to those of a CNC Series D Preferred Stock to be issued in the near future. Because of delays in reaching agreement with respect to the wholesale business, as well as delays in CNC's overall financing arrangements, Sattel subsequently elected to provide a $5 million bridge loan to CNC. This loan was not a condition of the Memorandum of Understanding. Full implementation of the Memorandum of Understanding is subject to final pricing and configuration, due diligence, and the execution of definitive agreements. Subsequently, the parties agreed that Sattel's investment in CNC will be limited to $5 million and that the wholesale business will be outside of CNC. In September 1996, Sattel sold approximately 50% of its investment in CNC to a third party for $2.5 million. CNC will offer the wholesale business "most favored nation" prices, terms and conditions. Sattel began offering switching equipment in 1995. Sattel has incurred losses and experienced negative cash flow. There can be no assurance that revenue will grow at rates anticipated by management or that Sattel will achieve acceptable profitability or significant positive cash flow from operations. In addition, Sattel may continue to experience fluctuations in operating results in the future caused by various factors, including general economic conditions, industry acceptance of Sattel's product, technological obsolescence, specific economic conditions in the telecommunications access industry, user demand, capital expenditures and other costs relating to the expansion of the operations, and the introduction of new products by Sattel or its competitors. 3 The telecommunications switching equipment and access businesses are highly competitive. Currently Sattel competes with a number of national and regional telecommunications equipment providers such as Ascend, Xylogic, Xircom, Racal Datacom, and US Robotics. In the switching equipment segment, while Sattel provides smaller scaleable switches, there are other large manufacturers of large scale switches such as Lucent Technologies, Nortel, Digital Switch, Siemens and others. While they have not demonstrated movement at this time, there is no assurance that they will not attempt to move into Sattel's target market. It is also possible that large communication carriers such as AT&T, Sprint Corporation, MCI Communications Corp., and the Regional Bell Operating Companies may enter the telecommunications access and/or switching equipment business. Many of Sattel's competitors possess financial resources significantly greater than those of Sattel and accordingly could initiate and support prolonged price competition to gain market share. Future growth at Sattel could place a significant strain on Sattel's administrative, operational, and financial resources, and increase demands on its systems and controls. In addition, as Sattel expands there will be additional demands on the sales, marketing, and administrative resources. While Sattel believes that its operating and financial control systems are adequate to address expansion plans, there can be no assurance that such systems and controls will be adequate to maintain and effectively monitor future growth. Sattel anticipates that its continued growth will require it to recruit and hire a substantial number of new managerial, technical, and sales and marketing personnel. The inability to continue to upgrade the operating and financial control systems, the inability to recruit and hire necessary personnel, or the emergence of unexpected expansion difficulties could adversely effect the Company's business, results of operations, and financial condition. In addition, production, distribution or other difficulties could adversely affect Sattel's ability to fulfill market demand on a timely basis or increase its manufacturing costs. Sattel is dependent upon its ability to provide continued access to the Public Switched Telecommunications Network. Sattel's products, which have been installed in the United States and overseas, have access and are operating with the PSTN. While not currently envisioned, and as with any other telecommunications equipment, should the PSTN technical specifications be changed in any particular country in the future, Sattel may be required to modify its equipment in order to reflect such changes and to provide continuous access to that country's PSTN. Any system failure attributable to Sattel that causes interruptions in the Public Carrier's operations could have a material adverse effect on the Company. Sattel's success depends to a significant degree upon the continued contributions of its senior operating management. The loss of the services of these individuals, as well as key system development personnel, could have a material adverse effect on Sattel. Sattel's success also will depend on its ability to attract and retain qualified management, marketing, technical, and sales executives and personnel. Competition for such executives and personnel in the telecommunications access industry is intense and there are a limited number of persons with sufficient knowledge and experience. There can be no assurance that Sattel will be successful in attracting and retaining such executives and personnel. Sattel's success and ability to compete is dependent in part upon its technology, although Sattel believes that its success is more dependent upon its technical expertise than its proprietary rights. Sattel relies upon a combination of patent, copyright, trademark and trade secret laws, and 4 contractual restrictions to establish and protect its technology. There can be no assurance that the steps taken by Sattel will be adequate to prevent misappropriation of its technology or that Sattel's competitors will not independently develop technologies that are substantially equivalent or superior to Sattel's technology. A key component of Sattel's strategy is its planned expansion into international markets. There can be no assurance that Sattel will be able to obtain the permits and operating licenses required for it to operate, to hire and train employees or to market, sell and deliver high quality services in these markets. In addition to the uncertainty as to Sattel's ability to expand its international presence, there are certain risks inherent to doing business on an international level, such as unexpected changes in regulatory requirements, trade barriers, difficulties in staffing and managing foreign operations, longer payment cycles, problems in collecting accounts receivable, political instability, fluctuations in currency exchange rates, seasonal reductions in business activity, and potentially adverse tax consequences, which could adversely impact the success of Sattel's international operations. In many countries, Sattel may need to enter into a joint venture or other strategic relationship with one or more third parties in order to successfully conduct its operations. There can be no assurance that such factors will not have an adverse effect on Sattel's future international operations and, consequently, on Sattel's business, results of operations and financial condition. Sattel's DSS/Switch product is manufactured by STI with complete facilities to provide a turnkey product. STI provides complete manufacturing of all board, chassis, and system level assemblies for Sattel. Currently, STI also does final assembly and testing. STI has from time to time experienced delays in receipt of certain hardware components. A failure by a supplier to deliver quality products on a timely basis, or the inability to develop alternative sources if and as required, could result in delays which could materially adversely affect Sattel. Sattel believes that quality assurance is maintained to all required levels specified in ISO and MIL-Specs. Sattel generally uses industry standard components for its products and has specified alternate sources for these parts under the approved vendor lists provided to the contractor by Sattel's engineering department. Certain components, including crystals and microprocessors are presently single sourced or are available from a limited number of sources. Any interruption in business between Sattel and STI could have a material adverse effect on the Company. Certain software and hardware associated with adjunct and peripheral equipment used by Sattel to provide certain functions and features is licensed, or procured under OEM arrangements, from other vendors. C&L C&L operates nationwide with its administrative headquarters and distribution center located in San Antonio, Texas. C&L is an international distributor of products sold to wide area and local area integrated networks to transport voice, data and video communications. C&L's principal products include digital networking products, multiplexors, frame relay access devices, ATM, digital switches, call controllers, wide area network routers, ethernet switches and ethernet hubs. C&L's customers are comprised of long distance carriers, interconnect companies, value added resellers, networking companies, systems integrators, independent telephone companies, some large end users and local area network resellers. The long distance carrier portion of the customer base includes 5 virtually all significant U.S. long distance companies. No single customer accounted for more than 10% of consolidated net sales for the year ended March 30, 1996. C&L sales and technical staff have a technical background and knowledge of the products' technical applications to allow for added services for C&L's customers. C&L's technical support group deals with multiple vendors' products. Therefore, C&L operates as a value-added distributor, providing configurations services, technical support and training in the multiple vendor solution environment. In fiscal 1996, C&L's primary product suppliers are Newbridge Networks, Inc. ("Newbridge") which supplies digital networking products and Mitel Corporation ("Mitel") which supplies call controllers. For the year ended March 30, 1996, these two companies supplied approximately 72% of C&L's inventory purchases. Although C&L has introduced new products from manufacturers other than Newbridge and Mitel, the loss of either vendor would have a negative impact on C&L's operations. C&L has no manufacturing operations. Newbridge is a leading international manufacturer of digital network communications systems. In 1992, Newbridge acknowledged C&L as being the largest of their authorized U.S. distributors, a distinction which it still holds at March 30, 1996. Mitel is an international manufacturer of call controllers and other sophisticated business telecommunications equipment. C&L has been an authorized distributor of Mitel call controllers since early 1985, and C&L's management believes that its relationship with Mitel is satisfactory. C&L's competition in the digital networking product market comes from (1) other telecommunications distributors and (2) manufacturers of digital products who sell direct. C&L competes by offering high quality products at competitive prices while providing technical assistance to its customers. C&L believes that most of its competitors do not offer C&L's level of technical assistance. Voice and Data Network Installation and Service Segment Valley offers its customers broad experience and expertise in design, engineering, installation and testing of all major structured wiring systems for voice and data networking. In addition to facility wiring, Valley also provides electronic data hardware, such as hubs, routers and bridges with associated support, for Local and Wide Area Networks. Valley offers engineering expertise in fiber optics, ethernet and token rings networking, switching products, paging systems, as well as conforming to NEC, ANSI, OSHA and other industry standards. As part of Valley's overall project design, the Company works with and sells all industry standard network systems and products. Most of Valley's business is in local area network design and installation. The Company's main business is in installation projects involving 50 or more workstations, with a floor of about $15,000 to $20,000 in total project billings, and exceeding $2,000,000 in the upper range. In recent years Valley has developed extensive experience in planning and installing large projects involving fiber optic cable. Valley has four locations in California: Fremont, Sacramento, Irvine and Fresno. Valley's business is primarily within these areas, however, Valley is considering expanding its operations outside of California. 6 Valley is a Value Added Reseller (VAR) for several of the largest industry suppliers. Valley is one of AT&T's largest VARs on the West Coast. Other structured wiring system manufacturers such as Northern Telecom have entered into agreements with Valley to represent their product lines as well. An important component of Valley's success has been the cultivation of relationships with major equipment manufacturers. Valley is a resource for potential customers looking for advice on hardware to use for their systems. Valley periodically offers seminars to its clients on new technologies and products in conjunction with selected manufacturers. Valley has positioned itself through business relationships with hardware manufacturers and design consultants to benefit from the growth in the networking market. Valley's growth in the low-voltage portion of the communications market has been fueled in large part by the continuing shift by major customers from mainframes to LAN systems, and the increasing demand for higher data systems speeds and the cabling to handle them. This has resulted in ongoing, retrofit programs for existing customers in addition to new system installations. Previously, local phone companies held a monopoly position on installation and maintenance of telephone cabling within all residential and commercial buildings in California. In August 1993, the California Public Utilities Commission issued an order switching responsibility for this cabling from the local phone company to the owners of the buildings themselves. The owners are now responsible for managing the design, administration, engineering, installation and maintenance of all telephone cabling beyond the Minimum Port of Entry. Owners will be accountable for compliance to strict standards. Telephone cabling can usually be installed at the same time as other planned networking systems, for the same customers with no additional marketing or service calls. Most of Valley's customers are Fortune 500 companies, large corporations or governmental agencies. A significant share of Valley's private sector clients are high-tech companies. No single customer accounts for more than 10% of consolidated sales. The network installation and service business in California is highly fragmented with the strong demand for sophisticated networks being tempered by a very competitive local business climate. Wholesale Distribution of Meat and Seafood Segment APC distributes primarily beef, pork, poultry, and seafood in the southeastern region of the United States. APC sells primarily to retail food outlets, meat wholesalers, food service enterprises and restaurants. It owns and operates a warehouse facility in Atlanta, Georgia from which it delivers these products to its customers. Sam's Club accounted for more than 10% of consolidated net sales for the year ended March 30, 1996. The products purchased for distribution are supplied by food manufacturers and processors, the two largest of which accounted for approximately 37% of total purchases. APC does not have contracts with any suppliers. Wholesale meat and seafood distribution in the geographic area in which APC operates is highly competitive. APC competes with both national and local food wholesalers and processors, many of which have greater financial resources and sales volume. Competition is based primarily on price, service and quality of product. 7 Research and Development The Company had no significant research and development activities during the last three fiscal years, however, the Company anticipates that, beginning in fiscal 1997, Sattel will incur material research and development expenses. Environmental Protection Compliance with federal, state and local regulations relating to environmental protection do not have a material effect upon capital expenditures, operating results or the competitive position of the Company. Employees of Registrant At March 30, 1996, Diana had 496 employees, of whom 60 were within the telecommunications equipment segment, 182 were within the voice and data network installation and service segment, 245 were within the wholesale food distribution segment, and 9 performed corporate functions. In the wholesale food distribution segment, 185 employees are truck drivers and warehousemen, some of which are covered by a collective bargaining agreement which expires in May 1997. In the voice and data network installation and services segment, 138 technicians are covered by a collective bargaining agreement which expires in August 1998. No work stoppage occurred in fiscal 1996. The Company believes that it generally has good relationships with all its employees. ITEM 2. Properties Diana's corporate offices are located in a leased 5,000 square foot office located in Milwaukee. The Company owns vacant parcels of land in Eldridge, Iowa. Sattel leases 3,600 square feet of office and warehouse space in Chatsworth, California. C&L leases 8,000 square feet of warehouse space and 9,000 square feet of office space in San Antonio, Texas. Substantially all of C&L's assets are pledged as collateral under its Loan and Security Agreement (see Note 4 to the Consolidated Financial Statements). Valley leases 21,000 square feet of office and warehouse space which consists of four locations in Fremont, Sacramento, Irvine and Fresno, California. Substantially all of Valley's assets are pledged as collateral under its Loan and Security Agreement (see Note 4 to the Consolidated Financial Statements). APC owns a 91,000 square foot building in Atlanta, Georgia which contains its office and warehouse space. APC owns or leases trucks used in its distribution activities and various warehouse equipment used in its warehouse operations. Substantially all of APC's assets are pledged as collateral under its Loan and Security Agreement (see Note 4 to the Consolidated Financial Statements). ITEM 3. Legal Proceedings There are no material legal proceedings. 8 ITEM 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders during the fourth quarter of fiscal 1996. 9 PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's Common Stock is traded on the New York Stock Exchange under the symbol DNA. The table below sets forth by quarter the high and low sales prices of the Company's Common Stock on the New York Stock Exchange Composite Tape for the last two fiscal years. Fiscal Fiscal 1996 1995 Quarter High Low Quarter High Low First 8 3/8 4 1/4 First 13 3/4 7 Second 13 7/8 5 5/8 Second 9 3/8 6 1/2 Third 26 5/8 10 1/8 Third 8 5 5/8 Fourth 30 1/2 12 3/8 Fourth 6 1/4 4 At June 10, 1996, the Company had 1,325 shareholders of record. There were no cash dividends declared during the last two fiscal years. The Company has no plans to pay cash dividends in the foreseeable future. The payment of cash dividends by the Company is restricted by the Company's subordinated debentures which provide that the consolidated tangible net worth of the Company cannot be reduced to less than an amount equal to the aggregate principal amount of the subordinated debentures, or $1,254,000. 10 ITEM 6. Selected Financial Data THE DIANA CORPORATION SELECTED FINANCIAL DATA (In Thousands, Except Per Share Amounts)
March 30, April 1, April 2, April 3, March, 28, 1996 1995 1994 1993 1992 -------- ------- ------ -------- -------- (4) (3) (2) Net sales $267,602 $250,386 $243,641 $222,254 $161,607 ======= ======= ======= ======= ======= Earnings (loss) before items noted below....... $ (3,365) $ (720) $ 3,457 $ 1,857 $ (1,013) Extraordinary items...... --- --- (266) 1,318 --- Accounting change........ --- --- 262 --- --- ------- ------- ------- ------- ------- Net earnings (loss)...... $ (3,365) $ (720) $ 3,453 $ 3,175 $ (1,013) ======= ======= ======= ======= ======= Earnings (loss) per common share: Primary Earnings (loss) before items noted below...... $ (.76) $ (.17) $ .84 $ .46 $ (.24) Extraordinary items..... --- --- (.06) .33 --- Accounting change....... --- --- .06 --- --- ------- ------- ------- ------- ------- Net earnings (loss)... $ (.76) $ (.17) $ .84 $ .79 $ (.24) ======= ======= ======= ======= ======= Fully diluted Earnings (loss) before items noted below...... $ (.76) $ (.17) $ .81 $ .46 $ (.24) Extraordinary items..... --- --- (.06) .33 --- Accounting change....... --- --- .06 --- --- ------- ------- ------- ------- ------- Net earnings (loss)... $ (.76) $ (.17) $ .81 $ .79 $ (.24) ======= ======= ======= ======= ======= Cash dividends per common share................... $ --- $ --- $ --- $ --- $ --- ======= ======= ======= ======= ======= Total assets............. $ 53,533 $ 45,327 $ 54,043 $ 46,072 $ 40,536 Long-term debt (1)....... 4,006 3,307 3,784 3,853 3,409 Working capital.......... 13,283 15,489 19,007 17,490 18,942 Shareholders' equity..... 24,686 19,729 18,852 15,492 12,326 (1) Includes current portion of long-term debt. (2) The fourth quarter of fiscal 1992 contains the results of C&L, which was acquired in December 1991. (3) Fiscal 1993 contains 53 weeks. All other years contain 52 weeks. (4) See Note 2 of the Notes to Consolidated Financial Statements regarding the acquisition of Sattel and Valley.
