<PAGE>   1

                                 UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                                   FORM 10-K
                 FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
           SECTIONS 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)
(X)  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934
For the fiscal year ended July 31, 1997

                                       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  0-8193

                           DAEDALUS ENTERPRISES, INC.
                           --------------------------
               (Exact name of registrant as specified in charter)

              DELAWARE                               38-1873250
              --------                               ----------
       (State or other jurisdiction of            (I.R.S. Employer
      incorporation or organization)              Identification No.)


  300 PARKLAND PLAZA (P.O. BOX 1869)
    ANN ARBOR, MICHIGAN  48106                       (313) 769-5649
    --------------------------                       --------------
(Address of principal executive offices)     (Registrant's telephone number)

Securities registered pursuant to Section 12(b) of the Act:   NONE

Securities registered pursuant to Section 12(g) of the Act:   COMMON STOCK,
$.01 PAR VALUE

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.
        Yes [X]    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.    [X]

Aggregate market value of voting common stock held by non-affiliates of
Registrant at September 30, 1997 (computed by reference to the average bid and
asked prices of the Registrant's common stock):  $1,335,474.  (Assuming, but
not admitting for any purpose, that all executive officers and directors of the
Registrant, and their associates, may be deemed affiliates.)

Number of shares outstanding of common stock, $.01 par value, as of September
30, 1997:  534,024  shares

                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the following document are  incorporated by reference in Part III
of this Annual Report on Form 10-K:  Definitive Proxy Statement for the 1997
Annual Meeting of Stockholders - Items 10, 11,  and 12.


<PAGE>   2

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


                                     PART I
ITEM 1.  BUSINESS

General

Daedalus Enterprises, Inc., incorporated in August 1968, manufactures products
for, and performs development projects in, the field broadly described as
"remote sensing."  Remote sensing is the detection or measurement of various
physical parameters of an object or system without making direct contact with
the observed object.  The Company's customers use these remote sensing products
to detect and measure either the emitted or reflected radiation of objects or
systems.

The Company is also developing a remote sensing service operation that would
utilize the Company's technology to acquire and process remote sensing data for
users of such data.  See "Growth Plan".

Products

The principal products manufactured by the Company are airborne imaging
systems.  The Company's customers install these systems in aircraft and use
them to acquire optical radiation data from objects on the earth's surface and
in the atmosphere.  This data is then processed into a useful form by data
handling and data processing equipment which, in some cases, is also
manufactured by the Company.  A principal application of the Company's remote
sensing products has been the measurement of environmental parameters in
support of pollution control programs and environmental impact studies.

The Company manufactures these products by integrating precision optical,
mechanical and electronic components into unified systems.  These components
are either purchased off the shelf, or custom designed by the Company and
manufactured by the Company, or designed and specified by the Company for
outside manufacture.  Highly technical personnel, supported by supervisors and
engineers, assemble, test and calibrate these systems in preparation for
delivery to customers.

The Company engages in customer-funded projects for the development of advanced
equipment in the remote sensing field.  In addition to being a source of
revenue, the Company undertakes these projects to increase its technical
expertise in areas demonstrating strong potential for use in future products.
Some of these projects may lead to the incorporation of newly developed
technology into the existing product line or an expansion of the product line.

During fiscal 1997, the Company shared costs on two U.S. government sponsored
Small Business Innovation Research (SBIR) programs.  One of these programs,
Large Format Multispectral Camera, is scheduled for completion in early fiscal
1998.  The other, Laser Search and Rescue, will be completed in late fiscal
1998. The Company has applied for a patent related to the LASAR search and
rescue technology developed under the SBIR program. The Company  is conducting
marketing efforts and actively seeking partners for participation in Phase III
commercialization efforts for these two programs, as well as lobbying the U.S.
Government for additional funds for these programs.

Revenue from standard remote sensing systems and customer-funded product
development systems during the three most recent fiscal years ended July 31 was
approximately as follows:



                                      2

<PAGE>   3

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


<TABLE>
<CAPTION>
                   Standard      Customer-Funded Product
        Year       Systems         Development Systems       Total
                    (000)                 (000)              (000)
        -----------------------------------------------------------
        <S>         <C>                   <C>                <C>
        1997        $2,200                  $788             $2,988
        1996        $1,657                  $430             $2,087
        1995        $2,340                $1,278             $3,618
</TABLE>


Marketing

Marketing activities are conducted principally through the Company's office in
Ann Arbor, Michigan, primarily through direct customer contact.  The Company
markets its products through direct sales and leases with a purchase option.
In addition to direct marketing of its standard systems, the Company is engaged
in seeking customer-funded product development projects for advanced equipment.
See "Growth Plan" for a description of expected changes in the Company's
marketing strategy as it implements its growth plan.