11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations - Fiscal Year Ended March 30, 1996 versus April 1, 1995 In fiscal 1996, the Company acquired an 80% ownership interest in Valley and increased its ownership interest in Sattel from 50% to 80%. The results of operations of Valley were included in the consolidated group beginning in December 1995 and Sattel beginning in January 1996 (see Notes 1 and 2 to the Consolidated Financial Statements). The following is a summary of sales by segment (see Note 14 to the Consolidated Financial Statements) for fiscal 1996 and 1995, including sales by significant product line for the meat and seafood segment (in thousands): 1996 1995 Telecommunications equipment $ 25,350 $ 35,245 Network installation and service 6,144 --- Beef 109,785 107,055 Pork 46,822 42,700 Other 79,501 65,386 ------- ------- Meat and seafood total 236,108 215,141 ------- ------- $267,602 $250,386 ======= ======= For the fiscal year ended March 30, 1996, net sales increased $17,216,000 or 6.9% over fiscal 1995. C&L's net sales decreased $9,895,000 or 28.1% from fiscal 1995. C&L's sales decrease is due primarily to lower call controller sales and lower sales of digital network communications products (see further discussion below). APC's net sales increased $20,967,000 or 9.7% over fiscal 1995 net sales. APC's overall volume (based on tonnage) during this period increased by 3.4%. The increase in APC's net sales is primarily attributable to increased business resulting from the addition of Sam's Club as a customer in December 1994. Approximately 31.8% of consolidated net sales for the year ended March 30, 1996 were made by APC to two customers. As discussed above, Valley's fiscal 1996 sales are for a four month period beginning in December 1995. Sattel did not make any sales outside the consolidated group within the period from January 1996 to March 1996. The market for call controllers has been negatively impacted by a continuing consolidation of long distance carriers and continuing growth of equal access resulting in a reduction of demand for the product. Long distance carriers have historically been the largest customer group purchasing call controllers. The decrease in long distance carriers has and will continue to result in lower unit sales of call controllers. Equal access is the ability of a long distance customer to access a long distance carrier by dialing 1 and not a string of long dialing codes. One of the functions of the call controller is to simplify the access to a carrier network that is not provided equal access. Once access to the carrier network is simplified through equal access, the need for a call controller for this purpose is eliminated. In addition, the digital network communications marketplace in the United States is growing at a slower pace than in previous years due to the proliferation of voice T-1 circuits. Network providers are seeking faster access devices which can compress data more cost effectively. Consequently, there has been downward pricing 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations - (Cont.) pressure in this market which has impacted the digital products that are sold by C&L. C&L is addressing the changing dynamics in the telecommunications marketplace through the introduction of new product lines including frame relay, digital switches, ATM and ISDN. For the fifty two weeks ended March 30, 1996, other income (loss) improved from a loss of $417,000 to income of $519,000. During fiscal 1996, the Company had gains on sales of marketable securities of $26,000 as compared to a loss of $1,227,000 incurred during fiscal 1995. In addition, during fiscal 1996, the Company had smaller amounts of investments in corporate debt as compared to fiscal 1995 resulting in lower interest income. The components of other income (loss) are shown in Note 9 to the Consolidated Financial Statements. In fiscal 1996 gross profit decreased $506,000 or 4.5% from fiscal 1995. On a consolidated basis, gross profit as a percentage of net sales was 4.0% as compared to 4.5% in fiscal 1995. Gross profit was adversely impacted primarily by decreases in C&L's sales and gross profit margins. The decrease in C&L's gross profit percentage in fiscal 1996 is attributable to lower margins on both call controllers and digital products due to the factors discussed in the sales analyses. In addition, the departure of several of C&L's key employees, some of which went to work for a newly formed competitor, has adversely affected C&L's sales and margins (see further discussion below). For the fiscal year ended March 30, 1996, selling and administrative expenses increased $2,071,000 or 20.1% over fiscal 1995. Selling and administrative expenses have increased primarily because of the inclusion of Valley's and Sattel's results subsequent to the transactions discussed in the first paragraph. Selling and administrative expenses as a percentage of net sales was 4.6% in fiscal 1996 as compared to 4.1% in fiscal 1995. As a result of recent efforts to sell APC, the Company has concluded there has been a decrease in the fair value of APC which did not support the recoverability of the remaining goodwill balance related to the acquisition of APC. The determination of fair value was based on the sales price included in a letter of intent and asset purchase agreement relating to a proposed sale of APC. The sales price of the assets of APC to be sold (which excluded goodwill and other noncurrent assets) was generally at book value. The buyer had the option to purchase all of APC's fixed assets at $2,800,000 or to enter into a triple net lease with APC. The carrying amount of each major component of APC's assets are: current assets - $14,523,000, fixed assets - $3,170,000 and other noncurrent assets (excluding goodwill) - $355,000. The Company has prepared projections of APC's cash flows (before interest expense) for fiscal 1997-1999 which reflect cash flow of approximately $3.6 million. During the fourth quarter of fiscal 1996, the Company concluded that an impairment of goodwill has occurred and wrote off the remaining goodwill of $852,000 originally attributable to the acquisition of APC. The goodwill write off has no effect on the Company's cash flow or tangible shareholders' equity. On August 12, 1996, all negotiations and agreements with third parties concerning the proposed sale of APC were terminated. 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations - (Cont.) For the fiscal year ended March 30, 1996, interest expense decreased $22,000 or 2.0% from fiscal 1995. The decrease is primarily attributable to lower borrowings by C&L under its line of credit due to reduced receivable and inventory levels. Equity in loss of unconsolidated subsidiaries increased to a loss of $370,000 in fiscal 1996 from a loss of $69,000 in fiscal 1995. The components of these losses are shown in Note 11 to the Consolidated Financial Statements. The increase in the loss is primarily due to an increased loss incurred by Sattel attributable to the development of its business prior to the inclusion of Sattel in the Company's Consolidated Financial Statements in January 1996 (see Note 1 to the Consolidated Financial Statements). In October 1995, C&L appointed a new chief executive officer who has excellent senior management experience in telecommunications switching and data communications. Subsequently, several employees resigned from C&L including, among others, the chief financial officer, the vice president of sales and marketing, the sales manager and six out of fourteen sales people. Several if not all of these former employees went to work for a newly formed competitor. Subsequently, a sales person that went to work for the newly formed competitor returned to C&L. C&L has replaced the other departed personnel. Results of Operations - Fiscal Year Ended April 1, 1995 versus April 2, 1994 The following is a summary of sales for fiscal 1995 and 1994, including sales by significant product line for APC (in thousands): 1995 1994 Telecommunications equipment $ 35,245 $ 28,308 Beef 107,055 116,557 Pork 42,700 40,770 Other 65,386 58,006 ------- ------- Meat and seafood total 215,141 215,333 ------- ------- $250,386 $243,641 ======= ======= For the fiscal year ended April 1, 1995, net sales increased $6,745,000 or 2.8% over fiscal 1994. C&L's net sales increased $6,937,000 or 24.5% over fiscal 1994. C&L's sales increase is due primarily to increased sales of call controllers (see discussion in the following paragraph) and products used in digital networks for integrated voice and data communications systems. APC's net sales decreased $192,000 or .1% over fiscal 1994 net sales. APC's overall volume (based on tonnage) during this period increased by 1.8%. 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations - (Cont.) During the second quarter of fiscal 1995 C&L completed the sale of call controllers pursuant to a purchase commitment made by a customer in fiscal 1994. This order resulted in call controller sales of $3,648,000 in fiscal 1995. Sales attributable to this order significantly impacted the increase in C&L's year-to-date call controller sales and total year-to-date sales over the prior year results. During the fourth quarter of fiscal 1995, C&L's sales were 10% below fourth quarter fiscal 1994 sales. This decrease in sales is primarily attributable to lower call controller sales. The fourth quarter of fiscal 1994 included sales under the purchase commitment referred to above. In addition, the market for call controllers has been negatively impacted by a continuing consolidation of long distance carriers and continuing growth of equal access resulting in a reduction of demand for the product. The components of other income (loss) are disclosed in Note 9 to the Consolidated Financial Statements. The decrease in other income (loss) is attributable to lower interest income from marketable securities and losses incurred on the disposition of marketable securities. The increase in interest rates during fiscal 1995 adversely impacted Diana's marketable securities which prior to the end of the second quarter of fiscal 1995 consisted primarily of investments in corporate debt obligations. Consequently, Diana's corporate office has reduced its investment in these securities resulting in reduced interest income and losses on investments that were sold. In addition, during fiscal year 1994, Diana recorded $747,000 of interest income resulting from the refund of federal income taxes of $400,000 (shown separately as an income tax credit) paid in a prior year. In fiscal 1995 gross profit increased $287,000 or 2.6% over fiscal 1994. On a consolidated basis, gross profit as a percentage of net sales was 4.5% in fiscal 1995 unchanged from fiscal 1994. C&L's gross profit percentage was 19.5% in fiscal 1995 as compared to 20.7% in fiscal 1994. The decrease in C&L's gross profit percentage is due to a lower gross profit percentage achieved on the large call controller sale discussed above and to an increasingly competitive market for products used in digital networks for integrated voice and data communications systems. APC's gross profit percentage was 2% in fiscal 1995 as compared to 2.3% in fiscal 1994. APC's fiscal 1995 gross profit and gross profit percentage decreased from fiscal 1994 primarily due to increased transportation and warehouse costs and inventory losses due to inefficiencies in APC's warehouse and transportation operations (see discussion below) partially offset by lower product costs. For the fiscal year ended April 1, 1995, selling and administrative expenses increased $1,157,000 or 12.6% over fiscal 1994. Selling and administrative expenses have increased primarily because of increased selling and advertising expenses incurred by C&L to penetrate new and existing markets. During fiscal 1995 C&L incurred expenses attributable to the development and distribution of an updated product catalog, increased participation in trade shows and increased advertising and promotional efforts. In addition, C&L attempted to expand its business outside of the United States through the development of an international sales department and the opening of a sales and distribution office in Mexico. As a result of these efforts, C&L increased its business as evidenced by the sales increase of 24.5% in fiscal 1995 as compared to fiscal 1994. The attempt to expand 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations - (Cont.) international business was unsuccessful due to the devaluation of the Peso and the international sales department and office in Mexico were closed. Selling and administrative expenses as a percentage of net sales was 4.1% in fiscal 1995 as compared to 3.8% in fiscal 1994. For the fiscal year ended April 1, 1995, interest expense decreased $93,000 or 7.8% over fiscal 1994. The decrease is primarily attributable to a reduction in short term borrowings by Diana's corporate office. Diana's corporate office utilized short term (margin) borrowings to purchase some marketable securities. Some of the proceeds from the sale of marketable securities as discussed above were used to repay all of the short term borrowings. The decrease in minority interest is attributable to the Company's acquisition of the remaining 20% of C&L's common stock from its minority shareholders. In fiscal 1995, APC incurred increased warehouse and transportation payroll expenses and inventory losses. Consequently, APC made management changes and implemented new procedures in an attempt to improve its warehouse and transportation operations. Furthermore, during the latter part of fiscal 1995's third quarter, APC began selling to Sam's Club. APC services the Southeastern region of this national warehouse club. Sam's Club generated a significant amount of volume at margins that were lower than APC's average historical margins. Initially, the addition of this new business increased the operational costs discussed above which management believes is the primary reason for the loss of $749,000 incurred in the fourth quarter of fiscal 1995. Liquidity and Capital Resources The Company recorded cash flow from operating activities of $1,368,000 as compared to $6,717,000 in fiscal 1995. The decrease in cash flow is primarily attributable to an increase in net loss and less cash provided by the net change in working capital items. The increase in receivables is primarily attributable to the acquisition of Valley partially offset by reduced receivables at APC and C&L. The increase in accounts payable is primarily attributable to the acquisition of Valley. Marketable securities decreased in fiscal 1996 primarily due to the Company's decision to invest its excess funds in more liquid investments so that cash is more readily available for its operating requirements. The Company generated cash of $5,380,000 through sales of marketable securities. In fiscal 1996, the Company had $696,000 of capital expenditures consisting primarily of purchases by APC to improve its distribution facility and Sattel for the development of its business. The Company estimates that fiscal 1997 capital expenditures will approximate $1.8 million. Significant capital expenditures are anticipated for testing equipment for Sattel and for trailers and equipment for APC. The revolving line of credit agreements discussed in Note 4 to the Consolidated Financial Statements include covenants that limit fiscal 1997 capital expenditures for C&L, Valley and APC to $1,100,000. 16 In fiscal 1996, the Company utilized cash of $4,412,000 in connection with advances made to Sattel and its acquisitions of Valley and its additional 30% interest in Sattel (see Note 2 to the Consolidated Financial Statements). The Company utilized cash of $3,320,000 for the acquisition of Valley. In addition, the Company received $1 million of seller financing which is payable over a 5 year period at $200,000 per year. The Company believes that Valley will generate sufficient cash flow from operations, after the payment of dividends to Valley's minority shareholders, to service the acquisition debt. The Company may be required to make future payments to the sellers through fiscal 2001 based on a percentage of Valley's pretax earnings as further described in Note 2 to the Consolidated Financial Statements if Valley's pretax earnings are in excess of certain defined levels. This arrangement was established to provide the Company a return on its investment in Valley prior to the payment by the Company of additional purchase price to the Valley minority shareholders. Additional purchase price payments will not have an adverse effect on liquidity due to the minimum earning levels of Valley that are required. Any such payments will have the effect of limiting the return on the investment in Valley to the extent of the payments. APC, C&L and Valley have separate revolving line of credit facilities which provide working capital financing to these subsidiaries. The terms of these credit facilities and related borrowings and credit availability under these credit facilities is described in Note 4 to the Consolidated Financial Statements. APC's revolving line of credit facility ("APC Revolver") contains financial covenants requiring a minimum level of tangible net worth, earnings and net cash flow. The following is a comparison of APC's performance against the covenants at March 30, 1996 (in thousands): Covenant Actual Requirement Performance Tangible Net Worth $ 3,900,000 $ 5,575,000 ========== ========== Earnings (400,000) (1,045,000) ========== ========== Net Cash Flow 230,000 449,000 ========== ========== At March 30, 1996 APC failed to satisfy the earnings covenant due to the write off of goodwill of $852,000. In June 1996, APC and its lender entered into a waiver and amendment agreement relating to the APC Revolver in order to avoid violating certain financial covenants at March 30, 1996 and in fiscal 1997. The amended APC Revolver provides for the following financial covenants during fiscal 1997: minimum tangible net worth of $3,900,000 through March 28, 1997 and $4,400,000 on March 29, 1997, a net loss of not greater than $40,000 and net cash flow on a rolling 13-period basis (measured at the end of each four week period) ranging from $385,000 to $500,000. Based upon APC's projections, the Company believes that APC will have adequate working capital for fiscal 1997. Because the APC Revolver provides for repayment of borrowings after a 90 day notice from the lender, the indebtedness is classified as short term. The fiscal 1995 financial statements have been reclassified to conform to fiscal 1996 presentation. In October 1996, APC refinanced its revolving line of credit with a new lender. The new credit facility provides for a revolving line of credit up to $10 million with certain terms more favorable than the previous credit facility. 17 C&L's revolving line of credit facility ("C&L Revolver") contains financial covenants requiring minimum levels of tangible net worth and pretax income computed on a rolling 12-month basis, a minimum ratio of current assets to current liabilities and a maximum ratio of total liabilities to tangible net worth. At March 30, 1996, C&L failed to satisfy the pretax income requirement. In June 1996, C&L and its lender entered into a waiver and amendment agreement relating to the C&L Revolver in order to avoid violating certain financial covenants at March 30, 1996 and in fiscal 1997. The amended C&L Revolver provides for the following financial covenants during fiscal 1997: minimum tangible net worth of $2,000,000; minimum cumulative income from operations, calculated on a quarterly basis of $115,000, $446,000, $730,000 and $1,174,000, respectively; a current ratio of 1:1 and a maximum ratio of total liabilities to equity of 6:1. At June 27, 1996, based upon the representations and projections of C&L's management, the Company believes that C&L will meet the financial covenants during fiscal 1997 or will obtain any required waivers from the lender. In May 1996, the Company contributed an additional $10 million to Sattel. Sattel loaned $5 million to CNC pursuant to a Promissory Note due September 30, 1996 in favor of Sattel which is convertible into CNC Series D Preferred Stock under certain conditions outlined in the Note. In addition, Sattel may, pursuant to the terms of the Memorandum of Understanding, invest an additional $5,000,000 in Series D Preferred Stock of CNC. In the fourth quarter of fiscal 1996 and in the first quarter of fiscal 1997, the Company raised approximately $17.4 million, after commissions and expenses, through the sale of 600,000 shares of Common Stock. The Company believes that it has adequate resources to meet its liquidity needs for fiscal 1997. On a long term basis, financing for the Company's operations, including working capital requirements for Sattel and capital expenditures, will come from cash generated from operations, the sale of additional equity or other securities, additional bank borrowings and other sources of capital, if available. The Company intends to file a registration statement in July 1996 for shelf registration of up to 500,000 shares of common stock, which may be sold in fiscal 1997 if conditions warrant. The Company is investigating how it can be restructured in order to maximize shareholder value. Management is currently looking at several alternative approaches, based on separating operating units by industry type into independent publicly traded companies. Management will present their restructuring plans to the Board as soon as possible. Management has retained the services of Hambrecht & Quist, LLC, an investment banking firm, to assist them with this effort. Forward Looking Statements The following may be considered "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995: the Company's estimate of fiscal 1997 capital expenditures, the statements that the Company believes APC and C&L will meet financial covenants in its loan agreement or obtain any required waivers during fiscal 1997, the Company believes that it and APC will have adequate working capital in fiscal 1997, the Company's estimate of APC's cash flows for fiscal 1997-1999 will be approximately $3.6 million and the Company believes that Valley will generate sufficient cash flows from operations to service the acquisition debt incurred for the Valley acquisition. Actual results or developments may differ materially from those contained in the forward looking statements. Factors which may cause such a difference to occur include but are not 18 limited to (i) whether extraordinary repairs are needed to APC's distribution facility, (ii) whether the Company can continue to grow its business, (iii) whether the Company can control the operating expenses of APC which began to increase in fiscal 1994, (iv) product demand, competition, the cost of products, and industry conditions, (v) whether vendors continue to provide credit to APC on satisfactory terms, (vi) whether APC's secured lender exercises its demand right or grants any necessary waivers and (vii) new competitors entering APC's marketplace and (viii) the risks and uncertainties discussed in Item 1 relating to Sattel's business. Accounting Pronouncements Effective April 2, 1994, the Company adopted the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". The effect as of April 2, 1994 of adopting SFAS No. 115 increased net earnings by $412,000, or $.10 per fully diluted share. In March 1995, the Financial Accounting Standards Board ("FASB") issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement establishes accounting 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. This statement is effective for financial statements for fiscal years beginning after December 15, 1995. Management has concluded that an impairment of APC's assets has not occurred based on the operating cash flows of approximately $1.2 million (before interest expense) generated by APC during fiscal 1996 and estimates of APC's cash flows for future periods. The Company believes that the adoption of this standard will not have a material effect on its consolidated results of operations or financial position. In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock- Based Compensation." This statement establishes financial accounting and reporting standards for stock-based employee compensation plans and is effective for fiscal years beginning after December 15, 1995. The Company has decided to continue accounting for employee stock compensation under currently existing accounting principles, but will disclose pro forma results using the new standard's alternative accounting treatment as is permitted under SFAS No. 123. Effective April 4, 1993, the Company adopted the liability method of accounting for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes". The cumulative effect as of April 4, 1993 of adopting SFAS No. 109 increased net earnings for fiscal 1994 by $262,000. Impact of Inflation Inflation has not had a significant impact on net sales or earnings (loss) before extraordinary items or accounting change for the three most recent fiscal years. 19 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA THE DIANA CORPORATION AND SUBSIDIARIES PAGE Report of Price Waterhouse LLP, Independent Accountants......... 21 Report of Ernst & Young LLP, Independent Auditors............... 22 Consolidated Balance Sheets..................................... 23 Consolidated Statements of Operations........................... 24 Consolidated Statements of Changes in Shareholders' Equity...... 25 Consolidated Statements of Cash Flows........................... 26 Notes to Consolidated Financial Statements...................... 27 20 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of The Diana Corporation In our opinion, the consolidated financial statements listed under Item 14(a)(1) and (2) appearing in this report present fairly, in all material respects, the financial position of The Diana Corporation and its subsidiaries at March 30, 1996, and the results of their operations and their cash flows for the year in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Milwaukee, Wisconsin June 27, 1996, except as to the stock dividend described in Note 17 which is as of October 2, 1996 21 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Board of Directors and Shareholders The Diana Corporation We have audited the accompanying consolidated balance sheet of The Diana Corporation and subsidiaries (the Company) as of April 1, 1995, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the two years in the period ended April 1, 1995. Our audits also included the financial statement schedules as of April 1, 1995 and for each of the two years in the period ended April 1, 1995 listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Diana Corporation and subsidiaries at April 1, 1995, and the consolidated results of its operations and its cash flows for each of the two years in the period ended April 1, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in Note 10 to the consolidated financial statements, the Company changed its method of accounting for income taxes, effective April 4, 1993. Milwaukee, Wisconsin ERNST & YOUNG LLP June 2, 1995 22 THE DIANA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)
March 30, April 1, 1996 1995 -------- ------- ASSETS Current assets Cash and cash equivalents............................ $ 6,254 $ 2,440 Marketable securities................................ 1,215 6,211 Receivables, less allowance for doubtful accounts of $772 and $600.................. 16,171 14,785 Inventories.......................................... 12,337 12,237 Other current assets................................. 1,009 690 ------ ------ Total current assets............................... 36,986 36,363 Property and equipment Land................................................. 357 357 Building and improvements............................ 4,702 4,400 Fixtures and equipment............................... 4,182 3,298 ------ ------ 9,241 8,055 Less accumulated depreciation........................ (5,083) (4,252) ------ ------ 4,158 3,803 Intangible assets...................................... 11,585 4,137 Other assets........................................... 804 1,024 ------ ------ $53,533 $45,327 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable..................................... $13,707 $12,355 Accrued liabilities.................................. 2,514 1,390 Revolving line of credit............................. 7,038 6,803 Current portion of long-term debt.................... 444 326 ------ ------ Total current liabilities...................... 23,703 20,874 Long-term debt......................................... 3,562 2,981 Other liabilities ..................................... 1,582 1,743 Commitments and contingencies (Note 6)................. Shareholders' equity Preferred stock - $.01 par value. Authorized 5,000,000 shares; none issued............ --- --- Common stock - $1 par value. Authorized 15,000,000 shares; issued 5,526,282 and 4,810,353 shares....... 5,526 4,810 Additional paid-in capital........................... 59,456 48,548 Accumulated deficit.................................. (34,776) (28,178) Unrealized loss on marketable securities............. (876) (713) Treasury stock at cost............................... (4,644) (4,738) ------ ------ Total shareholders' equity..................... 24,686 19,729 ------ ------ $53,533 $45,327 ====== ======
See notes to consolidated financial statements. 23 THE DIANA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Amounts)
Fiscal Year Ended ------------------------------ March 30, April 1, April 2, 1996 1995 1994 -------- -------- -------- Net sales.............................. $267,602 $250,386 $243,641 Other income (loss).................... 519 (417) 2,697 ------- ------- ------- 268,121 249,969 246,338 Cost of sales.......................... 256,920 239,198 232,740 Selling and administrative expenses.... 12,385 10,314 9,157 Write-off of goodwill.................. 852 --- --- ------- ------- ------- Operating earnings (loss).............. (2,036) 457 4,441 Interest expense....................... (1,076) (1,098) (1,191) Non-operating income................... 95 34 --- Income tax credit (expense)............ (87) --- 400 Equity in earnings (loss) of unconsolidated subsidiaries.......... (370) (69) 97 Minority interest...................... 109 (44) (290) ------- ------- ------- Earnings (loss) before extraordinary item and accounting change........... (3,365) (720) 3,457 Extraordinary item..................... --- --- (266) ------- ------- ------- Earnings (loss) before accounting change............................... (3,365) (720) 3,191 Cumulative effect of accounting change. --- --- 262 ------- ------- ------- Net earnings (loss).................... $ (3,365) $ (720) $ 3,453 ======= ======= ======= Earnings (loss) per common share: Primary Before extraordinary item........... $ (.76) $ (.17) $ .84 Extraordinary item.................. --- --- (.06) Accounting change................... --- --- .06 ------- ------- ------- Net earnings (loss)................. $ (.76) $ (.17) $ .84 ======= ======= ======= Fully diluted Before extraordinary item........... $ (.76) $ (.17) $ .81 Extraordinary item.................. --- --- (.06) Accounting change................... --- --- .06 ------- ------- ------- Net earnings (loss)................. $ (.76) $ (.17) $ .81 ======= ======= ======= Weighted average number of common shares outstanding Primary............................. 4,401 4,224 4,108 ======= ======= ======= Fully diluted....................... 4,401 4,224 4,255 ======= ======= =======
See notes to consolidated financial statements. 24 THE DIANA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in Thousands)
Common Stock Additional Unrealized Loss Treasury Stock Total Number of Par Paid in Accumulated on Marketable Number of Shareholders' Shares Value Capital Deficit Securities Shares Cost Equity Balance at April 3, 1993 4,637,530 $ 4,638 $ 45,786 $ (27,818) $ --- 1,344,667 $(7,114) $ 15,492 Net earnings --- --- --- 3,453 --- --- --- 3,453 5% stock dividend --- --- 214 (1,084) --- (163,889) 866 (4) Exercise of stock options --- --- (47) --- --- (15,500) 82 35 Unrealized loss on marketable securities --- --- --- --- (412) --- --- (412) Other --- --- 288 --- --- --- --- 288 --------- ------ ------- -------- ------ --------- ------- ------- Balance at April 2, 1994 4,637,530 4,638 46,241 (25,449) (412) 1,165,278 (6,166) 18,852 Net loss --- --- --- (720) --- --- --- (720) 5% stock dividend 172,823 172 1,830 (2,009) --- --- --- (7) Exercise of stock options --- --- (14) --- --- (4,500) 24 10 Change in unrealized loss on marketable securities --- --- --- --- (301) --- --- (301) Acquisition of minority interest --- --- 491 --- --- (265,262) 1,404 1,895 --------- ------ ------- -------- ------- --------- ------- ------- Balance at April 1, 1995 4,810,353 4,810 48,548 (28,178) (713) 895,516 (4,738) 19,729 Net loss --- --- --- (3,365) --- --- --- (3,365) 5% stock dividend 195,929 196 3,022 (3,233) --- --- --- (15) Exercise of stock options --- --- (39) --- --- (12,300) 65 26 Change in unrealized loss on marketable securities --- --- --- --- (163) --- --- (163) Acquisition of Sattel 350,000 350 4,594 --- --- --- --- 4,944 Issuance of common stock 170,000 170 3,315 --- --- --- --- 3,485 Other --- --- 16 --- --- (5,524) 29 45 --------- ------ ------- -------- ------- --------- ------- ------- Balance at March 30, 1996 5,526,282 $ 5,526 $ 59,456 $ (34,776) $ (876) 877,692 $ (4,644) $ 24,686 ========= ====== ======= ======== ======= ========= ======= =======
See notes to consolidated financial statements. 25 THE DIANA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)
Fiscal Year Ended ------------------------------ March 30, April 1, April 2, 1996 1995 1994 -------- -------- -------- Operating activities Earnings (loss) before extraordinary items and accounting change.......... $(3,365) $ (720) $ 3,457 Adjustments to reconcile earnings (loss) to net cash provided (used) by operating activities: Loss (gain) on sale of marketable securities.............. (26) 1,227 (479) Depreciation and amortization....... 1,441 1,154 1,098 Provision for losses on accounts receivable......................... 509 313 153 Write-off of goodwill............... 852 --- --- Equity in loss (earnings) of unconsolidated subsidiaries........ 370 69 (97) Minority interest................... (109) 44 290 Payments of net liabilities of unconsolidated subsidiary.......... (242) (95) (361) Other............................... (256) 311 (14) Changes in current assets and liabilities........................ 2,194 4,414 (4,355) ------ ------ ------ Net cash provided (used) by operating activities............................ 1,368 6,717 (308) Investing activities Purchases of property and equipment... (696) (599) (555) Affiliate advances and acquisitions, net of cash acquired................. (4,412) --- (1,983) Purchases of marketable securities.... (475) (5,647) (20,218) Sales of marketable securities........ 5,380 9,276 21,031 Collection of notes receivable........ 138 194 252 Other................................. 55 (195) --- ------ ------ ------ Net cash provided (used) by investing activities............................ (10) 3,029 (1,473) Financing activities Changes in short-term borrowings...... 236 (5,667) 1,190 Payments on long-term debt............ (1,265) (478) (390) Payments toward bond settlements...... --- (2,822) (178) Common stock issued................... 3,485 --- --- ------ ------ ------ Net cash provided (used) by financing activities............................ 2,456 (8,967) 622 ------ ------ ------ Increase (decrease) in cash and cash equivalents........................... 3,814 779 (1,159) Cash and cash equivalents at the beginning of the year................. 2,440 1,661 2,820 ------ ------ ------ Cash and cash equivalents at the end of the year.............................. $ 6,254 $ 2,440 $ 1,661 ====== ====== ======
See notes to consolidated financial statements. 26 THE DIANA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 30, 1996 NOTE 1 - Summary of Significant Accounting Policies Basis of Presentation The consolidated group (hereafter referred to as the "Company") included the following companies during the past three years. The following describes each entity in the consolidated group and its current status: The Diana Corporation ("Diana") Diana and its wholly-owned subsidiaries are included in the consolidated group for all three fiscal years. Sattel Communications ("Sattel") Diana had a 50% ownership interest in Sattel and accounted for its investment in Sattel using the equity method of accounting from November 1994 to December 1995. In January 1996, Diana increased its ownership interest in Sattel from 50% to 80%. Sattel was included in the consolidated group effective January 1996. Sattel is a provider of central office voice and data switching equipment for communications providers worldwide. C&L Communications, Inc. ("C&L") C&L is included in the consolidated group for all three fiscal years. Effective June 1994, Diana increased its ownership interest in C&L from 80% to 100%. C&L is a distributor of telecommunications equipment for wide area and local area integrated networks to transport voice, data and video communications primarily in North America. Valley Communications, Inc. ("Valley") Valley was acquired by C&L on November 20, 1995 and is included in the consolidated group subsequent to the acquisition date. C&L owns 80% of Valley. Valley provides design, installation and service for voice and data networks and equipment primarily in California. Entree Corporation ("Entree") Entree and its wholly-owned subsidiary, Atlanta Provision Company, Inc. ("APC"), are included in the consolidated group for all three fiscal years. APC distributes meat and seafood in the southeastern United States. A majority of APC's sales are to retail food stores and meat wholesalers, with the remaining sales to food service enterprises and restaurants. Diana owns 81.25% of Entree. Investments in 20%-50% owned subsidiaries in which management has the ability to exercise significant influence are accounted for using the equity method of accounting (see Note 11). Accounts and transactions between members of the consolidated group are eliminated in the consolidated financial statements. In fiscal 1996, the minority interest attributable to the 20% owners of Sattel and Valley amounted to $507,000 and is included in other liabilities. 27 NOTE 1 - Summary of Significant Accounting Policies (Continued) Fiscal Year The Company's fiscal year ends on the Saturday closest to March 31. There were 52 weeks in all years presented. Financial Instruments The carrying value of cash and cash equivalents, marketable securities, receivables, accounts payable and borrowings at March 30, 1996 and April 1, 1995 approximate fair value. Marketable Securities The Company accounts for marketable securities in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Under SFAS No. 115, management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in other income (loss). Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value (based on published market values), with the unrealized gains and losses reported in a separate component of shareholders' equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in other income (loss). Realized gains and losses, interest income and dividends are included in other income (loss). For purposes of determining the gain or loss on a sale, the cost of securities sold is determined using the average cost of all shares of each such security held at the dates of sale. Concentrations of Risk APC performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. Receivables from APC's customers are generally due within 7 to 30 days. Approximately 31.8% of consolidated net sales for the year ended March 30, 1996 were made by APC to two customers. Approximately 14.1% of consolidated receivables at March 30, 1996 were due from these two customers. Approximately 72% of C&L's inventory purchases are from two companies. The loss of either company would have a negative impact on C&L's operations. Inventories Inventories, consisting of finished product, are stated at the lower of cost or market. Items are removed from inventory based on the specific identification method or the average cost method. 28 NOTE 1 - Summary of Significant Accounting Policies (Continued) Property and Equipment Property and equipment are stated at cost. Provisions for depreciation are computed on the straight-line method for financial reporting purposes over 3 to 10 years for equipment and 5 to 25 years for building and improvements. Depreciation for income tax purposes is computed on accelerated cost recovery methods. Expenditures which substantially increase value or extend asset lives are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. Intangible Assets Intangible assets consist of the following (in thousands): 1996 1995 Intellectual property rights $ 5,029 $ --- Goodwill 5,491 2,846 Covenants not to compete 1,021 1,291 Other 44 --- ------ ----- $11,585 $4,137 ====== ===== Intellectual property rights are amortized on a straight line basis over a 20 year period. Goodwill is amortized on a straight line basis over 5-40 years. Covenants not to compete are amortized over the non-compete periods of 5-7 years. Accumulated amortization was $1,930,000 and $1,598,000 at March 30, 1996 and April 1, 1995, respectively. Goodwill is reviewed for impairment whenever events or circumstances provide evidence that suggest that the carrying amount of the asset may not be recoverable. Impairment is generally determined by using identifiable cash flows over the remaining amortization period to estimate fair value. As a result of recent efforts to sell APC, the Company has concluded there has been a decrease in the fair value of APC which did not support the recoverability of the remaining goodwill balance related to the acquisition of APC. The determination of fair value was based on the sales price included in a letter of intent and agreement relating to a proposed sale of APC. During the fourth quarter of fiscal 1996, the Company concluded that an impairment of goodwill has occurred and wrote off the remaining goodwill of $852,000 resulting from the acquisition of APC. Management has concluded that a measurement date with respect to the proposed sale of APC has not been reached as of March 30, 1996. Management considered the probability of contingencies, including the potential buyer obtaining suitable financing, the lack of approval of a formal plan of disposal and management's stated intent to remove APC from the market if a sale does not culminate in the near future in arriving at its conclusion. In March 1995, the Financial Accounting Standards Board ("FASB") issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement establishes accounting 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. This statement is effective for financial statements for fiscal years beginning after December 15, 1995. Management has concluded that an 29 impairment of APC's assets has not occurred based on the operating cash flows of approximately $1.2 million (before interest expense) generated by APC during fiscal 1996 and estimates of APC's cash flows for future periods. The Company believes that the adoption of this standard will not have a material effect on its consolidated results of operations or financial position. Revenue Recognition The Company recognizes revenue when product is shipped. Income Taxes The Company accounts for income taxes using the liability method in accordance with SFAS No. 109, "Accounting for Income Taxes." Earnings (Loss) Per Common Share Primary and fully diluted per share amounts are determined by dividing earnings (loss) by the weighted average number of shares of common stock and materially dilutive common stock equivalents (stock options) outstanding. 30 NOTE 1 - Summary of Significant Accounting Policies (Continued) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Statement of Cash Flows For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Reclassifications Certain amounts in the financial statements as of April 1, 1995 and for each of the two years in the period ended April 1, 1995 have been reclassified to conform with the classifications used for the year ended March 30, 1996. NOTE 2 - Acquisitions Sattel Communications In November 1994, the Company and Sattel Technologies, Inc. ("STI") entered into a general partnership agreement to establish Sattel, which was subsequently converted into a limited liability corporation. The Company and STI each received a 50% interest in Sattel. Profits and losses were allocated equally among the two partners. Under the terms of this agreement, initial contributions to be made to the partnership by the Company were operating capital and the cost of a marketing study which in the aggregate would not exceed $200,000. In addition, the Company agreed to prepare a business plan and arrange for ongoing product production if the partners approved the marketing plan. STI agreed to develop, design and test a telecommunications product, manufacture three units, provide administrative services and provide the use of its facilities to Sattel until permanent facilities were determined. In addition, STI agreed to contribute to the partnership certain technology and other intangibles. On January 16, 1996, the Company acquired an additional 30% ownership interest in Sattel. The acquisition was accounted for as a purchase of a minority interest. As a result, the Company increased its ownership interest in Sattel from 50% to 80%. The Company issued 350,000 shares of its newly issued common stock ("the Diana Shares") to STI in connection with the transaction. The value assigned to the Diana Shares was $4,944,000, or $14.125 per share, based on the average closing market price of the Company's common stock from January 12, 1996 through January 18, 1996. In addition, the Company agreed to provide Sattel with additional cash to increase its capital contributions to Sattel to $2.5 million and to loan Sattel $1.425 million. The total purchase price related to the Company's additional 30% interest in Sattel, including the 350,000 shares issued, the minority partner's share of additional equity contributions, liabilities assumed and costs of the acquisition, was allocated based on the fair value of assets acquired at the acquisition date, consisting principally of intellectual property rights of approximately $5.1 million. 31 On May 3, 1996, the Company and STI entered into a Supplemental Agreement to amend the Exchange Agreement entered into on January 16, 1996. STI agreed to convey to the Company an additional 15% of Sattel and 50,000 Diana Shares in exchange for being released from certain product development obligations and STI's proportionate share of a $10 million capital contribution to Sattel. In May 1996, the Company contributed $10 million to Sattel pursuant to the Supplemental Agreement. This transaction will result in a net reduction of approximately $1,825,000 of intangible assets recorded at March 30, 1996. In addition, subsequent to March 30, 1996, Sattel granted equity participation interests to certain employees of the Company. The Company's effective ownership of Sattel remains at approximately 80% after the grant of these interests. STI's effective ownership interest in Sattel was reduced to approximately 4% as a result of all of these transactions. Sattel has an option to purchase the equity participation interests in the event of the employee's termination from the Company. The purchase price of the equity participation interest will either be an agreed upon amount or a price determined by an appraiser. In addition, certain holders of equity participation interests have the right to require an initial public offering of Sattel ("IPO") provided Sattel's cumulative pretax income for four consecutive quarters has been at least $15 million. A minimum of three holders of equity participation interests holding at least 25% of the profit interest units are required to provide written notice to Sattel of a request for an IPO. Sattel may redeem the equity participation interests held by holders requesting an IPO in lieu of an IPO. The redemption price will either be an agreed upon amount or a price determined by an appraiser. No compensation expense will be recognized upon the granting of the equity interests. The estimated fair value of the equity participation interests at the date of grant is considered immaterial to the financial statements based on the subordinated nature of the interests resulting from the priority distributions payable to Sattel Communications Corp. in accordance with the Sattel Communications LLC operating agreement. Compensation expense will be recognized prospectively when it becomes probable that an initial public offering by Sattel or other defined triggering event will occur. Compensation cost will be charged to expense over the period from the date the triggering event becomes probable to the date the equity interest become convertible or the end of the required service period, whichever occurs first. If Sattel exercises its option to repurchase equity interests previously granted upon termination of the employee(s) or in lieu of initiating an initial public offering of Sattel, total compensation cost will be equal to the cash paid upon repurchase. 