Products are marketed to government customers in the United States and Canada
by the Company's sales force which consists of three persons, one of whom is an
officer who carries on other duties in addition to sales efforts, and a
commissioned representative who handles commercial customers.

The Company has no active international subsidiaries or branch offices.  In
several countries, the Company has exclusive Sales Agency Agreements with
existing high technology marketing operations.  These agents' efforts are
supported by the Company's own sales personnel, who also travel to other
countries where there is no formal representation.

Customers

The Company's customers include aerospace, aerial survey, oil and mineral
exploration companies, universities and domestic and foreign federal and state
government agencies.  The Company's ability to continue to contract with such
parties is dependent on political, economic and social factors.  Revenue from
international markets are sometimes subject to receiving approved U.S.
government export licenses.  A substantial portion of revenue in both domestic
and international markets is generated by customers who depend, at least in
part, upon federal, state or local government appropriations.  Many of these
customers are involved in programs aimed at improving man's impact on the
environment.  See "Growth Plan" for a description of the Company's efforts to
diversify its customer base.

The following table sets forth information with respect to domestic and
international revenue during the three most recent fiscal years ended July 31:


                                      3


<PAGE>   4

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES



<TABLE>
<CAPTION>
                                  INTERNATIONAL AND DOMESTIC REVENUE
                                           (in thousands)
     ------------------------------------------------------------------------------------------
     Year                   International                           Domestic
     ------------------------------------------------------------------------------------------
                  Asia            Europe         Other(1)   U.S. Gov't.      Other        Total
                  ----            ------         -----      -----------      -----        -----
     <S>           <C>              <C>            <C>          <C>           <C>         <C>
     1997          $1,178             $154         $0           $1,625        $31         $2,988
     1996            $562             $814         $0             $618        $93         $2,087
     1995             $43           $2,255         $8           $1,228        $84         $3,618
</TABLE>


                    (1) Revenue from geographic areas that amount to less than
                        10% of total revenue are shown as "Other."

International revenue normally consists largely of standard products, while
domestic revenue is largely customer-funded product development.  The standard
product and customer-funded product development portions of the business are
conducted by the same pool of personnel using the same operating space and
equipment and constitute a single industry segment.  For further information
regarding the Company's revenue by geographic area and operations, see the
table included under the caption "Selected Financial Data", and Note J to
Consolidated Financial Statements which table and note are incorporated herein
by reference.

To protect against foreign currency transaction losses, international sales are
generally contracted in U.S. dollars and many large contracts are secured by
irrevocable letters of credit.  The Company also generally receives substantial
deposits on large orders from international customers.

A majority of the Company's  revenue each year is derived from a small number
of high dollar value equipment sales and contracts to a relatively small number
of customers.  Because each customer may represent a substantial portion of
total revenue for that fiscal year, a small increase or decrease in the number
of customers with whom the Company has contracts could generate a relatively
large percentage increase or decrease in total revenue.  Revenue during a
particular fiscal year may result, in substantial part, from contracts with a
single customer.  Revenue from U.S. Government agencies accounted for
approximately 54%, 30% and 34% of revenue for fiscal 1997, 1996 and 1995,
respectively.  Asian customers are an important source of revenue for the
Company, generating 38% and 29% of operating revenue for fiscal years ended
July 31, 1997 and 1996.  Italian customers were an important source of revenue
for the Company in fiscal 1995 (28%), but no significant orders were received
in fiscal 1997 or fiscal 1996 as the Italian market for the Company's current
products is near saturation.

In fiscal 1997, 1996 and 1995, the Company had three, four and three major
customers, respectively, each accounting for at least 10% of the Company's
revenue from operations.  Such major customers accounted for approximately 91%,
81% and  91% of the Company's revenue from operations in fiscal 1997, 1996 and
1995, respectively.  See Note J to Consolidated Financial Statements.  No
single customer has generated a majority of the Company's revenue during any
consecutive years during this period.  Management does not consider the
Company's business to be dependent upon a single customer or group of
customers.