32 NOTE 2 - Acquisitions Valley On November 20, 1995, C&L Acquisition Corporation, a subsidiary of C&L, acquired 80% of the common stock of Valley from Henry P. Mutz, Christopher M. O'Connor and Kenneth R. Hurst (collectively, the "Minority Shareholders") for approximately $4,320,000 (including expenses) and future consideration. The terms of the future consideration payable to the Minority Shareholders are as follows: (1) For the year ended August 31, 1996 - 100% of Valley's pretax earnings as defined in the purchase agreement in excess of $1,300,000; (2) For the 7 months ended March 31, 1997 - 50% of Valley's pretax earnings in excess of $758,000, and (3) For the years ended March 31, 1998, 1999, 2000 and 2001 - 50% of Valley's pretax earnings in excess of $1,300,000. The Company will account for any future consideration with respect to the acquisition of Valley as an adjustment to the purchase price of Valley in accordance with EITF 95-8. Funding for the acquisition was obtained from cash, revolving line of credit draws and a loan of $1,000,000 from the Minority Shareholders (see Note 5). The acquisition was accounted for as a purchase. The cost of the acquisition exceeded the fair value of the net assets of Valley by approximately $2,936,000. The excess is being amortized on the straight line method over 40 years. Valley is one of the largest network installation and service companies in California. Valley has a first right of refusal on the sale of stock by a Minority Shareholder (except for a sale to a permitted transferee). Generally, the stock shall be offered to Valley upon the same terms and conditions as offered to the prospective purchaser except that the offering price of the stock shall be the proposed sale price or 75% of the appraised value of the shares as defined in the Stockholders Agreement, whichever is less. The Minority Shareholders have the option, exercisable at any time during the Put Period, as defined below, upon the delivery of a written notice to Valley, to require that Valley purchase from the Minority Shareholders the number of shares specified in the notice at a price equal to the appraised value of the shares as defined in the Stockholders Agreement. The redemption price shall be paid in cash at closing. The term "Put Period" as used herein shall mean the period of time commencing on the fifteenth day after receipt by the Minority Shareholders of Valley's audited financial statements for the fiscal year ended March 31, 2000, and expiring thirty days after receipt by the Minority Shareholders of Valley's audited financial statements for the fiscal year ended March 31, 2004. The Minority Shareholders have the option to require Valley to purchase the remainder of a Minority Shareholder's ownership interest upon death or disability (incapacitation for 90 days in any 12-month period) of a Minority Shareholder. In addition, if a Minority Shareholder is terminated by Valley for certain causes as defined in the Employment Contract, the Minority Shareholder has the option to require Valley to purchase 50% of the Minority Shareholder's ownership interest on the date of termination and 50% on November 20, 2000. The purchase price of the shares acquired by Valley pursuant to this paragraph shall be equal to the appraised value of the shares based on a multiple of earnings as defined in the Employment Contract. 33 NOTE 2 - Acquisitions (Continued) The Company will account for any stock acquired by Valley pursuant to the provisions discussed in the above three paragraphs by the purchase method of accounting for the acquisition of minority interest in accordance with Accounting Interpretation No. 26 of APB 16. Shareholders of Valley owning 10% or more of the outstanding common stock of Valley shall have the right to require Valley to pay annual dividends in the amount of the lesser of $1,300,000 (prorated for any period less than one fiscal year) or the After-Tax Operating Profit of Valley for such period, provided, however, that such dividend payment (i) does not reduce the net worth of Valley below $1,400,000, (ii) does not render Valley insolvent or otherwise impair its capital, (iii) does not violate any agreement with creditors of Valley, and (iv) does not contravene otherwise applicable laws. Valley may sell subordinated notes ("Sub-Debt") due in five (5) years and bearing interest at twenty-five percent (25%) per annum with interest payments due quarterly not to exceed the amount of dividends paid by Valley after November 20, 1995. The Sub-Debt shall be offered to all stockholders of Valley in proportion to their percentage ownership of the stock of Valley, provided, however, that if any stockholder declines to purchase any sub-debt, the sub-debt shall be offered to all stockholders who purchased sub-debt in proportion to their relative holdings of stock of Valley. The following unaudited pro forma results of operations for the fifty two weeks ended March 30, 1996 and April 1, 1995, respectively, assume the acquisitions of Valley and Sattel occurred at the beginning of each period (with respect to Sattel in 1995, since its inception in November 1994) (in thousands, except per share amounts): 1996 1995 Net sales $ 297,307 $ 264,087 ======= ======= Net loss $ (3,312) $ (157) ======= ======= Loss per common share $ (.75) $ (.04) ======= ======= This pro forma information does not purport to be indicative of the results that actually would have been obtained if the combined operations had been conducted during the periods presented and is not intended to be a projection of future results. NOTE 3 - Marketable Securities Effective April 2, 1994, the Company adopted the provisions of SFAS No. 115. In accordance with SFAS No. 115, prior period financial statements have not been restated to reflect the change in accounting principle. The effect as of April 2, 1994 of adopting SFAS No. 115 increased net earnings by $412,000 or $.10 per fully diluted share. 34 NOTE 3 - Marketable Securities (Continued) The following is a summary of available-for-sale and held-to-maturity marketable securities (in thousands): Available-for-Sale Marketable Securities March 30, 1996 ------------------------------------------ Gross Gross Estimated Unrealized Unrealized Fair Cost Gains Losses Value ---- --------- --------- ------- Debt securities $ 303 $--- $ 12 $ 291 Equity securities 1,788 --- 864 924 ------ --- ---- ------ $ 2,091 $--- $ 876 $ 1,215 ====== === ==== ====== Available-for-Sale Marketable Securities April 1, 1995 ------------------------------------------ Gross Gross Estimated Unrealized Unrealized Fair Cost Gains Losses Value ---- --------- --------- ------- Debt securities $ 1,156 $ 21 $ 58 $ 1,119 Equity securities 1,604 --- 676 928 ------ --- ---- ------ $ 2,760 $ 21 $ 734 $ 2,047 ====== === ==== ====== Held-to-Maturity Marketable Securities April 1, 1995 ------------------------------------------ Gross Gross Estimated Unrealized Unrealized Fair Cost Gains Losses Value ---- --------- --------- ------- U.S. treasury security $ 4,164 $--- $ --- $ 4,164 ====== === ==== ====== The gross realized gains on sales of available-for-sale securities totaled $31,000, $14,000 and $592,000 in fiscal 1996, 1995 and 1994, respectively, and the gross realized losses totaled $5,000, $1,241,000 and $113,000 in fiscal 1996, 1995 and 1994, respectively. The net adjustment to unrealized losses on available-for-sale securities included as a separate component of shareholders' equity totaled $876,000 and $713,000 at March 30, 1996 and April 1, 1995, respectively. The Company considers its marketable securities to be primarily a resource for potential acquisitions. Pending such uses, the Company invests its marketable securities for the purpose of generating additional income and/or capital appreciation. The Company does not limit its potential investments of marketable securities based on level of risk or investment concentration. 35 NOTE 3 - Marketable Securities (Continued) Expected maturities of marketable securities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. The amortized cost and estimated fair value of marketable securities at March 30, 1996, by contractual maturity, are shown below (in thousands): Available-for-Sale Securities ----------------------------- Estimated Cost Fair Value ---- ---------- Due after five years $ 303 $ 291 Equity securities 1,788 924 ------ ------ $ 2,091 $ 1,215 ====== ====== NOTE 4 - Revolving Line of Credit Revolving line of credit consists of the following (in thousands): 1996 1995 APC $2,996 $4,241 C&L 2,996 2,562 Valley 1,046 --- ----- ----- $7,038 $6,803 ===== ===== APC has a Loan and Security Agreement ("APC Revolver") with a lender (amended for the seventh time effective June 27, 1996) providing a revolving line of credit through November 1997 of up to $9,500,000 with interest at the prime rate plus 2.0% (prime was 8.25% at March 30, 1996). A $2 million letter of credit facility with fees of 2.0% is included within the total credit facility. At March 30, 1996, APC borrowed $2,996,000 and had letters of credit of $2,000,000 issued on its behalf by the lender. Borrowings under the APC Revolver are restricted based on defined percentages of eligible accounts receivable and inventories. The amount available under the APC Revolver at March 30, 1996 was $3,754,000. APC pays a fee of 1/2% on the average unused line of credit. Substantially all assets of APC are pledged as collateral under the APC Revolver. The APC Revolver restricts APC in a number of areas, including, but not limited to, declaration of dividends, mergers and acquisitions, transactions with affiliates, capital expenditures and additional indebtedness. APC's Revolver contains financial covenants requiring a minimum level of tangible net worth, earnings and net cash flow. At March 30, 1996 APC failed to satisfy the earnings covenant. In June 1996, APC and its lender entered into a waiver and amendment agreement relating to the APC Revolver in order to avoid violating certain financial covenants at March 30, 1996 and in fiscal 1997. Because the APC Revolver provides for repayment of borrowings after a 90 day notice from the lender, the indebtedness is classified as short term. 36 NOTE 4 - Revolving Line of Credit (Continued) C&L has a Loan and Security Agreement ("C&L Revolver") with a lender (amended for the first time effective June 27, 1996) providing a revolving line of credit through January 1999 of up to $6,000,000, with interest at the prime rate or LIBOR plus 2.25%. In addition, there is an unused line fee of .25%. Borrowings under the C&L Revolver are restricted based on defined percentages of eligible accounts receivable and inventories. The amount available under the C&L Revolver at March 30, 1996, was $803,000. Substantially all assets of C&L are pledged as collateral under the C&L Revolver. The C&L Revolver restricts C&L in a number of areas, including, but not limited to, declaration of dividends, payment of salaries to officers, mergers and acquisitions, transactions with affiliates, capital expenditures and additional indebtedness. C&L's Revolver contains financial covenants requiring minimum levels of tangible net worth and pretax income computed on a rolling 12-month basis, a minimum ratio of current assets to current liabilities and a maximum ratio of total liabilities to tangible net worth. At March 30, 1996, C&L failed to satisfy the pretax income requirement. In June 1996, C&L and its lender entered into a waiver and amendment agreement to the C&L Revolver in order to avoid violating certain financial covenants at March 30, 1996 and in fiscal 1997. Valley has a Loan and Security Agreement ("Valley Revolver") with a lender providing a revolving line of credit through March 1999 of up to $2,500,000 with interest at the prime rate or LIBOR plus 2.25%. In addition, there is an unused line fee of .25%. Borrowings under the Valley Revolver are restricted based on defined percentages of eligible accounts receivable and inventories. The amount available under the Valley Revolver at March 30, 1996 was $1,206,000. Substantially all assets of Valley are pledged as collateral under the Valley Revolver. The Valley Revolver provides for the maintenance of certain financial ratios and restricts Valley in a number of areas including, but not limited to, declaration of dividends, payments of salaries to officers, mergers and acquisitions, transactions with affiliates, capital expenditures and additional indebtedness. At March 30, 1996, the Company classified all borrowings made by C&L and Valley under their respective revolving lines of credit as current liabilities in accordance with EITF 95-22. These revolving lines of credit have 3 year terms expiring in fiscal 1999. C&L's borrowings under its revolving line of credit at April 1, 1995 have been classified as a current liability for consistent presentation. 37 NOTE 5 - Long-Term Debt Long-term debt consists of the following (in thousands): March 30, April 1, Note Due Date 1996 1995 ---- ------------ ----------- ---------- Debentures and interest A January 2002 $ 2,099 $ 2,240 Note payable B October 2000 1,000 --- Mortgage notes C August 2006 837 875 Notes payable D May 1998 70 158 Other obligations --- 34 ------ ------ 4,006 3,307 Less current portion (444) (326) ------ ------ $ 3,562 $ 2,981 ====== ====== A. Principal of $1,254,000 and capitalized interest of $845,000. Interest at 11.25%. The debentures are unsecured. The payment of cash dividends by the Company is restricted by the Company's subordinated debentures which provide that the consolidated tangible net worth of the Company cannot be reduced to less than an amount equal to the aggregate principal amount of the subordinated debentures, or $1,254,000. B. Note payable to the minority shareholders of Valley collateralized by the common stock of Valley owned by the Company (see Note 2). Interest at 10%. C. Interest at 7% and 8.25%. The mortgage notes are collateralized by land and building with a carrying value of $2,627,000 as of March 30, 1996. D. Interest at 8.75% - 11.0%. The notes are collateralized by equipment. Approximate annual amounts payable by the Company and its subsidiaries on long-term debt are as follows (in thousands): 1997 .................... $ 444 1998 .................... 403 1999 .................... 397 2000 .................... 399 2001 .................... 404 Thereafter .............. 1,959 ------ $ 4,006 ====== NOTE 6 - Commitments and Contingencies The Company and its subsidiaries lease various facilities and equipment under noncancelable lease arrangements for varying periods. Leases that expire generally are expected to be renewed or replaced by other leases. Total rental expense (including contingent rentals) under operating leases in fiscal 1996, 1995 and 1994 was $2,090,000, $1,870,000 and $1,929,000, respectively. 38 NOTE 6 - Commitments and Contingencies (Continued) Future minimum payments (excluding contingent rentals) under noncancelable operating leases with initial terms of one year or more for fiscal years subsequent to March 30, 1996 are as follows (in thousands): 1997 .................... $ 1,094 1998 .................... 751 1999 .................... 567 2000 .................... 393 2001 .................... 300 Thereafter .............. 11 ------ $ 3,116 ====== C&L participates in an equipment leasing partnership. C&L is subject to a contingent obligation relating to the equipment lease of approximately $386,000 at March 30, 1996, if income from the underlying lease is insufficient to fund future operations of the partnership. The lease for equipment expires in January 1999. The prior owners of C&L have indemnified the Company with respect to any future obligations. 39 NOTE 7 - Stock Options In fiscal 1986, the Company's Board of Directors adopted The Diana Corporation 1986 Nonqualified Stock Option Plan (the "Plan"), which permits the Company to grant nonqualified stock options to key employees and directors of the Company and its subsidiaries. The Plan is limited to 775,609 common shares. The Plan is administered by the Company's Board of Directors, which is authorized, among other things, to determine which persons receive options under the Plan, the number of shares for which an option may be granted, and the exercise price and expiration date for each option. Options granted under the Plan may not be exercised after eleven years from the date of grant, and no options may be granted after December 10, 1997. The exercise price will not be less than the fair market value of the Company's common stock on the date of grant, although the Board has discretion to set the exercise price at any amount that it may establish from time to time. Transactions for fiscal 1996, 1995 and 1994 are as follows: 1996 1995 1994 Options outstanding at beginning of year 566,976 544,264 533,110 Changes during year: 5% stock dividend 31,482 27,212 26,654 Options granted 85,000 --- --- Options exercised (12,300) (4,500) (15,500) ------- ------- ------- Net increase 104,182 22,712 11,154 ------- ------- ------- Options outstanding at end of year 671,158 566,976 544,264 ======= ======= ======= Options exercisable 661,158 566,976 544,264 Option price range $2.05- $20.00 In March 1996, the Company's Board of Directors adopted the Sattel Communications LLC Employees Nonqualified Stock Option Plan (the "Sattel Plan"), which permits the Company to grant nonqualified stock options for the Company's common stock to key employees and directors of Sattel. The Plan is limited to 500,000 shares of the Company's common stock. The Sattel Plan is administered by the Company's Board of Directors, which is authorized, among other things, to determine which persons receive options under the Sattel Plan, the number of shares for which an option may be granted, and the exercise price and expiration date for each option. Options granted under the Sattel Plan may not be exercised after eleven years from the date of grant, and no options may be granted after March 8, 2007. The exercise price will not be less than the fair market value of the Company's common stock on the date of grant, although the Board has discretion to set the exercise price at any amount that it may establish from time to time. 40 NOTE 7 - Stock Options (Continued) In March 1996, stock options for 300,000 shares of the Company's common stock were granted under the Sattel Plan at an exercise price of $20.00 per share . These options, if vested, may be exercised any time between March 31, 1999 and March 31, 2001. The stock options shall vest as follows: (a) 100,000 option shares vest if Sattel's pretax earnings for the fiscal year ending March 31, 1997 exceeds $15 million, (b) 100,000 option shares vest if Sattel's pretax earnings for the fiscal year ending March 31, 1998 exceeds $22.5 million (whether or not the conditions in (a) are satisfied), and (c) 100,000 option shares vest if Sattel's pretax earnings for the fiscal year ending March 31, 1999 exceeds $33.75 million (whether or not the conditions in (a) or (b) are satisfied), provided that, in each case, the grantee is employed by Sattel on March 31, 1999. Notwithstanding the foregoing, if Sattel's pretax earnings for the fiscal year ending March 31, 1997 is between $10 million and $15 million, the option shall vest with respect to 100,000 option shares referred to in (a) in the previous paragraph, if Sattel pretax earnings for the fiscal year ending March 31, 1998 exceeds $22.5 million, provided the grantee is employed by Sattel on March 31, 1999. NOTE 8 - Employee Benefit Plans APC contributes to a multiemployer defined benefit pension plan pursuant to the terms of a collective bargaining agreement. Amounts contributed to this plan by APC were $25,000, $34,000 and $39,000, for fiscal years 1996, 1995 and 1994, respectively. Certain subsidiaries offer qualified employees the opportunity to participate in 401(k) plans. The Company accrued $15,000 for matching contributions in fiscal 1996. There were no contributions under these plans for any other year presented. NOTE 9 - Other Income (Loss) Other income (loss) consists of the following for the last three fiscal years (in thousands): 1996 1995 1994 Interest income........................... $ 326 $ 570 $2,132 Net gains (losses) on sales of marketable securities (See Note 3)................. 26 (1,227) 479 Other - net............................... 167 240 86 ----- ------ ----- $ 519 $ (417) $2,697 ===== ====== ===== 41 NOTE 10 - Income Taxes Effective April 4, 1993, the Company adopted the liability method of accounting for income taxes in accordance with SFAS No. 109. The cumulative effect as of April 4, 1993 of adopting SFAS No. 109 increased net earnings for fiscal 1994 by $262,000. A reconciliation of the income tax provision and the amount computed by applying the statutory federal income tax rate (34%) to earnings (loss) before extraordinary items, accounting change, minority interest and income tax credit (expense) is as follows (in thousands): Fiscal Year Ended March 30, April 1, April 2, 1996 1995 1994 Expense (credit) at statutory rate......... $(1,181) $ (230) $ 1,138 Write-off of goodwill...................... 290 --- --- Settlements of liabilities of unconsolidated subsidiary................ (156) (36) (1,357) Reversal of liabilities of unconsolidated subsidiary............................... --- --- (71) Tax effect of net operating loss not benefited................................ 918 198 180 Other, net................................. 216 68 110 ------ ------ ------ Income tax provision....................... $ 87 $ --- $ --- ====== ====== ====== In fiscal 1996, the Company recorded income tax expense of $87,000 primarily attributable to state income taxes of a subsidiary. In fiscal 1994, the Company recorded an income tax credit of $400,000 resulting from the refund of federal income taxes paid in a prior year. 42 NOTE 10 - Income Taxes (Continued) Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and income tax purposes. Components of the Company's deferred tax assets and liabilities are as follows (in thousands): March 30, April 1, 1996 1995 Deferred tax assets: Federal net operating loss carryforwards $ 7,830 $ 6,809 Federal capital loss carryforward 408 417 State net operating loss carryforwards 2,436 2,247 Capitalized interest on Diana debentures 338 394 Deferred compensation 460 530 Allowance for doubtful accounts 278 225 Intangible assets (net) --- 227 General business credit carryforwards 145 145 All other 532 461 ------- ------- Total deferred tax assets 12,427 11,455 Valuation allowance for deferred tax assets (9,366) (10,279) ------- ------- Net deferred tax assets 3,061 1,176 Deferred tax liabilities: Intangible assets (net) 1,949 --- Building and improvements basis difference 494 523 Tax over book depreciation 245 263 All other 373 390 ------- ------- Total deferred tax liabilities 3,061 1,176 ------- ------- Net deferred taxes $ --- $ --- ======= ======= The Company has approximately $23,000,000 and $31,250,000 in federal and state net operating loss carryforwards, respectively. These carryforwards expire at various dates through fiscal 2011. NOTE 11 - Equity in Earnings (Loss) of Unconsolidated Subsidiaries Prior to the Company's acquisition of an additional 30% interest in Sattel in January 1996 (see Note 2), the Company accounted for its 50% ownership interest in Sattel under the equity method of accounting. The Company's proportionate share of Sattel's loss from April 2, 1995 to December 31, 1995 was $393,000. APC has a 50% ownership interest in Fieldstone Meats of Alabama, Inc. ("Fieldstone"), a company which produces cured hams and bacon. Diana owns a 50% interest in a partnership that holds promissory notes, secured by inventory and equipment, due over a five year period which substantially ended in fiscal 1996. At March 30, 1996 and April 1, 1995, the carrying value of the Company's investment in unconsolidated subsidiaries was $312,000 and $557,000, respectively, and is included within other assets. 43 NOTE 11 - Equity in Earnings (Loss) of Unconsolidated Subsidiaries (Continued) The Company's equity in the earnings (loss) of unconsolidated subsidiaries for the last three fiscal years are as follows (in thousands): 1996 1995 1994 Sattel $(393) $ (62) $ --- Fieldstone 7 (35) 48 Partnership 16 28 49 ---- ---- ---- $(370) $ (69) $ 97 ==== ==== ==== NOTE 12 - Extraordinary Items Carl and Dorothy Ossmann, Mary Leach, Wilmer and Florence Tiede, and Rosemary and Ray Ward V. The Diana Corporation, Donald E. Runge and Richard Y. Fisher (the "Ossmann Suit"), and First Trust National Association and Norwest Bank Minnesota V. Farm House Foods Corporation and The Diana Corporation (the "First Trust Suit"). In March 1994, the remaining parties to the Ossmann Suit and the First Trust Suit entered into an Amended Memorandum of Understanding (the "Settlement") providing for settlement of the matter. In fiscal 1995, the defendants made total payments of $3,237,000 to the trustees pursuant to the Settlement as full and complete payment of all amounts due, including principal and accrued interest with a carrying value of $3,391,000 and trustee fees and costs. In addition, a payment of $180,000 was made to the attorneys of the class pursuant to the Settlement. The Company accounted for the Settlement in accordance with SFAS No. 76, "Extinguishment of Debt" and recorded an extraordinary loss, including the direct costs of settlement, of $266,000 in fiscal 1994. The amounts included in extraordinary item are not net of taxes due to the existence of net operating loss carryforwards (see Note 10). NOTE 13 - Related Party Transactions Certain of the Company's non-employee directors provide services to the Company and/or its subsidiaries for which they are compensated. Amounts accrued or paid to all directors for these services during fiscal 1996, 1995 and 1994 are $63,000, $367,000 and $329,000, respectively. Included in other assets is a receivable of $324,000 from the sellers of C&L. Pursuant to the Stock Purchase Agreement executed in connection with the acquisition of C&L, the sellers are to reimburse the Company for any of the Company's net operating losses used to offset taxable income generated by certain investments owned by C&L. The sellers are currently employees of C&L. C&L leases its building and certain vehicles from certain employees of C&L. Total rent expense on such leases was $143,000, $144,000 and $141,000 for the years ended March 30, 1996, April 1, 1995 and April 2, 1994, respectively. Effective June 1994, the Company acquired the remaining 20% of C&L's common stock from its minority shareholders in exchange for 265,262 shares (adjusted for the 5% stock dividend paid in July 1994) of the Company's common stock. 44 NOTE 14 - Business Segment Information The Company operates in the following business segments: the wholesale distribution of meat and seafood, telecommunications equipment and voice and data network installation and service. The wholesale distribution of meat and seafood segment consists of APC. In fiscal 1996, APC had one customer that comprised 24.9% of its net sales and 21.9% of consolidated net sales. The telecommunications equipment segment consists of the Company's 80%-owned subsidiary, Sattel, and C&L. The voice and data network installation and service segment consists of the Company's 80%-owned subsidiary, Valley, which was acquired in November 1995. The operating results of Sattel and Valley have been consolidated since their respective acquisition dates in fiscal 1996 (see Note 2). There are no material export sales. Information by industry segment is as follows (in thousands):