                                      4


<PAGE>   5

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


Product Development

The Company is in an industry characterized by technological change, which
requires continuous expenditure of funds for research, development and product
improvement.  The Company currently intends to use, whenever possible, external
contract funds and licensing agreements to expand its product line and minimize
internal research and development costs.

The Company has incurred research and development expense of approximately
$102,000, $469,000 and $586,000 for fiscal 1997, 1996 and 1995, respectively.
In fiscal 1997, 1996 and 1995 the Company expended approximately $789,000,
$395,000 and $839,000, respectively, in performing customer-funded product
development under contracts for advanced equipment in the field of remote
sensing.

The Company has five employees whose primary responsibility is product
development and five employees who, in addition to their primary production,
manufacturing and administrative duties, also contribute to the product
development effort.

Patents

Although the Company has several patents and considers patent protection of any
technological advances to be desirable and intends to apply for patents when
appropriate, it believes that the Company's future success  depends principally
upon its engineering, marketing and manufacturing skills rather than upon
patent protection.

Raw Materials

The Company's operations require a variety of unique precision
optical-mechanical and electronic components and other supplies.  Although most
components and supplies are generally available from many commercial sources,
certain components, which are designed and specified to meet the Company's
particular requirements, have a limited number of manufacturing sources.  Due
to the specialized nature of these components and the limited quantities in
which they are purchased, procurement lead times may be as long as six months.
However, the Company believes that the loss of a single supplier would not be
expected to have a material adverse effect on the Company.

Competition

There are several competitors that compete with individual products produced by
the Company.  During the past few years, one of these competitors has begun
offering to build products that compete with more of the Company's standard
remote sensing systems.  To date, the Company has not been  materially affected
by this competition.  The Company expects an increase in the number of
competitors as governments worldwide continue to reduce military spending since
many companies selling similar instruments for military purposes are now
beginning to pursue non-military customers.  In addition, the Company's
products compete with related technologies, such as satellite remote sensing
systems.  In general, the superior spectral and spatial resolution and
scheduling flexibility of the Company's products enable the Company to compete
effectively with suppliers of satellite-based data when the capabilities of the
Company's products justify the generally more costly airborne data.  The
Company has been able to compete successfully against its competitors through
the demonstrated performance of its products and

                                      5



<PAGE>   6

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

its product support mechanisms, and through the excellent reputation it has
earned and maintained for the durability of its products.  The Company also
competes on the basis of its continuous efforts to offer product improvements
and new products that keep its technology at the leading edge and offer
customers the latest innovations.

Management believes that the Company competes successfully in the field of
product development due to the Company's special capabilities in remote sensing
technology and its history of successful completion of such development
products.  See "Growth Plan" for a description of expected changes in
competition as the Company implements its growth plan.

Backlog

Total August 31, 1997 backlog of unfilled customer orders was approximately
$530,000 compared to approximately $895,000 one year earlier.  The Company
expects to fill substantially all of its August 1997 backlog during fiscal
1998.  See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - New Orders and Backlog".

Government Contracts

Contracts with U.S. Government agencies generally provide for reimbursement of
costs plus a fee.  Revenue, fees and profits on such contracts are generally
recognized on the costs incurred to date.  Reimbursable contract costs
(including overhead and general and administrative expenses) are generally
subject to audit and adjustment by negotiation between the Company and U.S.
government representatives.  Revenue under these contracts is recorded at
amounts that are expected to be realized upon the final settlement with any
adjustments to revenue reflected in the year of settlement.

Growth Plan

The Company is in the process of implementing a growth plan that is focused on
two initiatives to provide growth in revenues and profits from new market
areas.  The goal of the growth plan is to diversify the Company's
revenue-producing activities and reduce fluctuations in the Company's revenue
and earnings.  Management has focused its efforts on two areas of the plan with
the most near-term potential.

The first growth area involves the use and sale of airborne digital cameras
(ADC) developed by the Company for the mapping of infrastructure within narrow
corridors.  Examples of the types of infrastructure that would be mapped with
such a system include gas pipelines, electrical distribution systems, railroads
and highways.  The Company has developed an enhanced version of the ADC and an
image processing system that can be bundled with the ADC for delivery to its
customers and for use by the Company in performing services for customers.  The
Company completed three contracts in fiscal 1996 for which it has utilized the
ADC, and in the fourth quarter of fiscal 1996, the Company entered into a
marketing alliance with a major company which provides infrastructure
maintenance services to the electric and gas utilities, and railroads in the
United States and Canada.  Although the Company did not receive any such
contracts in fiscal 1997, marketing efforts by the Company and its marketing
partner have generated considerable market interest in the ADC which the
Company hopes will generate orders in fiscal 1998.  The Company has also been
requested to team with several engineering companies to provide airborne
digital camera services for a large multi-year inventory program that

                                      6



<PAGE>   7

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

would establish a foothold in this emerging market. The Company is continuing
to pursue various alternatives to obtain the additional funding necessary to
bring these services to market.  However, there can be no assurance that such
funding will be obtained.  See "Liquidity and Sources of Capital".

The other growth area involves performing domestic environmental surveys to
provide a better applications market for the Company's airborne multispectral
scanners.  In order to exploit this market, the Company must perform specific
applications and show the results to be reliable and cost-effective.  To date,
the Company has completed several contracts in this area for customers such as
the U.S. Environmental Protection Agency and the U. S. Bureau of Reclamation,
and continues to pursue other demonstration projects.  In addition, the Company
has completed development of an airborne digital multispectral camera for NASA
under a SBIR project and has negotiated a strategic alliance to bring this
product to the commercial market in the spring of 1998.

Competition in these new areas of business will be different than that faced by
the Company in its core business and competitors  will be more numerous since
there are many more companies offering products and services in each of these
areas of new business.  Competition will include conventional aerial survey
firms using film cameras and commercial remote sensing satellite data.  The
commercial remote sensing satellite competitors are in the formative stage and
will not have products to offer until two to three years in the future.  The
Company believes, however,  that its capabilities in providing the source of
unique data using its airborne digital camera and multispectral scanners for
each of these market areas, coupled with its strategy to team with selected
partners in processing and analyzing such data, will provide the opportunity to
secure significant new business and will enable the Company to  compete
successfully in each of these market areas.

These growth plan initiatives will require changes in the Company's sales and
marketing strategies and budgets.  The marketing alliance for the
infrastructure information service calls for the Company's partner to perform
most marketing and sales functions.  However, the Company will provide
brochures, data samples, and other support to its partner.  In addition, it is
anticipated that this market will require more participation in trade shows and
more space advertising than the Company has engaged in during previous years.

The customers for these new products and services will also be different than
those involved in the Company's core product business.  It is expected that
these customers are unfamiliar with the Company.  However, they are familiar
with the services provided by the Company's marketing alliance partner and this
is one of the primary strategies to accelerate access to these markets.

Although implementation of the growth plan began in fiscal 1995, material
revenue impact is not expected until late fiscal 1998 at the earliest.  These
strategies are intended to reduce fluctuations in the Company's revenue and
earnings and enhance the Company's profitability and stockholder value.
However, the Company's implementation of these growth initiatives has been
slowed by the small size of the Company's staff, by its current financial
position and by the lack of solid market information caused by the Company's
limited resources.  The Company is seeking partners and additional financing to
help bring these services into the market more quickly. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Sources of Capital".



                                      7

<PAGE>   8

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


Personnel

As of September 30, 1997, the Company had 16 full-time employees, three of whom
were executive officers.

Executive Officers of the Company

The executive officers of the Company (who serve as such at the pleasure of the
Board of Directors), their ages and the position or office held by each are as
follows:


<TABLE>
<CAPTION>
               Name               Age                   Positions with the Company
     --------------------------------------------------------------------------------------
     <S>                           <C>   <C>
     Thomas R. Ory                 58    President & Chief Executive Officer and Director


     Charles G. Stanich            53    Vice President-Research & Development &
                                         Chief Operating Officer and Director

     Jane E. Barrett               46    Vice President-Finance, Treasurer  & Chief Financial
                                         Officer
</TABLE>


Mr. Ory, who was appointed President and Chief Executive Officer in August
1987, joined the Company in 1972 as Director of its Applications Division,
served as Vice President-Marketing from 1979 to 1984, and Executive Vice
President from 1985 to 1987.

Mr. Stanich, who was appointed Chief Operating Officer in 1987, joined the
Company in 1974 and served as Manager, Research & Development from 1979 to
1984, and Vice President-Research & Development since 1984.