Fiscal Years Ended ------------------------------ March 30, April 1, April 2, 1996 1995 1994 -------- -------- -------- Net sales: Meat and seafood................. $236,108 $215,141 $215,333 Telecommunications equipment..... 25,350 35,245 28,308 Network installation and service. 6,144 --- --- ------- ------- ------- $267,602 $250,386 $243,641 ======= ======= ======= Operating earnings (loss): Meat and seafood................. $ (306) $ 234 $ 1,013 Telecommunications equipment..... (816) 2,734 2,549 Network installation and service. 652 --- --- Corporate........................ (1,566) (2,511) 879 ------- ------- ------- $ (2,036) $ 457 $ 4,441 ======= ======= ======= Depreciation and amortization: Meat and seafood................. $ 639 $ 605 $ 551 Telecommunications equipment..... 695 524 496 Network installation and service. 73 --- --- Corporate........................ 34 25 51 ------- ------- ------- $ 1,441 $ 1,154 $ 1,098 ======= ======= ======= Capital expenditures: Meat and seafood................. $ 408 $ 474 $ 655 Telecommunications equipment..... 241 113 217 Network installation and service. 22 --- --- Corporate........................ 25 12 3 ------- ------- ------- $ 696 $ 599 $ 875 ======= ======= ======= Identifiable assets: Meat and seafood................. $ 18,048 $ 20,569 $ 21,329 Telecommunications equipment..... 21,702 16,720 18,109 Network installation and service. 7,881 --- --- Corporate........................ 5,902 8,038 14,605 ------- ------- ------- $ 53,533 $ 45,327 $ 54,043 ======= ======= =======
45 NOTE 15 - Statement of Cash Flows Supplemental cash flow information is as follows for the last three fiscal years (in thousands): 1996 1995 1994 Change in current assets and liabilities: Receivables......................... $ 2,066 $ 189 $(3,797) Inventories......................... 1,845 3,204 (4,760) Other current assets................ 292 168 (218) Accounts payable.................... (1,420) 718 4,287 Other current liabilities........... (589) 135 133 ------ ------ ------ $ 2,194 $ 4,414 $(4,355) ====== ====== ====== Supplemental information: Interest paid......................... $ 1,002 $ 1,001 $ 1,090 Non-cash transactions: Purchase of minority interest with common stock......................... 4,944 1,895 --- Reduction of net liabilities of unconsolidated subsidiary............ 219 --- 655 Purchase of subsidiary financed by seller............................... 1,000 --- --- Purchase of property and equipment financed by seller................... --- --- 320 NOTE 16 - Quarterly Results of Operations (Unaudited) Fiscal Year Ended March 30, 1996 (in thousands, except per share amounts): 12 Weeks 12 Weeks 12 Weeks 16 Weeks Ended Ended Ended Ended March 30, January 6, October 14, July 22, 1996 1996 1995 1995 Net sales....................... $64,110 $61,111 $60,828 $81,553 Cost of sales................... 60,834 58,658 58,497 78,931 Net earnings (loss)............. (2,512) (598) 146 (401) Earnings (loss) per common share (.54) (.14) .03 (.09) As a result of recent efforts to sell APC, the Company has concluded there has been a decrease in the market value of APC. During the fourth quarter of fiscal 1996, the Company concluded that an impairment of goodwill has occurred and wrote off the remaining goodwill of $852,000 resulting from the acquisition of APC. 46 NOTE 16 - Quarterly Results of Operations (Unaudited) (Continued) Fiscal Year Ended April 1, 1995 (in thousands, except per share amounts): 12 Weeks 12 Weeks 12 Weeks 16 Weeks Ended Ended Ended Ended April 1, January 7, October 15, July 23, 1995 1995 1994 1994 Net sales....................... $64,223 $55,159 $56,255 $74,749 Cost of sales................... 62,218 52,274 53,059 71,647 Net earnings (loss)............. (749) 392 424 (787) Earnings (loss) per common share (.17) .09 .09 (.20) NOTE 17 - Subsequent Event In April 1996, the Company raised approximately $14 million, after commissions and expenses, through the sale of 430,000 shares of common stock. In June 1996, Concentric Network Corporation ("CNC") executed a Promissory Note for $5,000,000 in favor of Sattel due September 30, 1996 which is convertible into CNC Series D Preferred Stock ("CNC Stock") under certain conditions outlined in the Note. In addition, CNC granted to Sattel a warrant to purchase 551,470 shares of CNC Stock at an exercise price of $1.36 per share as additional consideration for the loan to CNC. The warrant is exercisable immediately and expires on June 6, 1999. On September 3, 1996, the Board of Directors of the Company declared a 5% stock dividend which was paid on October 2, 1996 to shareholders of record on September 16, 1996. Per share amounts in the accompanying financial statements have been restated for the stock dividend. Note 18 - Subsequent Event (Unaudited) On August 12, 1996, all negotiations and agreements with third parties concerning the proposed sale of APC were terminated. In August 1996, the Promissory Note and accrued interest receivable were converted into 3,729,110 shares of CNC Series D Preferred Stock. In September 1996, Sattel sold to a third party 1,838,234 shares of its CNC Series D Preferred Stock for $2.5 million. 47 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K Form 10-K (a) Financial Statements and Financial Statement Schedules Page Number (1) The following consolidated financial statements of The Diana Corporation and its subsidiaries are included in Item 8: Report of Price Waterhouse LLP, Independent Accountants 20 Report of Ernst & Young LLP, Independent Auditors 21 Consolidated Balance Sheets - March 30, 1996 and April 1, 1995 22 Consolidated Statements of Operations - Fiscal Years Ended March 30, 1996, April 1, 1995 and April 2, 1994 23 Consolidated Statements of Changes in Shareholders' Equity - Fiscal Years Ended March 30, 1996, April 1, 1995 and April 2, 1994 24 Consolidated Statements of Cash Flows - Fiscal Years Ended March 30, 1996, April 1, 1995 and April 2, 1994 25 Notes to Consolidated Financial Statements 26 (2) The following consolidated financial statement schedules of The Diana Corporation are included in Item 14(d): Schedule I - Condensed Financial Information of Registrant 50 Schedule II - Valuation and Qualifying Accounts 54 All other schedules are omitted because the required information is not present or is not present in amounts sufficient to require submission of the schedules or because the information required is included in the consolidated financial statements or the notes thereto. (b) Reports on Form 8-K: During the last quarter of fiscal 1996, the Company filed (1) a Form 8-K on January 31, 1996 regarding its increased ownership interest in Sattel from 50% to 80%; (2) a Form 8-K/A on January 31, 1996 to amend the Form 8-K filed on December 5, 1995; (3) a Form 8-K on March 7, 1996 regarding a change in its certifying accountant; (4) a Form 8-K/A on March 8, 1996 to amend the Form 8-K filed on March 7, 1996; and (5) a Form 8-K on March 19, 1996 related to the sale of APC. 48 (c) Exhibits Exhibit Number Description 3.1 Restated Certificate of Incorporation, as amended September 1, 1992 (incorporated herein by reference to Exhibit 3.1 of Registrant's Form 10-K for the year ended April 3, 1993). 3.2 By-Laws of Registrant, as amended (April 2, 1991) (incorporated herein by reference to Exhibit 3.2 of the Registrant's Form 10-K for the year ended March 30, 1991). 4.1 Loan and Security Agreement between C&L Communications, Inc. and Sanwa Business Credit dated January 2, 1996 (incorporated herein by reference to Exhibit 10.1 of the Registrant's Registration Statement on Form S-3 Reg. No. 333-1055). 4.2 First Amendment to Loan and Security Agreement and Waiver Agreement between C&L Communications, Inc. and Sanwa Business Credit Corporation dated June 27, 1996. 4.3 Loan and Security Agreement between Barclays Business Credit, Inc. and Atlanta Provision Company, Inc. dated November 24, 1992 (incorporated herein by reference to Exhibit 10.10 of the Registrant's Form 10-Q for the 40 weeks ended January 2, 1993). 4.4 Waiver and First Amendment to Loan and Security Agreement between Atlanta Provision Company, Inc. and Barclays Business Credit, Inc. dated June 25, 1993 (incorporated herein by reference to Exhibit 4.2 of Registrant's Form 10-Q for the period ended July 24, 1993). 4.5 Waiver and Second Amendment to Loan and Security Agreement between Atlanta Provision Company, Inc. and Barclays Business Credit, Inc. dated September 9, 1993 (incorporated herein by reference to Exhibit 4.1 of Registrant's Form 10-Q for the period ended October 16, 1993). 4.6 Waiver and Third Amendment to Loan and Security Agreement between Atlanta Provision Company, Inc. and Barclays Business Credit, Inc. dated June 1, 1994 (incorporated herein by reference to Exhibit 4.8 of Registrant's Form 10-K for the year ended April 2, 1994). 4.7 Waiver and Fourth Amendment to Loan and Security Agreement between Atlanta Provision Company, Inc. and Shawmut Capital Corporation (successor to Barclays Business Credit, Inc.) dated June 28, 1995 (incorporated herein by reference to Exhibit 4.9 of Registrant's Form 10-K for the year ended April 1, 1995). 4.8 Waiver and Fifth Amendment to Loan and Security Agreement between Atlanta Provision Company, Inc. and Shawmut Capital Corporation (successor to Barclays Business Credit, Inc.) dated August 31, 1995 (incorporated herein by reference to Exhibit 4.1 of Registrant's Form 10-Q for the period ended July 22, 1995). 49 Exhibit Number Description 4.9 Waiver and Sixth Amendment to Loan and Security Agreement between Atlanta Provision Company, Inc. and Shawmut Capital Corporation (successor to Barclays Business Credit, Inc.) dated November 28, 1995 (incorporated herein by reference to Exhibit 4.1 of Registrant's Form 10-Q for the period ended October 14, 1995). 4.10 Waiver and Seventh Amendment to Loan and Security Agreement between Atlanta Provision Company, Inc. and Fleet Capital Corporation (successor to Barclays Business Credit, Inc.) dated June 27, 1996. 4.11 Certain other long-term debt as described in Note 5 of Notes to Consolidated Financial Statements. The Registrant agrees to furnish to the Commission, upon request, copies of any instruments defining the rights of holders of any such long-term debt. 10.1 Employment Arrangement between Richard Y. Fisher and the Registrant effective April 4, 1993 and ending April 1, 1995 (incorporated herein by reference to Exhibit 10.12 of Registrant's Form 10-K for the year ended April 3, 1993).* 10.2 Amended and Restated Employment Agreement between Richard Y. Fisher and The Diana Corporation dated April 2, 1995 (incorporated herein by reference to Exhibit 10.2 of Registrant's Form 10-K for the year ended April 1, 1995).* 10.3 Employment Agreement between Donald E. Runge and Farm House Foods Corporation dated October 16, 1987, which was guaranteed by the Registrant on September 29, 1988 (incorporated herein by reference to Exhibit 10.14 of Registrant's Form 10-K for the year ended April 3, 1993).* 10.4 Employment Agreement between Donald E. Runge and The Diana Corporation dated April 2, 1995 (incorporated herein by reference to Exhibit 10.4 of Registrant's Form 10-K for the year ended April 1, 1995).* 10.5 Employment Agreement between Sydney B. Lilly and The Diana Corporation dated April 2, 1995 (incorporated herein by reference to Exhibit 10.5 of Registrant's Form 10-K for the year ended April 1, 1995).* 10.6 Consulting Agreement dated December 23, 1991 and ending December 23, 1996 between C&L Acquisition Corporation and Jack E. Donnelly (incorporated herein by reference to Exhibit 10.11 of Registrant's Form 10-K for the year ended April 3, 1993).* ___________________________________________________________________________ * Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated. 50 Exhibit Number Description 10.7 Amendment to Consulting Agreement between C&L Acquisition Corporation and Jack E. Donnelly dated March 7, 1995 (incorporated herein by reference to Exhibit 10.7 of Registrant's Form 10-K for the year ended April 1, 1995).* 10.8 1986 Nonqualified Stock Option Plan of Registrant as amended (incorporated herein by reference to Exhibit 10.13 of Registrant's Form 10-K for the year ended April 3, 1993).* 10.9 1993 Nonqualified Stock Option Plan of Entree Corporation (incorporated herein by reference to Exhibit 10.12 of Registrant's Form 10-K for the year ended April 2, 1994).* 10.10 Agreement dated May 14, 1995 between Atlanta Provision Company, Inc. and The United Food & Commercial Workers Union Local 1996 (incorporated herein by reference to Exhibit 10.1 of the Registrant's Form 10-Q for the period ended July 22, 1995). 10.11 Purchase Agreement dated August 14, 1995 by and between C&L Acquisition Corporation and Henry Mutz, Chris O'Connor and Ken Hurst (incorporated herein by reference to Exhibit 2.1 of the Registrant's Form 8-K/A dated January 31, 1996). 10.12 Exchange Agreement dated January 16, 1996 by and among The Diana Corporation and Sattel Technologies, Inc. (incorporated herein by reference to Exhibit 10.2 of the Registrant's Registration Statement on Form S-3 Reg. No. 333-1055). 10.13 1996 Sattel Communications LLC Employees Nonqualified Stock Option Plan. 10.14 Agreement Regarding Award of Class B Units between Sydney B. Lilly and Sattel Communications LLC dated April 1, 1996.* 10.15 Memorandum of Understanding between The Diana Corporation, Sattel Communications Corp. and Sattel Technologies, Inc. dated May 3, 1996. 10.16 Second Supplemental Agreement Relating to Joint Venture and Exchange Agreement Reformation between The Diana Corporation, Sattel Technologies, Inc. and D.O.N. Communications Corp. dated May 3, 1996. 10.17 Operating Agreement of Sattel Communications, LLC. 10.18 Amendment to the Operating Agreement of Sattel Communications LLC. 10.19 Second Amendment to the Operating Agreement of Sattel Communications LLC. 11 Computation of Earnings Per Share 51 Exhibit Number Description 22 Subsidiaries of Registrant 23 Consent of Independent Auditors 27 Financial Data Schedule ___________________________________________________________________________ * Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated. 52 THE DIANA CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (In Thousands)
March 30, April 1, 1996 1995 ASSETS Current assets: Cash and cash equivalents........................ $ 3,567 $ --- Marketable securities............................ 1,213 --- Other current assets............................. 201 389 ------ ------ Total current assets........................... 4,981 389 Land and equipment (net)........................... 158 16 Investments in and advances to unconsolidated subsidiaries...................................... 23,536 23,789 ------ ------ $28,675 $24,194 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable................................. $ 177 $ --- Accrued liabilities.............................. 638 682 Current portion of long-term debt................ 141 141 ------ ------ Total current liabilities...................... 956 823 Long-term debt..................................... 1,958 2,099 Other liabilities.................................. 1,075 1,543 Shareholders' equity: Common stock..................................... 5,526 4,810 Additional paid-in capital....................... 59,456 48,548 Accumulated deficit.............................. (34,776) (28,178) Unrealized loss on marketable securities......... (876) (713) Treasury stock................................... (4,644) (4,738) ------ ------ Total shareholders' equity..................... 24,686 19,729 ------ ------ $28,675 $24,194 ====== ======
See notes to condensed financial statements and notes to consolidated financial statements. 53 THE DIANA CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Amounts)
Fiscal Year Ended March 30, April 1, April 2, 1996 1995 1994 Other income.......................... $ 774 $ 47 $ 755 Administrative expenses............... (1,878) (1,621) (1,388) Interest expense...................... (106) (112) (119) Non-operating income (expense)........ (50) 199 208 Income tax credit..................... --- --- 400 Equity in earnings (loss) of unconsolidated subsidiaries.......... (2,105) 767 3,601 ------ ------ ------ Earnings (loss) before extraordinary item and accounting change........... (3,365) (720) 3,457 Extraordinary item.................... --- --- (266) ------ ------ ------ Earnings (loss) before accounting change............................... (3,365) (720) 3,191 Cumulative effect of accounting change --- --- 262 ------ ------ ------ Net earnings (loss)................... $(3,365) $ (720) $ 3,453 ====== ====== ====== Earnings (loss) per common share: Primary Before extraordinary item.......... $ (.76) $ (.17) $ .84 Extraordinary item................. --- --- (.06) Accounting change.................. --- --- .06 ------ ------ ------ Net earnings (loss)................ $ (.76) $ (.17) $ .84 ====== ====== ====== Fully diluted Before extraordinary item.......... $ (.76) $ (.17) $ .81 Extraordinary item................. --- --- (.06) Accounting change.................. --- --- .06 ------ ------ ------ Net earnings (loss)................ $ (.76) $ (.17) $ .81 ====== ====== ====== Weighted average number of common shares outstanding Primary............................ 4,401 4,224 4,108 ====== ====== ====== Fully diluted...................... 4,401 4,224 4,255 ====== ====== ======
See notes to condensed financial statements and notes to consolidated financial statements. 54 THE DIANA CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) STATEMENTS OF CASH FLOWS (In Thousands)
Fiscal Year Ended March 30, April 1, April 2, 1996 1995 1994 Operating activities Earnings (loss) before extraordinary items and accounting change..................... $(3,365) $ (720) $ 3,457 Adjustments to reconcile earnings (loss) to net cash used by operating activities: Depreciation & amortization.............. 29 8 10 Equity in (earnings) loss of unconsolidated subsidiaries............. 2,105 (767) (3,601) Non-operating income..................... --- --- (208) Payments of net liabilities of unconsolidated subsidiary............... (242) (95) (361) Changes in current assets and liabilities: Receivables............................ --- 1,374 (1,370) Other.................................. (79) (181) 184 ------ ------ ------ Net cash used by operating activities....... (1,552) (381) (1,889) Investing activities Additions to equipment.................... (25) (11) (3) Purchase of securities.................... (475) --- --- Proceeds of sale of securities............ 5,380 --- --- Changes in investments in and advances to unconsolidated subsidiaries.............. (3,430) 3,475 2,318 ------ ------ ------ Net cash provided by investing activities... 1,450 3,464 2,315 Financing activities Payments on long-term debt................. (141) (261) (261) Issuance of common stock................... 3,485 --- --- Payments toward bond settlements........... --- (2,822) (178) ------ ------ ------ Net cash provided (used) by financing activities................................. 3,344 (3,083) (439) ------ ------ ------ Increase (decrease) in cash................. 3,242 --- (13) Increase in cash resulting from merger with subsidiary................................. 325 --- --- Cash at the beginning of the year........... --- --- 13 ------ ------ ------ Cash at the end of the year................. $ 3,567 $ --- $ --- ====== ====== ====== Supplemental information: Interest paid.............................. $ 106 $ 11 $ 17 Non-cash transactions: Purchase of minority interest with common stock..................................... 4,944 1,895 --- Reduction of net liabilities of unconsolidated subsidiary................. 219 --- 655
See notes to condensed financial statements and notes to consolidated financial statements. 55 THE DIANA CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) NOTES TO CONDENSED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION The condensed financial information of the Registrant includes the accounts of the parent company. In fiscal 1996, the parent's wholly-owned subsidiary, D.O.N., Incorporated was merged into the parent. Substantially all investments in and advances to unconsolidated subsidiaries are eliminated in the consolidated financial statements. In fiscal 1996, other income includes management fees and interest income of $448,000 that is eliminated in the consolidated financial statements. Intercompany profits between related parties are eliminated in these financial statements. NOTE 2 - LONG-TERM OBLIGATIONS Approximate annual amounts due on long-term obligations for the five years subsequent to March 30, 1996 are (in thousands): 1997 $ 141 1998 141 1999 141 2000 141 2001 141 Thereafter 1,394 ----- $2,099 ===== NOTE 3 - COMMITMENTS AND CONTINGENCIES Diana leases its corporate office space under a noncancelable lease with a rental commitment of $36,000 in fiscal 1997. Diana has guaranteed obligations of an unconsolidated subsidiary not to exceed $1,050,000 of which $370,000 was outstanding at March 30, 1996. Subsequent to March 30, 1996, Diana guaranteed the obligations of another unconsolidated subsidiary not to exceed $400,000. Subsequent to March 30, 1996, Diana extended an unsecured line of credit of $1 million at prime plus 2% to an unconsolidated subsidiary. 56 THE DIANA CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Fiscal Year Ended March 30, April 1, April 2, 1996 1995 1994 (In Thousands) Valuation accounts deducted in balance sheet from assets to which they apply: Allowance for doubtful accounts: Balance at beginning of period...... $ 600 $ 517 $ 784 Additions - Charged to costs and expenses..... 519 313 153 Reductions - Accounts written off, net of recoveries....................... (347) (230) (420) ----- ----- ----- Balance at end of period............ $ 772 $ 600 $ 517 ===== ===== ===== Allowance for unrealized losses on inventory: Balance at beginning of period...... $ 189 $ 106 $ 345 Additions - Charged to costs and expenses...... 399 273 123 Reductions - Amounts written off on sale or disposal of inventories........... (185) (190) (362) ----- ----- ----- Balance at end of period............ $ 403 $ 189 $ 106 ===== ===== ===== Allowance for net unrealized losses on current marketable securities: Balance at beginning of period...... $ 713 $ 412 $ --- Addition-charge against shareholders' equity............... 163 301 412 ----- ----- ----- Balance at end of period............ $ 876 $ 713 $ 412 ===== ===== =====
57 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized this 15th day of October, 1996. The Diana Corporation By /s/ R. Scott Miswald Vice President, Treasurer and Controller 58 EXHIBIT 11 THE DIANA CORPORATION AND SUBSIDIARIES COMPUTATION OF EARNINGS (LOSS) PER SHARE
Fiscal Year Ended March 30, April 1, April 2, 1996 1995 1994 (In Thousands, Except Per Share Data) Primary Average shares outstanding............. 4,401 4,224 4,002 Net effect of dilutive stock options - based on the treasury stock method using average market price............ --- --- 106 ------ ------ ------ Total.................................. 4,401 4,224 4,108 ====== ====== ====== Net earnings (loss).................... $(3,365) $ (720) $ 3,453 ====== ====== ====== Per share amount....................... $ (.76) $ (.17) $ .84 ====== ====== ====== Fully diluted Average shares outstanding............. 4,401 4,224 4,002 Net effect of dilutive stock options- based on the treasury stock method using the greater of average market price or year end market price........ --- --- 253 ------ ------ ------ Total.................................. 4,401 4,224 4,255 ====== ====== ====== Net earnings (loss).................... $(3,365) $ (720) $ 3,453 ====== ====== ====== Per share amount....................... $ (.76) $ (.17) $ .81 ====== ====== ======