Ms. Barrett, who was appointed Vice President-Finance and Chief Financial
Officer in March 1997 and who was appointed Treasurer in August 1996, joined
the Company in May 1996 as its Controller.  Prior to joining the Company, Ms.
Barrett was employed by Federal-Mogul Corporation, a Fortune 500 manufacturer
and distributor of automotive parts, from 1984 to 1996 in various managerial
accounting positions.  Her most recent position was International Accounting
Manager with responsibility for the financial functions of a $600 million
international division.

ITEM 2.  PROPERTIES

The Company's office is located in Ann Arbor, Michigan.  The office and
research facility is situated on approximately 11 acres of property.  The
building encompasses 24,000 square feet, of which approximately 17,500 square
feet are devoted to engineering, manufacturing, testing and research and
development; and 3,800 square feet are devoted to marketing and administrative
activities. This facility, which is owned by the Company, is subject to a
mortgage.  See Note D to Consolidated Financial Statements.

The Company is attempting to sell its building and lease back a portion of the
facility from the new owner.  If the Company must relocate, management is
confident that a suitable facility can be found and that the Company's business
will not be materially disrupted.  See "Liquidity and Sources of Capital."


                                      8


<PAGE>   9

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


ITEM 3.  LEGAL PROCEEDINGS

There are no pending legal proceedings to which the Company is a party or to
which any of its property is subject.

 Item 4.  Submission of Matters to a Vote of Security Holders

No matters were presented to a vote of security holders during the fourth
quarter of fiscal 1997.


                                    PART II

ITEM 5.  MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET PRICE AND DIVIDEND INFORMATION

The Company's common stock is traded in the over-the-counter market.  The
following table sets forth the quarterly range of high and low bid prices for
the common stock and dividends declared on the common stock since July 31,
1995.  Prices shown are as reported by National Quotation Bureau, Incorporated.
Such quotations reflect inter-dealer prices without retail mark-up, mark-down
or commission and may not represent actual transactions.


<TABLE>
<CAPTION>
                                                                          QUARTER ENDED
                                         ------------------------------------------------------------------------------
                                         OCT. 31  JAN. 31   APR. 30   JULY 31    OCT. 31  JAN. 31    APR. 30    JULY 31
                                           1995     1996      1996      1996       1996     1997       1997       1997
                                         ------------------------------------------------------------------------------
        <S>                                <C>     <C>       <C>        <C>       <C>        <C>        <C>        <C>
        High                               2 3/4   2 3/4     2 1/4      2 1/4     2 1/4      2          2 3/8      2 5/8
        Low                                 2      1 1/2     1 9/16     1 1/2     1 5/8      1 5/8      1 7/8      2 1/8
        Cash dividend per share             $.00    $.00       $.00      $.00      $.00       $.00       $.00       $.00
</TABLE>


As of September 30, 1997, the Company's common stock was held by approximately
200 holders of record.

The payment of future dividends will depend on the operating performance of the
Company, its prospects, its operating cash requirements and the consent of its
principal bank lender.


                                      9


<PAGE>   10

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                    1997         1996        1995       1994        1993
                                                                           (thousands except for per share data)
----------------------------------------------------------------------------------------------------------------------------
FIVE YEAR SUMMARY OF OPERATIONS AND FINANCIAL POSITION
<S>                                                                  <C>        <C>         <C>         <C>         <C>
OPERATING REVENUE

  Standard products                                                   $2,200      $1,657      $2,340        $505     $2,614
  Customer-funded product development                                    788         430       1,278       1,938      3,654
----------------------------------------------------------------------------------------------------------------------------
                                                                       2,988       2,087       3,618       2,443      6,268
OTHER INCOME                                                              13           3           6          10         37
----------------------------------------------------------------------------------------------------------------------------
                                                                       3,001       2,090       3,624       2,453      6,305
COSTS AND EXPENSES
  Cost of revenue - standard products(1)                               1,342       1,037       1,180         223      1,064
  Cost of revenue - product development(1)                               629         395         839       1,800      2,754
  Research and development                                               102         469         586         398        205
  Selling and administrative                                             932         947       1,473         977      1,624
  Interest                                                                64          77          83          36         25
---------------------------------------------------------------------------------------------------------------------------
                                                                       3,069       2,925       4,161       3,434      5,672
---------------------------------------------------------------------------------------------------------------------------
                             EARNINGS (LOSS) BEFORE INCOME TAXES        (68)       (835)       (537)       (981)        633
PROVISION (CREDIT) FOR INCOME TAXES                                      (4)         132       (175)       (328)        179
---------------------------------------------------------------------------------------------------------------------------
                                 INCOME (LOSS) BEFORE CUMULATIVE
                                  CHANGE IN ACCOUNTING PRINCIPLE        (64)       (967)       (362)       (653)        454
CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLE NET OF
  APPROXIMATELY $9,000 OF INCOME TAXES                                    0           0           0          22           0
---------------------------------------------------------------------------------------------------------------------------
                                             NET EARNINGS (LOSS)       $(64)      $ (967)      $(362)      $(631)       $454
===========================================================================================================================
EARNINGS (LOSS) PER SHARE BEFORE CUMULATIVE
 CHANGE IN ACCOUNTING PRINCIPLE (1)                                  $ (0.12)     $(1.85)     $(0.70)     $(1.28)      $0.78
===========================================================================================================================
 NET EARNINGS (LOSS) PER SHARE (2)                                   $ (0.12)     $(1.85)     $(0.70)     $(1.24)      $0.78
===========================================================================================================================
 CASH DIVIDENDS PER SHARE                                              $0.00       $0.00       $0.17       $0.15      $0.13
===========================================================================================================================


TOTAL ASSETS                                                          $2,070      $2,769      $3,930      $4,041     $4,762
WORKING CAPITAL                                                         $268        $213        $801      $1,562     $2,144
LONG-TERM DEBT                                                        $    0      $    0      $    0        $278       $314
STOCKHOLDERS' EQUITY                                                  $1,411      $1,473      $2,390      $2,830     $3,516


SALES BY GEOGRAPHIC AREA
  Europe                                                                $154        $814      $2,255        $916     $5,296
  Asia                                                                 1,178         562          43           5          0 
  United States                                                        1,656         711       1,312       1,522        970
  Other                                                                    0           0           8           0          2
---------------------------------------------------------------------------------------------------------------------------
                                                                      $2,988      $2,087      $3,618      $2,443     $6,268
===========================================================================================================================
</TABLE>

(1) Effective August 1, 1993, the Company changed from completed component to
cost incurred as a percentage of the total estimated cost as the method for
determining percentage completion for revenue recognition on standard product
contracts.  The cumulative effect of this accounting change reduced the loss by
$22,187, or $.04 per share, for fiscal 1994.

(2) See Note I of  Notes to Consolidated Financial Statements for a description
of the calculation of earnings per share.


                                      10


<PAGE>   11

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

GENERAL

The Company manufactures products for, and performs development projects in,
the field broadly described as "remote sensing".  The principal products
manufactured by the Company are airborne imaging systems which are installed in
aircraft for acquisition of data on environmental parameters.  A principal
application of the Company's remote sensing products has been the measurement
of environmental parameters in support of pollution control programs and
environmental impact studies.  The Company is also engaged in customer-funded
projects for the development of advanced equipment in the remote sensing field.
Some of these projects may lead to the incorporation of newly developed
technology into existing or future product lines.

These two portions of the business are conducted by the same pool of personnel
using the same equipment and operating space and constitute a single industry
segment. The margins associated with these two portions of the business are
different, with standard products generally having higher margins than
customer-funded development projects.  The Company receives the majority of its
revenue from a small number of relatively large contracts.  Standard product
contracts are generally of higher dollar value than customer-funded product
development contracts, with each contract representing a substantial portion of
total revenue each year.  Therefore, the timing of the receipt of a standard
product sales contract as well as the related manufacturing endeavor can have a
material impact on a quarter-to-quarter or year-to-year comparison of the
Company's results of operations.  Most standard product sales contracts and
some customer-funded product development contracts are also accompanied by a
significant deposit.  Therefore, the timing of the contract receipt can have a
material impact on the Company's cash flow.