EXHIBIT 23.1 Consent of Independent Accountants We hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statement on Form S-3 and in the Registration Statement on Form S-8 listed below of The Diana Corporation of our report dated June 27, 1996, except as to the stock dividend described in Note 17 which is as of October 2, 1996, on the financial statements of The Diana Corporation included in this Annual Report on Form 10-K. 1. Registration Statement on Form S-3 (Registration No. 33-88392) 2. Registration Statement on Form S-8 (Registration No. 33-67188) PRICE WATERHOUSE LLP Milwaukee, Wisconsin October 11, 1996 EXHIBIT 23.2 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-67188) pertaining to The Diana Corporation 1986 Nonqualified Stock Option Plan and the Registration Statement (Form S-3 No. 33-88392) of The Diana Corporation and in the related Prospectus of our report dated June 2, 1995, with respect to the consolidated financial statements and schedules of The Diana Corporation included in the Annual Report (Form 10-K/A, Amendment No. 1) for the fiscal year ended March 30, 1996. Milwaukee, Wisconsin ERNST & YOUNG LLP October 11, 1996 EX-10.17 2 OPERATING AGREEMENT OF SATTEL COMMUNICATIONS LLC a California limited liability company THIS OPERATING AGREEMENT is made and entered into as of the 1st day of April, 1996, by and among Sattel Communications Corp., a Nevada corporation ("Sattel") and those individuals entering into Agreements Regarding Award of Class B Units referred to in Section 2.3, below, concurrently with this Agreement. Capitalized terms used herein without definition shall have the meanings assigned thereto in Exhibit A, hereto. WHEREAS, Sattel, in order to encourage certain key employees of Sattel and other key contributing individuals to put forth their best effort for the success of Sattel, wish to give said persons an equity stake in the business; and WHEREAS, it has been determined that the most effective way to achieve this goal is to transfer the assets of Sattel to a newly-formed California limited liability company, Sattel Communication LLC (the "Company"), and to award such persons rights to profits' interests therein subject to certain restrictions. NOW, THEREFORE, in consideration of the mutual promises made herein, the parties hereby agree to manage and operate the Company pursuant to this Agreement as follows: ARTICLE I General Provisions 1.1. Name. The name of the Company is "Sattel Communications LLC." 1.2. Purpose. The purpose of the Company is to engage in any lawful act or activity for which a limited liability company may be organized under the California Act. 1.3. Term. Unless dissolved earlier pursuant to other provisions of this Agreement, the Company shall dissolve on December 31, 2046. 1 1.4. Registered Office and Agent. (a) Initial Office and Agent in California. The Company's registered office shall initially be 9145 Deering Avenue, Chatsworth, California 91311 and the Company's registered agent shall initially be Keith Steffel. (b) Changes. The Board of Directors may from time to time designate a new registered agent and may from time to time change the registered office if the Board of Directors determines such appointment or change to be appropriate. ARTICLE II Capital and Voting 2.1. Units. The equity of the Company shall be divided into Class A Units and Class B Units. Each Class A Unit and Class B Unit shall be entitled to one vote on all matters put to a vote or the consent of the Members. 2.2. Class A Units. In exchange for the Capital Contribution set forth on Exhibit C hereto (subject to assumption by the Company of the liabilities specified in such Exhibit), Sattel will be the holder of 8,000 Class A Units. The execution of documentation effecting such Capital Contribution (subject to assumption of such liabilities) will occur concurrently with the execution of this Agreement (to be signed on behalf of the Company by the Chief Executive Officer of the Company). 2.3. Class B Units. No Capital Contributions shall be required in exchange for Class B Units, except as may be required by the Board of Directors with respect to Class B Units awarded in the future as provided below. Concurrently with the execution of this Agreement, certain individuals are entering into Agreements Regarding Award of Class B Units, having varying terms, under which they are becoming members holding Class B Units and parties to this Agreement. Each such agreement, as well as each future agreement regarding the award of additional Class B Units, will be considered a part of this Agreement, and incorporated herein by reference, with respect to rights and obligations as between the Company and the individual entering into the agreement. The Board of Directors of the Company may in the future award additional Class B Units to key employees of the Company as well as other individuals as determined to be appropriate by the Board of Directors from time to time. Such 2 awards will result in a dilution of the other Members' interests in the Company. 2.4. Return of Capital. No Member is entitled to withdraw from the Company or receive a return of any part of his Capital Contribution, except as expressly provided in this Agreement. No member of the Company has the right to demand that distributions be in kind. 2.5. Additional Capital Contributions. No Member may be required to make additional Capital Contributions. If the Board of Directors determines that the Company needs additional equity capital, each Member shall be entitled to contribute that portion of the required equity capital as equals the percentage of Units which he holds. The Board of Directors may award additional Class A Units in connection with such contributions. Failure to make such contribution will result in a dilution of any non-contributing Member's interest in the Company. 2.6. Members. The members of the company are Sattel, those individuals entering into Agreements Regarding Award of Class B Units referred to in Section 2.3, any other person or entity to whom Class A Units or Class B Units are awarded under this Article II (such person or entity to become a member upon such award), and any successors thereto admitted as members to the Company in accordance with this Agreement. ARTICLE III Capital Accounts 3.1. Capital Accounts. There shall be established and maintained with respect to each Member a capital account ("Capital Account") in accordance with the following: (a) Credits. To each Member's Capital Account there shall be credited such Member's Capital Contributions and such Member's allocable share of Profits pursuant to Article V, below. (b) Debits. To each Member's Capital Account there shall be debited the amount of cash and the Asset Value of any property distributed to such Member and such Member's allocable share of Losses pursuant to Article V, below. (c) Transfers. In the event any Member assigns all or any part of his Units in accordance with the terms of this Agreement, his transferee shall succeed to the Capital 3 Account of the transferor to the extent it relates to the transferred Units. 3.2. Interpretation. The provisions of Section 3.1, above, and the other provisions of this Agreement relating to the maintenance of Capital Accounts are intended to comply with Section 1.704-1(b) of the Treasury Regulations and shall be interpreted and applied in a manner consistent therewith. ARTICLE IV Distributions 4.1. Current Distributions. (a) Current Tax Distributions. To the extent permitted by law and consistent with the Company's obligations to its creditors as determined by the Board of Directors, the Company shall make Tax Distributions on or before the Tax Distribution Dates. The aggregate amount of the Tax Distribution made with respect to any given Tax Distribution Date shall be the product of (i) the estimated federal taxable income of the Company under the provisions of the Code, for the Fiscal Period ending on the last day of the calendar month immediately preceding the Tax Distribu- tion Date and commencing on the first day of the calendar month that includes the immediately previous Tax Distribu- tion Date, multiplied by (ii) the Tax Rate. Notwithstanding the foregoing, to the extent the Company has had an estimated federal taxable loss for any prior Fiscal Period in that Fiscal Year, the amount in clause (i) above shall be reduced by that portion of the loss remaining after reducing taxable income for prior Fiscal Periods in such Fiscal Year for the loss. Each Member shall receive a Tax Distribution proportional with the amount of federal taxable income to be allocated to such Member pursuant to Article V hereof. (b) Additional Tax Distributions. In the event any income tax return of the Company, as a result of an audit or otherwise, reflects items of income, gain, loss, or deduction which are different from the amounts estimated pursuant to Section 4.1(a) above with respect to the Fiscal Year of such return in a manner that results in additional income or gain of the Company being allocated to the Members, an additional Tax Distribution shall be made under the principles of Section 4.1(a) above, except that (i) the last day of the calendar month in which such adjustment occurs shall be treated as a Tax Distribution Date, and (ii) 4 the amount of such additional income or gain shall be treated as the federal taxable income of the Company. (c) Cash Available for Distribution. Upon the approval of the Board of Directors, Cash Available for Distribution shall be distributed to the Members in proportion to the number of Units held by each Member. 4.2. Distributions of Cash Available from a Capital Event. Cash Available from a Capital Event shall be distributed among the Members as follows: (a) First, an amount equal to (or in proportion to if less than) $2,525,253 shall be distributed 99% to the Class A Members and 1% to the Class B Members in proportion to the number of Units held by the respective classes of Members; and (b) The balance, if any, shall be distributed to the Members in proportion to the number of Units held by each Member. 4.3. Liquidating Distribution. In the event the Company is liquidated pursuant to Article IX, below, distribu- tions pursuant to Section 8.3(d), below, shall be distributed to the Members in accordance with their Capital Account balances, after making the adjustments for allocations under Article V, below, up to and including the date of the liquidating distribution. ARTICLE V Allocation of Profits and Losses 5.1. Allocation of Profits. Except as provided in Exhibit D hereto, Profits shall be allocated among the Members in accordance with the following provisions: (a) First, 99% to the Class A Units and 1% to the Class B Units, in proportion to the number of Units held by the respective classes of Members, until the Class A Units have been allocated Profits which equal the sum of (i) the amount of Losses allocated to the Class A Members pursuant to Section 5.2 hereof (expressed as a positive number) and (ii) $2.5 million less (iii) their initial Capital Accounts; and (b) The balance among the Members in proportion to the Units held by each Member. 5 5.2. Allocation of Losses. Except as provided in Exhibit D hereto, Losses shall be allocated among the Members in proportion to the allocation of Profits pursuant to Section 5.1 above, except that to the extent Losses exceed all prior Profits reduced by prior distributions pursuant to Article IV hereof, such Losses shall be allocated among the Members holding Class A Units in proportion to the Units held by each Class A Member, provided, however, that no allocation shall be made to any Member to the extent that such allocation would produce an Adjusted Capital Account Deficit within the meaning of Section 1.704- 1(b)(2)(ii)(d) of the Treasury Regulations. ARTICLE VI Management of the Company 6.1. Authority and Powers of the Board of Directors. (a) Authority. Except as otherwise provided in this Agreement, the Members hereby delegate to the Board of Directors, on behalf of and as agent for the Members, all of the Member's rights and powers to do all acts necessary, convenient or incidental to carrying out the business of the Company. The Board of Directors shall have all of the rights, powers and obligations of the members of a limited liability company, the management of which has been reserved to its members under the California Act. (b) No Other Representatives. Except as other- wise provided in this Agreement, only the Board of Directors, and the Officers acting under its direction, shall have the right, power and authority to act and transact business on behalf of the Company, and no Member, in his capacity as such, shall have the authority to act or transact business on behalf of the Company in any manner. 6.2. Structure of the Board of Directors. (a) Number, Tenure and Qualifications of Direc- tors. The Directors shall be elected by Majority Consent. The number of Directors of the Company shall be eight (8) unless provided otherwise by Majority Consent. Members of the Board of Directors need not be members of the Company. (b) Withdrawal of Director. Unless otherwise provided by Majority Consent, an individual shall cease to be a Director upon the earliest to occur of any of the following: (i) his voluntary resignation, which shall be effective upon delivery of a written notice from him to the 6 Company unless the notice specifies a later effective date; (ii) his removal by Majority Consent; or (iii) his death, incapacity or inability to act as a Director for any reason. (c) Effect of Withdrawal. If a Director ceases to be a Director for any reason, the remaining Director or Directors, if any, shall continue to act as such unaffected thereby. Upon withdrawal of a Director the Members shall, as promptly as practicable, choose a substitute Director as provided in Section 6.2(a), above. If the Company at any time lacks Directors, the Members shall perform the duties of the Board of Directors by Majority Consent unless and until the Members elect by Majority Consent a substitute Director or Directors. The lack of Directors shall not cause a dissolution or termination of the Company. 6.3. Actions by Board of Directors. Any actions of the Board of Directors shall be taken in the manner set forth below. (a) Manner of Acting. The consent of the Direc- tors to any act or failure to act may be given at a meeting in which a majority in number of the Directors participate in person or by telephone or other electronic means. Consent to any act or failure to act shall be deemed given at a meeting of the Board of Directors if approved by the affirmative vote of a majority of the Directors. Alternatively, the Directors may act by unanimous written consent without the need for a meeting. (b) Meetings. Meetings of the Board of Directors may be called by the president of the Company or by any one Director. Meetings not held by electronic means shall be held at the principal place of business of the Company or at such other place as may be designated by a majority in number of the Directors. (c) Voting. Each Director shall be entitled to one vote. Any Director abstaining from voting on a given matter shall be deemed to have voted in the same manner as the majority, if any, of the Directors not abstaining from voting on that issue. Any Director having a personal stake, other than the economic stake inuring to the Director solely as a result of holding Units or of his employer holding Units, in the outcome of an issue, including, but not limited to, a personal stake as a transferor of Units, shall abstain from voting on the issue unless all Directors have such a personal stake. 7 (d) Notice. No matter shall be voted upon at a meeting of the Board of Directors unless at least twenty- four (24) hours notice of such matter is given or such notice is waived by any Director not receiving it. A Direc- tor shall be deemed to have waived notice of any matter acted upon at any meeting he attends or in which he partici- pates unless at the beginning of the meeting or promptly upon commencement of his participation therein he objects to the consideration of such matter because of lack of proper notice. No prior notice shall be required for any action taken by written consent of the Directors. (e) Expenses. All reasonable and customary out- of-pocket expenses incurred by a Director in connection with the Company's business shall be paid by the Company or be reimbursed to the Director by the Company. (f) Emergency Actions. Notwithstanding any other provisions of this Article VI, if Directors who could authorize an action or decision at a duly called meeting reasonably determine, in writing, that the Company is facing a significant business emergency that requires immediate action, those Directors may, without complying with gener- ally applicable procedures for meetings or actions by unanimous consent, authorize any action or decision that they deem reasonably necessary to allow the Company to benefit from a significant opportunity or to protect the Company from significant loss or damage, provided that they make reasonable efforts under the circumstances to contact and consult all Directors concerning the action or decision and the reason why the action or decision must be made without observing generally applicable procedures. 6.4. Officers. (a) Number of Officers. The Officers of the Company may consist of the offices of chief executive officer, president and chief operating officer, one or more vice-presidents, secretary, and chief financial officer and treasurer, each of whom shall be appointed by the Board of Directors and shall have such authority from the Board of Directors as is provided below or as is specially authorized by the Board of Directors. The Board of Directors may appoint such other Officers and assistant Officers as it deems necessary. If specifically authorized by the Board of Directors, an Officer may appoint one or more Officers or assistant Officers. The same individual may simultaneously hold more than one office in the Company. 8 (b) Appointment and Term of Office. The Officers of the Company shall be appointed by the Board of Directors for such term as is determined by the Board of Directors. Officers need not be members of the Company. If no term is specified, they shall hold office until their removal or resignation. The appointment of an Officer or the designa- tion of a specified term does not grant to the Officer any contract rights, and the Board of Directors may remove the Officer, with or without cause, at any time. Such removal shall be without prejudice to any rights created pursuant to an agreement, if any, with the individual so removed. (c) Chief Executive Officer. The chief executive officer shall be the principal executive officer of the Company and, subject to the control of the Board of Directors, shall in general supervise and control all of the business and affairs of the Company and its officers. He may sign certificates, deeds, mortgages, bonds, contracts, leases or other documents or instruments necessary or proper to be executed in the course of the Company's regular busi- ness or which the Board of Directors has authorized to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the Board of Directors to some other Officer or agent of the Company, or shall be required by law to be otherwise signed or executed, and he in general shall perform all duties incident to the office of chief executive officer and such other duties as may be prescribed by the Board of Directors from time to time. Except as otherwise provided by the Board of Directors, the chief executive officer may authorize the president or other Officer or agent of the Company to sign, execute, and acknowledge such documents or instruments in his place and stead. (d) President and Chief Operating Officer. In the absence of the chief executive officer or in the event or his death, inability or refusal to act, the president and chief operating officer shall perform the duties of the chief executive officer, and when so acting shall have all the powers and duties of the chief executive officer. In addition, the president and chief operating officer shall be responsible for the administration and management of the areas of the business and affairs of the Company assigned to him from time to time by the Board of Directors or the chief executive officer. (e) Vice-Presidents. In the absence of the president and chief operating officer, or in the event of his death, inability or refusal to act, the vice-president, 9 if one has been elected (or in the event that there is more than one, the vice-presidents in the order designated by the Board of Directors, or in the absence of designation, then in the order of their appointment), shall perform the duties of the president and chief operating officer, and when so acting, shall have all the powers of and be subject to all the restrictions on the president and chief operating officer. Any vice-president shall perform such duties as from time to time may be assigned to him by the president and chief operating officer or by the Board of Directors. (f) Secretary. The secretary shall: (i) keep the minutes of the proceedings of the Board of Directors in one or more books provided for that purpose; (ii) see that all notices are duly given in accordance with the provisions of Section 6.3(d) above; (iii) be custodian of the records of the Company, including all records required to be maintained by the Company pursuant to Section 17058 of the California Act; (iv) when requested or required, authenti- cate any records of the Company; (v) keep a register of the address of each Member; and (vi) in general perform all duties incident to the office of secretary and such other duties as from time to time may be assigned to him by the chief executive officer or by the Board of Directors. (g) Chief Financial Officer and Treasurer. The chief financial officer and treasurer shall: (i) have charge and custody of and be responsible for all funds and securities of the Company; (ii) receive and give receipts for moneys due and payable to the Company from any source whatsoever, and deposit all such moneys in the name of the Company in such bank, trust company, or other depository as shall be selected by the Board of Directors; and (iii) in general perform all of the duties incident to the office of chief financial officer and treasurer and such other duties as from time to time may be assigned to him by the chief executive officer or by the Board of Directors. (h) Assistant Secretaries and Assistant Trea- surers. The assistant secretaries and assistant treasurers, if any, shall in general perform such duties as shall be assigned to them by the secretary or the treasurer, respec- tively, or by the chief executive officer or the Board of Directors. 6.5. Limitation on Liability of the Directors and Officers; Indemnification. No Director or Officer shall be liable, responsible or accountable in damages or otherwise to the Company or the Members for any act or omission pursuant to the 10 authority granted by this Agreement if the Director or Officer, as the case may be, acted in good faith and in a manner he reasonably believed to be within the scope of the authority granted to him by this Agreement and in or not opposed to the best interests of the Company, provided that the Director or Officer, as the case may be, shall not be relieved of liability in respect of any claim, issue, or matter as to which he shall have been finally adjudicated to have breached this Section 6.5 or violated Section 17153 of the California Act. The Company shall defend, indemnify, save harmless and pay all judgments, claims, costs or expenses (including reasonable attorneys' fees) incurred by the parties indemnified hereunder. The Company shall advance costs or expenses (including reasonable attorneys' fees) to the indemnified parties so long as each indemnified party undertakes to repay such amounts if he or she is adjudicated not to be entitled to indemnification hereunder. 6.6. Actions by Members. Any actions of the Members shall be taken in the manner set forth below. (a) Manner of Acting. Except as otherwise provided in this Agreement, the consent of the Members to any act or failure to act may be given by Majority Consent at a meeting in which a quorum of such Members participate in person or by telephone or other electronic means. Members holding sufficient Units to give Majority Consent to the action taken at any meeting shall constitute a quorum of the Members at such meeting. Alternatively, the Members may act by unanimous written consent without the need for a meeting. (b) Meetings. Meetings of the Members may be called by the President or by any Director of the Company. Meetings not held by electronic means shall be held at the principal place of business of the Company or at such other place as may be designated by Majority Consent of the Members. (c) Voting. Each Unit shall be entitled to one vote. Each Member shall vote all of the Units held by him in the same manner as to any given matter submitted for consent. (d) Notice. No matter shall be voted upon at a meeting of Members unless at least forty-eight (48) hours notice of such matter is given or such notice is waived by any Member not receiving it. A Member shall be deemed to have waived notice of any matter acted upon at any meeting which he attends or in which he participates unless at the 11 beginning of the meeting or promptly upon commencement of its participation therein he objects to the consideration of such matter because of lack of proper notice. No prior notice shall be required for any action taken by written consent. 6.7. Other Permissible Activities. Any Member of the Company may engage in or possess interests in other business ventures of every kind and description, for his own account or otherwise, including, but not limited to, any customers, suppli- ers or other persons transacting business with the Company, and nothing in this Agreement shall be deemed to prohibit any Member or his Affiliates from investing in, dealing with or otherwise engaging in business with any person transacting business with the Company. Neither the Company nor any of its Members shall have any rights by virtue of this Agreement, by the relationship created hereby, or by the Articles of Organization in or to such other business ventures or to the income or profits derived therefrom, and the pursuit of such ventures shall not be deemed wrongful or improper. 6.8. Initial Directors and Officers. The initial members of the Board of Directors and the initial Officers of the Company shall be as listed in Exhibit E to this Agreement. ARTICLE VII Transfer of Units 7.1. Transferability of Class A Units. No Member holding Class A Units of the Company may sell, assign, hypothecate, or in any way transfer (the foregoing being hereinafter referred to as a "transfer") any Class A Units which it may now own or hereinafter acquire, whether voluntarily or by operation of law. Upon any such transfer, the Company immediately shall be dissolved. 7.2. Transferability of Class B Units. No Member holding Class B Units of the Company may voluntarily sell, assign, hypothecate, or in any way transfer the Class B Units which he may now own or hereinafter acquire, except in accordance with any agreement governing Class B Units between such Member and the Company. 7.3. Right of Transferee to Become a Member. Any transferee of Class B Units pursuant to an involuntary transfer of a Member's interest therein, or pursuant to an agreement of the kind referred to in Section 7.2, is only entitled to an economic interest in said Class B Units (within the meaning of 12 Section 17001(n) of the California Act). The transferee may only become a member of the Company with the consent of those Members holding a majority of the Units, determined by excluding the Class B Units held by the transferring Member, which consent may be withheld for any reason whatsoever. ARTICLE VIII Dissolution, Termination and Liquidation of the Company 8.1. Events Causing Dissolution. The Company shall be dissolved upon either (a) the bankruptcy (within the meaning of Section 17001(c) of the California Act) or insolvency of any of the Members, unless otherwise provided below, (b) the approval of such dissolution by the Board of Directors or the Members by Majority Consent, (c) the expiration of the term set out in Section 1.3 hereof or (d) the entry of a decree of dissolution pursuant to Section 17351 of the California Act. The Company shall not be dissolved upon any other event. Upon the occurrence of an event set out in subsection (a) hereof to a holder of Class B Units, the Company shall dissolve unless the business of the Company is continued by the affirmative vote of those Members holding a majority of the dollar value of the Capital Accounts and a majority of the Units, determined by excluding the Capital Account and Units held by the affected Class B Unit holder. 8.2. Termination. Dissolution of the Company shall be effective on the date on which the occurrence under Section 8.1, above, occurs (unless the Members vote to continue the Company pursuant thereto), but the Company shall not terminate until a Certificate of Dissolution has been duly filed under the California Act, the affairs of the Company have been wound up, and the assets of the Company have been distributed as provided in Section 8.3, below. Notwithstanding the dissolution of the Company, prior to the liquidation and termination of the Company, the business of the Company and the affairs of its Members, as such, shall continue to be governed by this Agreement. 8.3. Distribution of Assets Upon Termination. (a) Upon the dissolution of the Company pursuant to Section 8.1, unless the Company is continued pursuant thereto, a designated Officer (or if there is none, a person approved by Majority Consent as the liquidating trustee of the Company (the "Liquidating Trustee")), shall proceed diligently to wind up the affairs of the Company and distribute its assets in accordance with the provisions of Section 8.3(d). 13 (b) All saleable assets of the Company may be sold in connection with any dissolution at public or private sale or at such price and upon such terms as the designated Officer or the Liquidating Trustee, as the case may be, may deem advisable. A Member or any partnership, corporation or other entity in which a Member is in any way interested may purchase assets at such sale. The designated Officer or the Liquidating Trustee, as the case may be, in its sole and absolute discretion, may in accordance with Section 8.3(d) distribute the assets of the Company in kind on the basis of the fair market value thereof. (c) Profits and Losses of the Company shall be determined as of the end of the period of winding up in accordance with the provisions of this Agreement and shall be credited or charged to the respective Capital Accounts of the Members. (d) Upon the dissolution and winding up of the Company, the assets of the Company shall be distributed in the following order of priority to the extent available: (i) First, to creditors of the Company in satisfaction of any debts and liabilities of the Company (except for any loans made by Members) whether by payment or the establishment of any reserve which the designated Officer or the Liquidating Trustee deems necessary in its sole discretion to provide for any contingent, conditional or unmatured liabilities or obligations of the Company; at the expiration of such period of time as the authorized Officer or the Liquidating Trustee, as the case may be, deems advis- able, the balance remaining in any such reserve after payment of any such liabilities and obligations shall be distributed in the manner hereinafter set forth in this Section 8.3(d); (ii) Second, to the Members that have made loans to the Company pro rata (in accordance with the amount of principal of such loans then outstanding) until each shall have received the outstanding princi- pal of, and accrued and unpaid interest on, such loans; and (iii) Third, to the Members, in an amount equal to the positive balances in their respective Capital Accounts in proportion to such positive balances. 14 All distributions pursuant to this Section 8.3(d) shall be made no later than the later of (i) the end of the Fiscal Year during which the liquidation of the Company occurs or (ii) 180 days after the date of such liquidation. 8.4. Limitation on Liability. Each holder of a Unit shall look solely to the assets of the Company for all distribu- tions from the Company and the return of his Capital Contribution thereto and shall have no recourse (upon dissolution or other- wise) against any other Members, Officers, Directors or any of their Affiliates. ARTICLE IX Miscellaneous 9.1. Books and Records. Books and records of the Company shall be maintained at the principal office of the Com- pany or at any other place designated by the Board of Directors and shall be available for examination by any Member or his duly authorized representative(s) at any reasonable time for a proper purpose. Among the books and records maintained shall be those required by Section 17058 of the California Act. 9.2. Amendments to Operating Agreement. Any amendment or modification hereof or the Articles of Organization of the Company shall be valid if in writing and approved by Majority Consent, provided, however, that the holders of Class B Units shall be entitled to vote as a class on any matter which will adversely affect the rights of the Class B Units. Notwith- standing the foregoing, an amendment or modification of any agreement regarding Units between the Company and a holder of Units may be modified or amended only by a written agreement between the Company and such holder. 9.3. Binding Provisions. The covenants and agreements contained herein shall be binding upon, and inure to the benefit of, the successors and assigns of the respective parties hereto. This Agreement shall not inure to the benefit of any person other than the parties hereto, and no third party beneficiary claims may be based on this Agreement. 9.4. Governing Law. This Agreement shall be construed and interpreted in accordance with the internal laws of California, without application of choice of law principles. 9.5. Arbitration. All disputes and differences of any kind arising under this Agreement, including any dispute as to the existence or validity of this Agreement or the arbitrability 15 of any particular issue which cannot be settled amicably by the parties, shall be finally settled in an arbitration to be conducted under the rules of the American Arbitration Association (the "AAA") by a single arbitrator selected under the rules of the AAA. Any such arbitration proceeding shall be conducted in English and shall be held at a site in the United States selected under the rules of the AAA. The decision of any such arbitrator shall be final and binding upon the parties and may be enforced in any court of competent jurisdiction, and no party shall seek redress against any other in any court or tribunal except solely for the purpose of obtaining execution of any arbitral award or of obtaining a judgment consistent therewith. 9.6. Notices. Unless otherwise provided herein, all notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given when personally delivered, when delivered by reputable courier service, when transmitted by facsimile, or five (5) business days after being mailed, certified mail, with postage prepaid, addressed as follows (or to such other person or address as the Company, Director or Member may have designated from time to time by notice in writing pursuant hereto): if to the Company, c/o Chairman, The Diana Corporation, 8200 West Brown Deer Road, Milwaukee, Wisconsin 53223, or if to a Director or Member, to the address of the Director or Member, as the case may be, stated in the Company's records. 9.7. Entire Agreement. This Agreement, and any agree- ments being executed in connection herewith, embody the entire agreement and understanding between the parties and supersede all prior agreements and understandings relating to the Company. There are no representations, warranties, covenants, promises or agreements on the part of any party to another person which are not explicitly set forth herein and/or in the appendices hereto. 9.8. Specific Performance. The parties hereto declare that it is impossible to measure in money the damages which may be suffered by a party by reason of the failure of another party to perform any of its obligations under this Agreement or under any of the agreements that may be executed pursuant hereto. Accordingly, the parties agree that the provisions of this Agreement and each of the agreements that may be executed pursu- ant hereto may be specifically enforced, and if any arbitration proceeding shall be instituted to enforce the provisions hereof or any of the agreements that may be executed pursuant hereto, the party against whom the same is brought and its successors and assigns shall waive any claim or defense that the party bringing such action may be compensated adequately with money damages, shall not urge such claim or defense in any such proceeding and 16 shall consent to an order granting specific performance of this Agreement or any agreement that may be executed pursuant hereto. 9.9. Headings. The headings to the Articles and Sections of this Agreement are for reference only and shall not be used in construing the provisions hereof or otherwise affect the meaning hereof. 9.10. Interpretation. When the context in which words are used in this Agreement indicates that such is the intent, words in the singular shall include the plural and vice versa, and pronouns in the masculine shall include the feminine and neuter and vice versa. IN WITNESS WHEREOF, the undersigned has executed this Agreement as of the date first above written. SATTEL COMMUNICATIONS CORP. /s/ Richard Y. Fisher, President The individuals entering into Agreements Regarding Award of Class B Units referred to in Section 2.3, above, concurrently with this Agreement, by their execution and delivery of such agreements, have also become parties to this Agreement. 17 ACKNOWLEDGEMENT THE UNDERSIGNED hereby acknowledges that Exhibit B hereto contains a true and correct copy of the Articles of Organization filed by me with the California Secretary of State to organize the Company. /s/ Debra S. Koenig, Organizer 18 EXHIBIT A Definitions For purposes of this Agreement, the following terms shall have the meanings set forth below and any derivatives of such terms shall have correlative meanings: "Affiliate" means, as to any Person, another Person which controls the first Person or which the first Person controls or which is under common control with the first Person. The term "control" shall mean the power to elect a majority of the Board of Directors or other governing body of a Person or the power to direct the affairs of such Person, whether by reason of ownership of voting stock or other equity interest, by contract or otherwise. "Agreement" means the Operating Agreement dated February 20, 1996 of Sattel Communications LLC, a California limited liability company. "Articles of Organization" means the Articles of Organization of the Company as filed with the Secretary of State of California, as amended, a copy of which is attached to the Agreement as Exhibit B. "Asset Value" means as of any date, with respect to any asset, the asset's adjusted basis for federal income tax purposes as of such date, except as follows: (i) The initial Asset Value of any asset con- tributed by a Member to the Company shall be the gross fair market value of such asset, as reasonably determined by the Board of Directors; (ii) The Asset Values of all assets of the Com- pany shall be adjusted to equal their respective gross fair market values, as reasonably determined by the Board of Directors, as of the following times: (a) the acquisition of additional Units by any new or existing Member in exchange for more than a de minimis Capital Contribution; (b) the distribution by the Company to a Member of more than a de minimis amount of the Company's property as considera- tion for Units if the Board of Directors reasonably deter- mines that such adjustment is necessary or appropriate to reflect the relative economic interests of the Members; and (c) the liquidation of the Company within the meaning of Section 1.704-1(b)(2)(ii)(g) of the Treasury Regulations; (iii) The Asset Value of any asset of the Company distributed to any Member shall be the gross fair market value of such asset on the date of distribution reasonably determined by the Board of Directors; (iv) The Asset Value of the assets of the Company shall be increased (or decreased) to reflect any adjustments to the adjusted basis of such assets pursuant to Sections 734(b) or 743(b) of the Code, but only to the extent required by Section 1.704-1(b)(2)(iv)(m) of the Treasury Regulations; provided, however, that Asset Values shall not be adjusted pursuant to this clause (iv) to the extent the Board of Directors reasonably determines that an adjustment pursuant to clause (ii), above, is necessary or appropriate in connection with a transaction that otherwise would result in an adjustment pursuant to this clause (iv); and (v) If the Asset Value of an asset has been determined or adjusted pursuant to clause (i), (ii), or (iv), above, such Asset Value shall thereafter be adjusted by the Depreciation taken into account with respect to such asset for purposes of computing Profits and Losses. "Board of Directors" means the Directors acting as a group pursuant to the provisions of Article VI of this Agreement. "California Act" means the Beverly-Killea Limited Liability Company Act, as amended from time to time. "Capital Contribution" means the gross amount of cash, property, services rendered, or promissory notes or other written obligations to provide cash or property or to perform services, in each case at its Asset Value, contributed to the Company by any Member with respect to his Units in accordance with the terms of this Agreement. "Capital Event" means a sale, transfer, conveyance, or disposition of Company assets, whether or not in contemplation of or in connection with a liquidation of the Company, which assets have a fair market value greater than 25% of the aggregate fair market value of all of the Company's assets. "Cash Available for Distribution" means Cash Flow less Tax Distributions. "Cash Available from a Capital Event" means cash proceeds realized by the Company from a Capital Event less (i) the payment of all expenses related to the generation of such cash proceeds, (ii) the payment of indebtedness which the Board of Directors determines must or should be paid with proceeds from the Capital Event, and (iii) reserves established in the sole discretion of the Board of Directors. "Cash Flow" means cash funds provided from the operation of the Company's business, excluding a Capital Event, without deduction for depreciation, but after deducting cash funds used to pay all other expenses, debt payments, capital improvements and replacements and amounts set aside for the restoration or creation of reserves. "Code" means the Internal Revenue Code of 1986, as amended (or any corresponding provisions of succeeding law). "Company" means Sattel Communications LLC. "Depreciation" means, for each Fiscal Year of the Company, an amount equal to the depreciation, amortization, or other cost recovery deduction allowable with respect to an asset for such Fiscal Year under the Code, except that if the Asset Value of an asset differs from its adjusted basis for federal income tax purposes at the beginning of such Fiscal Year, Depre- ciation shall be an amount that bears the same ratio to such beginning Asset Value as the federal income tax depreciation, amortization, or other cost recovery deduction for such Fiscal Year bears to such beginning adjusted tax basis; provided, however, that if the adjusted basis for federal income tax purposes of an asset at the beginning of such Fiscal Year is zero, Depreciation shall be determined with reference to such beginning Asset Value using any reasonable method selected by the Board of Directors consistent with the purpose and intent hereof. "Director" means any person appointed to serve on the Board of Directors pursuant to Article VI of this Agreement. "Fiscal Period" means a portion of a Fiscal Year. "Fiscal Year" means any 12-month period selected by the Company from time to time as its fiscal year, provided that in the year of the formation, sale or liquidation of the Company, a Fiscal Year can be less than a 12-month period. "Majority Consent" means the consent, determined in accordance with Section 6.6 of this Agreement, of holders of more than fifty percent (50%) of all Units at the time of such consent, unless otherwise expressly provided in the Agreement. "Member Nonrecourse Debt" has the meaning set forth for Partner Nonrecourse Debt in Section 1.704-2(b)(4) of the Treasury Regulations. "Member Nonrecourse Debt Minimum Gain" means an amount, with respect to each Member Nonrecourse Debt, equal to the Minimum Gain that would result if such Member Nonrecourse Debt were treated as a Nonrecourse Liability, determined in accordance with Section 1.704-2(i)(3) of the Treasury Regulations. "Members" means the members of the Company described in Section 2.5. "Minimum Gain" has the same meaning as "partnership minimum gain" as set forth in Sections 1.704-2(b)(2) and (d) of the Treasury Regulations. "Nonrecourse Deductions" has the meaning set forth in Section 1.704-2(b)(1) of the Treasury Regulations. The amount of Nonrecourse Deductions for a Fiscal Period of the Company equals the net increase, if any, in the amount of Minimum Gain during that Fiscal Period, determined according to the provisions of Section 1.704-2(c) of the Treasury Regulations. "Nonrecourse Liability" has the meaning set forth in Section 1.704-2(b)(3) of the Treasury Regulations. "Officers" means the individuals appointed as the officers of the Company as provided in Section 6.8 or Section 6.4 of this Agreement. "Person" means any individual, corporation, partner- ship, joint venture, trust or unincorporated organization, a government or any agency or political subdivision thereof or any other entity. "Profits" and "Losses" mean, for each Fiscal Period, an amount equal to the Company's taxable income or loss for such Fiscal Period, determined in accordance with Section 703(a) of the Code (for this purpose, all items of income, gain, loss, or deduction required to be stated separately pursuant to Section 703(a)(1) of the Code shall be included in taxable income or loss), with the following adjustments: (i) Any income of the Company that is exempt from federal income tax and not otherwise taken into account in computing Profits or Losses pursuant to this definition shall be added to such taxable income or loss; (ii) Any expenditures of the Company described in Section 705(a)(2)(B) of the Code or treated as Section 705(a)(2)(B) expenditures described in Section 1.704- 1(b)(2)(iv)(i) of the Treasury Regulations, and not other- wise taken into account in computing Profits or Losses pursuant to this definition, shall be subtracted from such taxable income or loss; (iii) In the event the Asset Value of any asset of the Company is adjusted pursuant to the definition thereof, the amount of such adjustment shall be taken into account as gain or loss from the disposition of such asset for purposes of computing Profits and Losses; (iv) Gain or loss resulting from any disposition of any property by the Company with respect to which gain or loss is recognized for federal income tax purposes shall be computed by reference to the Asset Value of the property disposed of, notwithstanding that the adjusted tax basis of such property differs from its Asset Value; (v) In lieu of the depreciation, amortization, and other cost recovery deductions taken into account in computing such taxable income or loss, there shall be taken into account Depreciation for such Fiscal Year or other period; and (vi) To the extent an adjustment to the adjusted tax basis of any asset of the Company pursuant to Sections 734(b) or 743(b) of the Code is required pursuant to Section 1.704-1(b)(2)(iv)(m) of the Treasury Regulations to be taken into account in determining Capital Accounts as a result of a distribution other than in complete liquidation of a Mem- ber's Units, the amount of such adjustment shall be treated as an item of gain (if the adjustment increases the basis of the asset) or loss (if the adjustment decreases the basis of the asset) from the disposition of the asset and shall be taken into account for purposes of computing Profits or Losses. "Sattel" means Sattel Communications Corp.. "Tax Distribution" means the amount distributed to Members pursuant to Section 4.1(a) and (b). "Tax Distribution Dates" means, except as provided in Section 4.1(b), January 15, April 15, June 15 and September 15 of each Fiscal Year commencing with June 15, 1996. "Tax Rate" means the highest combined marginal income tax rate for Federal and California purposes for the Fiscal Period at issue applicable to corporations or individuals, whichever is greater, assuming in determining the tax rate that would apply to individuals maximum applicability of the phase-out of itemized deductions contained in Section 68 of the Code. "Treasury Regulations" means the regulations adopted from time to time by the Department of the Treasury under the Code, and any references to "partners" or "partnership" therein shall refer, as appropriate, to Members and the Company, respec- tively. "Units" means the Class A and Class B Units of the Company into which the proprietary interests in the Company are divided. EXHIBIT B STATE OF CALIFORNIA ACTING SECRETARY OF STATE TONY MILLER LIMITED LIABILITY COMPANY ARTICLES OF INCORPORATION 1. Limited liability company name: Sattel Communications LLC 2. Latest date on which the limited liability company is to dissolve: December 31, 2046 3. The purpose of the limited liability company is to engage in any lawful act or activity for which a limited liability company may be organized under the Beverly-Killea Limited Liability Company Act. 4. Enter the name of initial agent for service of process and check the appropriate provision below: Keith Steffel, which is [x] an individual residing in California. 5. If the initial agent for service of process is an individual, enter a business or residential street address in California: 9145 Deering Avenue, Chatsworth, California 91311. 6. The limited liability company will be managed by: [x] limited liability company members 7. If other matters are to be included in the articles of incorporation attach one or more separate pages. Number of pages attached, if any: N/A 8. It is hereby declared that I am the person who executed this instrument, which execution is my act and deed: /s/ Debra S. Koenig, Organizer Date: February 22, 1996 EXHIBIT C Sattel Capital Contribution For its Class A Units, Sattel is transferring to the Company all of its assets (excluding its interest in the Company), subject to assumption by the Company of all of its liabilities. These assets and liabilities include those listed on the schedule attached hereto under the column titled "Final 03/31/96." The Diana Corporation Sattel Communications Lead Schedule Final 03/31/96 -------- ASSETS CURRENT ASSETS Cash $ 913,301 Accounts receivable 0 Due from Sattel Technologies, Inc. 9,945 Inventories 1,087,422 Advance to Sattel Technologies, Inc. 221,378 Prepaid expenses 40,403 --------- 2,272,449 Equipment - Net 167,499 Deferred Organization Costs 44,064 Other Assets 79,970 --------- Total Assets $2,563,982 ========= LIABILITIES AND CAPITAL CURRENT LIABILITIES Accounts payable 306,008 Unearned revenue 138,856 Accrued payroll 30,701 Accrued interest 17,391 Other accrued liabilities 8,077 --------- Total current liabilities 501,033 Note Payable to The Diana Corporation 1,425,000 Partner's Capital 637,949 --------- Total Liabilities and Capital $2,563,982 ========= EXHIBIT D Allocations in Extraordinary Situations This Exhibit sets forth certain allocations that will apply to the extent and under the circumstances provided below in lieu of the allocation provided in Article V of the Agreement. In no event will an allocation or distribution under the Agreement (including this Exhibit D) be made which results in, or increases, an Adjusted Capital Account Deficit as of the end of the Fiscal Year to which such allocation or distribution relates. Except as otherwise provided, capitalized terms have the definitions provided with respect to the Agreement. 1. Special Allocations. The following special alloca- tions shall be made in the following order: (a) Minimum Gain Chargeback. Except as otherwise provided in Section 1.704-2(f) of the Treasury Regulations, notwithstanding any other provision of this Exhibit, if there is a net decrease in Minimum Gain during any Fiscal Period, each Member shall be specially allocated items of income and gain for such Fiscal Period (and, if necessary, subsequent Fiscal Period) in an amount equal to such Member's share of the net decrease in Minimum Gain, determined in accordance with Section 1.704-2(g) of the Treasury Regulations. The items to be so allocated shall be determined in accordance with Sections 1.704-2(f)(6) and (j)(2) of the Treasury Regulations. This Section 1(a) is intended to comply with the minimum gain chargeback requirement in Section 1.704-2(f) of the Treasury Regulations and shall be interpreted consistently therewith. (b) Member Minimum Gain Chargeback. Except as otherwise provided in Section 1.704-2(i)(4) of the Treasury Regulations, notwithstanding any other provision of this Exhibit, if there is a net decrease in Member Nonrecourse Debt Minimum Gain attributable to a Member Nonrecourse Debt during any Fiscal Period, each Member who has a share of the Member Nonrecourse Debt Minimum Gain attributable to such Member Nonrecourse Debt, determined in accordance with Section 1.704-2(i)(5) of the Treasury Regulations, shall be specially allocated items of income and gain for such Fiscal Period (and, if necessary, subsequent Fiscal Periods) in an amount equal to such Member's share of the net decrease in Member Nonrecourse Debt Minimum Gain attributable to such Member Nonrecourse Debt, determined in accordance with Section 1.704-2(i)(4) of the Treasury Regulations. The items to be so allocated shall be determined in accordance with Sections 1.704-2(i)(4) and (j)(2) of the Treasury Regulations. This Section 1(b) is intended to comply with the minimum gain chargeback requirement in Section 1.704-2(i)(4) of the Treasury Regulations and shall be interpreted consistently therewith. (c) Qualified Income Offset. In the event any Member unexpectedly receives any adjustments, allocations or Distributions described in Section 1.704-1(b)(2)(ii)(d)(4), (5) or (6), items of income and gain (including gross income) shall be specially allocated to each such Member in an amount and manner sufficient to eliminate, to the extent required by the Treasury Regulations, the Adjusted Capital Account Deficit of such Member as quickly as possible, provided that an allocation pursuant to this Section 1(c) shall be made if and only to the extent that such Member would have an Adjusted Capital Account Deficit after all other allocations provided for in this Exhibit have been tentatively made as if this Section 1(c) were not in the Agreement. (d) Nonrecourse Deductions. Nonrecourse Deduc- tions for any Fiscal Period shall be allocated among the Members in accordance with Article V of the Agreement. (e) Imputed Interest. To the extent the Company has taxable interest income or deduction with respect to any obligation of a Member to the Company pursuant to Section 483, Sections 1271 through 1288, or Section 7872 of the Code: (i) Such interest income or deduction shall be specially allocated to the Members to whom such obligation relates; and (ii) The amount of such interest income or deduction shall be excluded from the Capital Contributions credited or debited to such Member's Capital Account in connection with payments of prin- cipal with respect to such obligations. (f) Allocations Relating to Taxable Issuance of Units. Any income, gain, loss, or deduction realized as a direct or indirect result of the issuance of Units shall be allocated among the Members so that, to the extent possible, the net amount of such items, together with all other allocations under the Agreement to each Member, shall be equal to the net amount that would have been allocated to each such Member if such items had not been realized. 2. Curative Allocations. The allocations set forth in Sections 1(a), 1(b), 1(c), 1(d), 1(e) and 1(f), above, (the "Regulatory Allocations") are intended to comply with certain requirements of the Treasury Regulations. It is the intent of the Members that, to the extent possible, all Regulatory Allo- cations shall be offset either with other Regulatory Allocations or with special allocations of other items of income, gain, loss, or deduction pursuant to this Section 2. Therefore, notwith- standing any other provision of this Exhibit (other than the Regulatory Allocations), the designated Officer shall make such offsetting special allocations of income, gain, loss, or deduc- tion in whatever manner they determine appropriate so that, after such offsetting allocations are made, each Member's Capital Account balance is, to the extent possible, equal to the Capital Account balance such Member would have had if the Regulatory Allocations were not part of this Exhibit. In exercising his discretion under this Section 2, the designated Officer shall take into account future Regulatory Allocations under Sections 1(a) and 1(b), above, that, although not yet made, are likely to offset other Regulatory Allocations previously made under Sections 1(d), above. 3. Transfer of Units. In the event Units are transferred pursuant to the Agreement during any Fiscal Period, the Profits (or Losses) allocated to the Members for each such Fiscal Period shall be allocated among the transferring Members in proportion to the Units each holds from time to time during such Fiscal Period in accordance with Section 706 of the Code, using any convention permitted by law and selected by the designated Officer. 4. Tax Allocations. (a) Capital Contributions. In accordance with Section 704(c) of the Code and the Treasury Regulations thereunder, income, gain, loss, and deduction with respect to any Capital Contribution shall, solely for tax purposes, be allocated among the Members so as to take account of any variation between the adjusted basis of such property to the Company for federal income tax purposes and its initial Fair Market Value. (b) Adjustment of Asset Value. In the event the Asset Value of any asset of the Company is adjusted, subse- quent allocations of income, gain, loss, and deduction with respect to such asset shall take account of any variation between the adjusted basis of such asset for federal income tax purposes and its Asset Value as so adjusted in the same manner as under Section 704(c) of the Code and the Treasury Regulations thereunder. (c) Elections. Any elections or other decisions relating to such allocations shall be made by the designated Officer in any manner that reasonably reflects the purpose and intent of this Agreement. Allocations pursuant to this Section 4 are solely for purposes of federal, state, and local taxes and shall not affect, or in any way be taken into account in computing, any Capital Account or share of Profits, Losses, other items, or distributions pursuant to any provision of the Agreement. 5. Income Tax Consequences. The Members are aware of the income tax consequences of the allocations made by this Exhibit and hereby agree to be bound by the provisions hereof in reporting their shares of income and loss for income tax purposes. EXHIBIT E Officers and Directors Directors: Michael Camp Charles Chandler James Fiedler Richard Fisher Daniel Latham Donald Runge Michael Sonaco George Weischadle Officers: James Fielder Chairman of the Board and Chief Executive Officer Daniel Latham President and Chief Operating Officer Keith Steffel Chief Financial Officer, Secretary and Treasurer Mel Ethem Vice President and General Manager of North American Operations George Perzel Vice President International Sales Edmund Daly Chief Technology Officer Bruce Thomas Vice President Hardware Technology David Held Vice President Software Technology Mark Jacques Vice President Service and Support EX-10.18 3 AMENDMENT TO THE OPERATING AGREEMENT OF SATTEL COMMUNICATIONS LLC THIS AMENDMENT to the Operating Agreement of Sattel Communications LLC dated as of April 1, 1996 (the "Operating Agreement") is entered into as of the date of consent specified below. All terms used herein which are not otherwise defined shall have the meaning set forth in the Operating Agreement. 1. Exhibit A - Definitions. (a) Modifications. (i) The definition of "Capital Contribution" contained in Exhibit A of the Operating Agreement is modified by adding the following sentence at the end of the definition: Notwithstanding the foregoing, the amount of the initial Capital Contribution of Sattel is $637,949. (ii) The definition of "Cash Available for Distribution" contained in Exhibit A of the Operating Agreement is deleted and replaced with the following: "Cash Available for Distribution" for any Fiscal Period means Cash Flow less the sum of (a) distribu- tions of the Priority Return, (b) Tax Distributions and (c) distributions of Unreturned Capital, for that Fiscal Period. (iii) The definition of "Tax Distribution" contained in Exhibit A of the Operating Agreement is deleted and replaced with the following: "Tax Distribution" means the amount distributed to Members pursuant to Section 4.1(b) and (c). (iv) The definition of "Tax Distribution Dates" contained in Exhibit A of the Operating Agreement is deleted and replaced with the following: "Tax Distribution Dates" means, except as provided in Section 4.1(c), January 15, April 15, June 15 and September 15 of each Fiscal Year commencing with June 15, 1996. (v) For purposes of clarification, in the definition of "Majority Consent" contained in Exhibit A of the Operating Agreement, the phrase "holders of more than fifty percent (50%) of all Units" is modified to read "Members holding more than fifty percent (50%) of all Units (with Units held by a transferee of a Class B Member who is a permitted transferee under the agreement governing the Class B Units between the Company and the Member treated as held by the Member, unless the transferee is admitted as a Member)". (b) Additions. The following definitions are added to Exhibit A of the Operating Agreement: "Priority Return" means a sum equal to an annual rate of eight percent (8%), compounded annually, for the actual number of days occurring in the period for which the Priority Return is being determined, of the average daily balance of the Class A Member's Unre- turned Capital from time to time during the period to which the Priority Return relates, commencing on the date any Class A Member first makes a Capital Contribution after June 1, 1996, other than for additional Class A Units. "Unreturned Capital" means, as of any date, the excess, if any, of (a) the aggregate Capital Contributions of such Class A Member after June 1, 1996, other than for additional Class A Units, over (b) the aggregate distributions as of such date to such Class A Member pursuant to Sections 4.1(d) and 4.2(b) of this Agreement. 3. Articles IV and V. Articles IV and V of the Operating Agreement are hereby deleted in their entirety and are replaced with the following: ARTICLE IV Distributions 4.1. Current Distributions. To the extent permitted by law and consistent with the Company's obligations to its creditors as determined by the Board of Directors, the Company 2 shall make the following distributions from Cash Flow in the order of priority set forth herein. (a) Priority Return. First, the Company shall distribute to each Class A Member an amount equal to the excess, if any, of (i) the Priority Return of the Class A Member from the date such Class A Member first has Unre- turned Capital to the date of such distribution, over (ii) the sum of all prior distributions to such Class A Member pursuant to this Section 4.1(a) and Section 4.2(a). If less than the total amount distributable to all Class A Members under this Section 4.1(a) is to be distributed, the amount distributed shall be allocated among the Class A Members in proportion to the then unsatisfied amounts owing to them. (b) Current Tax Distributions. Second, the Company shall make Tax Distributions on or before the Tax Distribution Dates. The aggregate amount of the Tax Distribution made with respect to any given Tax Distribution Date shall be the product of (i) the estimated federal taxable income of the Company under the provisions of the Code, for the Fiscal Period ending on the last day of the calendar month immediately preceding the Tax Distribution Date and commencing on the first day of the calendar month that includes the immediately previous Tax Distribution Date, multiplied by (ii) the Tax Rate. Notwithstanding the foregoing, to the extent the Company has had an estimated federal taxable loss for any prior Fiscal Period in that Fiscal Year, the amount in clause (i) above shall be reduced by that portion of the loss remaining after reducing taxable income for prior Fiscal Periods in such Fiscal Year for the loss. Each Member shall receive a Tax Distribution propor- tional with the amount of federal taxable income to be allocated to such Member pursuant to Article V hereof. (c) Additional Tax Distributions. Third, in the event any income tax return of the Company, as a result of an audit or otherwise, reflects items of income, gain, loss, or deduction which are different from the amounts estimated pursuant to Section 4.1(b) above with respect to the Fiscal Year of such return in a manner that results in additional income or gain of the Company being allocated to the Members, an additional Tax Distribution shall be made under the principles of Section 4.1(b) above, except that (i) the last day of the calendar month in which such adjustment occurs shall be treated as a Tax Distribution Date, and (ii) the amount of such additional income or gain shall be treated as the federal taxable income of the Company. 3 (d) Return of Unreturned Capital. Fourth, the Company shall distribute to each Class A Member an amount equal to the Member's Unreturned Capital. If less than the total amount distributable to all Class A Members under this Section 4.1(d) is to be distributed, the amount distributed shall be allocated among the Class A Members in proportion to the then unsatisfied amounts owing to them. (e) Cash Available for Distribution. Finally, Cash Available for Distribution shall be distributed to the Members in proportion to the number of Units held by each Member. 4.2. Distributions of Cash Available from a Capital Event. Cash Available from a Capital Event shall be distributed among the Members in the following priority: (a) Priority Return. First, the Company shall distribute to each Class A Member an amount equal to the excess, if any, of (i) the Priority Return of the Class A Member from the date such Class A Member first has Unre- turned Capital to the date of such distribution, over (ii) the sum of all prior distributions to such Class A Member pursuant to Section 4.1(a) and this Section 4.2(a). If less than the total amount distributable to all Class A Members under this Section 4.2(a) is to be distributed, the amount distributed shall be allocated among the Class A Members in proportion to the then unsatisfied amounts owing to them. (b) Return of Unreturned Capital. Second, the Company shall distribute to each Class A Member an amount equal to the Member's Unreturned Capital. If less than the total amount distributable to all Class A Members under this Section 4.2(b) is to be distributed, the amount distributed shall be allocated among the Class A Members in proportion to the then unsatisfied amounts owing to them. (c) Special Distribution. Third, the Company shall distribute to Sattel an amount equal to $2,500,000 less the sum of all prior distributions made pursuant to this Section 4.2(c); and (d) Other Distributions. The Company shall distribute the balance of any Cash Available from a Capital Event to the Members in proportion to the number of Units held by each Member. 4 4.3. Liquidating Distribution. In the event the Company is liquidated pursuant to Article IX, below, distribu- tions pursuant to Section 8.3(d), below, shall be distributed to the Members in accordance with their Capital Account balances, after making the adjustments for allocations under Article V, below, up to and including the date of the liquidating distribu- tion. ARTICLE V Allocation of Profits and Losses 5.1. Allocation of Profits. Except as provided in Exhibit D hereto, Profits for any Fiscal Period shall be allocated among the Members in accordance with the following provisions: (a) First, to the Class A Members, to the extent of the excess, if any, of (1) the cumulative Priority Return distributions the Class A Members have received pursuant to Sections 4.1(a) and 4.2(a) hereof (regardless of when made) over (ii) the cumulative items of income and gain allocated to such Class A Members pursuant to this Section 5.1(a) for all prior Fiscal Periods; (b) Second, 99% to the Class A Units and 1% to the Class B Units, in proportion to the number of Units held by the respective classes of Members, until the Class A Units have been allocated Profits equal to the amount of Losses allocated to the Class A Members pursuant to Section 5.2 hereof (expressed as a positive number); (c) Third, 99% of Sattel and 1% to the Class B Units, in proportion to the number of Units held by the Class B Members, until Sattel has been allocated Profits under this Section 5.1(c) equal to $2.5 million less the initial Capital Contribution of Sattel; and (d) The balance among the Members in proportion to the Units held by each Member. 5.2. Allocation of Losses. Except as provided in Exhibit D hereto, Losses for any Fiscal Period shall be allocated among the Members in proportion to the Units held by each Member, except that to the extent Losses exceed all prior Profits reduced by prior distributions pursuant to Article IV hereof, such Losses shall be allocated among the Members holding Class A Units in proportion to the Units held by each Class A Member, provided, however, that no allocation shall be made to any Member to the 5 extent that such allocation would violate the Treasury Regulations promulgated under Section 704(b) of the Code. 3. Other Amendments. (a) Section 9.2. For purposes of clarification, in the first sentence of Section 9.2 of the Operating Agreement, regarding amendments, the phrase "holders of Class B Units shall be entitled to vote" is modified to read "Members holding Class B Units shall be entitled to act." (b) Section 2.5. Section 2.5 of the Operating Agreement is modified by adding the following sentence at the end of such section. Notwithstanding the foregoing, an existing Class A Member may at any time make a Capital Contribution without the issuance of any additional Units, upon approval of the Board of Directors. 4. Effect of Amendment. Except as otherwise modified by this Amendment, the Operating Agreement shall remain in full force and effect. The undersigned, constituting the holders of all of the outstanding Class A Units and a majority of the outstanding Class B Units (a total of 1,650 B Units are outstanding as of the date of this consent), hereby consent to the foregoing Amendment as of June 5, 1996. This consent may be executed in counterparts, all of which when taken together shall constitute one and the same instrument. SATTEL COMMUNICATIONS CORP. (8,000 Class A Units) By: /s/ Richard Y. Fisher, President /s/ James J. Fiedler (250 Class B Units) ___________________________________ Daniel W. Latham (150 Class B Units) (signatures continued on next page) 6 /s/ Mark Jacques (450 Class B Units) ___________________________________ Bruce E. Thomas (250 Class B Units) ___________________________________ David Held (250 Class B Units) ___________________________________ George M. Perzel (100 Class B Units) /s/ Keith R. Steffel (100 Class B Units) /s/ Sydney B. Lilly (100 Class B Units) 7 EX-10.19 4 SECOND AMENDMENT TO THE OPERATING AGREEMENT OF SATTEL COMMUNICATIONS LLC THIS SECOND AMENDMENT to the Operating Agreement of Sattel Communications LLC dated as of April 1, 1996 (the "Operating Agreement"), is entered into as of the date of consent specified below. All terms used herein which are not otherwise defined shall have the meanings set forth in the Operating Agreement. 1. Amendments. (a) Section 2.2 of the Operating Agreement is amended by adding the following sentence at the end of thereof: "Subject to Section 2.5, the Board of Directors of the Company may, in exchange for Capital Contributions, issue additional Class A Units to Sattel or other Persons as determined by the Board of Directors of the Company." (b) Section 4.2 of the Operating Agreement is amended by deleting the word "and" after subparagraph (c), redesignated subparagraph (d) as (e), and adding the following after subparagraph (c): "(d) Second Special Distribution. Fourth, the Company shall distribute to Class A Members other than Sattel an amount equal to the Capital Contributions for the applicable Class A Units less the sum of all prior distributions made pursuant to this Section 4.2(d); and". (c) Section 7.1 of the Operating Agreement is amended to add the following clause at the end of the first sentence after the word "law": ", except for a Member other than Sattel in accordance with any agreement governing Class A Units between such Member and the Company." (d) Section 7.3 of the Operating Agreement is amended to read in its entirety as follows: 7.3. Right of Transferee to Become a Member. Any transferee of Class A Units or Class B Units pursuant to an involuntary transfer of a Member's 1 interest therein, or pursuant to an agreement of the kind referred to in Section 7.1 or 7.2, is only entitled to an economic interest in said Class A Units or Class B Units (within the meaning of Section 17001(n) of the California Act). The transferee may only become a member of the Company with the consent of those Members holding a majority of the Units, determined by excluding the Class A Units or Class B Units held by the transferring Member, which consent may be withheld for any reason whatsoever. (e) Section 8.1 of the Operating Agreement is amended to read in its entirety as follows: 8.1 Events Causing Dissolution. The Company shall be dissolved upon either (a) the bankruptcy (within the meaning of Section 17001(c) of the California Act) or insolvency of any of the Members, unless otherwise provided below, (b) the approval of such dissolution by the Board of Directors or the Members by Majority Consent, (c) the expiration of the term set out in Section 1.3 hereof, (d) the entry of a decree of dissolution pursuant to Section 17351 of the California Act, or (e) upon a transfer of Class A Units that causes dissolution under Section 7.1. Upon the occurrence of an event set out in subsection (a) hereof to a holder of Class A Units (other than Sattel) or Class B Units, the Company shall dissolve unless the business of the Company is continued by the affirmative vote of those Members holding a majority of the dollar value of the Capital Accounts and a majority of the Units, determined by excluding the Capital Account and Units held by the affected Class A or Class B Unit holder. (f) The definition of "Agreement" is amended by changing "February 20, 1996" to "April 1, 1996." (g) The definition of "Members" is amended by changing "Section 2.5" to "Section 2.6." 2. Waiver and Consent. (a) Each of the undersigned hereby consents to the admission of Charles Chandler and Syd Lilly as Members holding Class A Units and waives its right under Section 2.5 of the Operating Agreement (and the Operating Agreement is hereby amended not to permit Members) to contribute equity capital in connection with the issuance of 350 Class A units to Charles Chandler and the issuance of 100 Class A Units to 2 Syd Lilly. Mr Lilly's 100 Class B Units are hereby cancelled and shall be considered void. (b) Each of the undersigned hereby waives (once the Operating Agreement is hereby amended not to require) compliance with Article VII of the Operating Agreement in connection with the issuance of 100 Class A Units to Syd Lilly as a result of a deemed transfer from Charles Chandler. 3. Effect of Amendment. Except as otherwise modified by this Agreement, the Operating Agreement shall remain in full force and effect. The undersigned, constituting the holders of all of the outstanding Class A Units and a majority of the outstanding Class B Units (a total of 1,650 B Units are outstanding as of the date of this Consent) hereby consent to the foregoing Amendment as of September 12, 1996. This Consent may be executed in counterparts, all of which when taken together shall constitute one and the same instrument. SATTEL COMMUNICATIONS CORP. (8,000 Class A Units) /s/ Richard Y. Fisher, President /s/ James J. Fiedler (250 Class B Units) __________________________________ Daniel W. Latham (150 Class B Units) /s/ Mark Jacques (450 Class B Units) 3 ___________________________________ Bruce E. Thomas (250 Class B. Units) ___________________________________ David Held (250 Class B Units) ___________________________________ George M. Perzel (100 Class B Units) /s/ Keith R. Steffel (100 Class B Units) /s/ Sydney B. Lilly (100 Class B Units) 4 -----END PRIVACY-ENHANCED MESSAGE-----