The Company incurred significant losses in fiscal 1996, 1995 and 1994 which
have caused the Company to experience liquidity problems from time to time and
to utilize its bank line of credit to maintain operations during these periods.
The Company received a substantial amount of new business which allowed the
Company to reduce the size of its losses to approximately $64,000 for fiscal
1997 and to reduce the outstanding amount borrowed under its line of credit to
zero at July 31, 1997.  The Company's short-term viability and operating
results are dependent on its ability to acquire additional equity capital and
to generate new business.  Until cash flow generated from operations is
sufficient to support the Company's operations, the Company's short-term
viability is also dependent on its ability to borrow money under its line of
credit agreement.  See "New Orders and Backlog" and "Liquidity and Sources of
Capital".  The Company's long-term viability is dependent upon its ability to
successfully implement its Growth Plan and attain consistent profitability.
The Growth Plan is not expected to have a material impact on revenue until late
fiscal 1998 at the earliest.  See "Business Growth Plan".



                                      11

<PAGE>   12

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


OPERATING REVENUE

<TABLE>
<CAPTION>
                                   STANDARD              PRODUCT             TOTAL
                                   PRODUCT             DEVELOPMENT         OPERATING
                                   REVENUE               REVENUE            REVENUE
                             --------------------------------------------------------
                                          % OF                 % OF
                               (000)      TOTAL     (000)      TOTAL         (000)
     --------------------------------------------------------------------------------
     <S>                        <C>        <C>       <C>       <C>            <C>
     1997                       $2,200     74          $788     26            $2,988
     1996                       $1,657     79          $430     21            $2,087
     1995                       $2,340     65        $1,278     35            $3,618
</TABLE>


Standard product revenue during fiscal 1997 was higher than fiscal 1996 due to
the revenue recognized on a significant standard product order received at the
beginning of fiscal 1997.  The decrease in  standard product revenue in fiscal
1996 compared to fiscal 1995 was attributable to reduced backlog at the
beginning of fiscal 1996 and the low number of new contracts received in fiscal
1996.

Product development revenue was higher in fiscal 1997 compared to fiscal 1996
due to the recognition of revenue on two product development contracts received
in late fiscal 1996. The decrease in product development revenue in fiscal 1996
compared to fiscal 1995 was attributable to the low level of product
development backlog at the beginning of fiscal 1996 and delays in the receipt
of new product development contracts until late in the fiscal year.  The
decline in customer-funded product development revenue was largely due to the
delay by the U.S. Congress in approving its fiscal 1996 budget resulting in a
delay in awarding Small Business Innovation Research contracts and in the
Company's recognition of revenue from such contracts.

The level of the Company's revenues and profits has historically fluctuated
from quarter-to-quarter and from year-to-year as the majority of its revenue is
derived from a small number of high dollar value contracts.  Although
fluctuations are normal given the Company's reliance on a small number of high
value contracts for the majority of its revenue, the low level of standard
product orders received in the last several years has caused severe liquidity
problems from time to time.  See "New Orders and Backlog" and "Liquidity and
Capital Resources".  

DOMESTIC VS. INTERNATIONAL REVENUE

<TABLE>
<CAPTION>
                                  INTERNATIONAL         DOMESTIC            TOTAL
                                    OPERATING           OPERATING         OPERATING
                                     REVENUE             REVENUE           REVENUE
                             --------------------------------------------------------
                                           % OF               % OF
                                (000)      TOTAL     (000)    TOTAL         (000)
     --------------------------------------------------------------------------------
     <S>                         <C>        <C>      <C>                     <C>
     1997                        $1,332     45       $1,656    55            $2,988
     1996                        $1,376     66         $711    34            $2,087
     1995                        $2,306     64       $1,312    36            $3,618
</TABLE>


International operating revenue remained relatively constant during fiscal 1997
compared to fiscal 1996. The increase in domestic operating revenue during
fiscal 1997 compared to fiscal 1996 was due to the  revenue earned on the NASA
contract received in the second quarter of fiscal 1997 and the recognition of
revenue on the two domestic product development contracts received in late
1996.  The decrease in international operating revenue during fiscal 1996 and
1997 compared to fiscal 1995 was primarily due to the Company's receipt of
contracts with a lesser value during fiscal 1996 and 1997 than the relatively



                                      12

<PAGE>   13

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

large contract orders received in fiscal 1995 and, to a lesser extent, to the
low international backlog as of the beginning of fiscal 1996 and 1997.  The
decrease in domestic operating revenue during fiscal 1996 compared to fiscal
1995 was due to the delay by the U.S. Congress in approving its fiscal 1996
budget resulting in a delay in awarding Small Business Innovation Research
contracts and in the Company's recognition of revenue from such contracts.

Management expects a significant portion of the Company's revenue to be
generated from the international market in fiscal 1998 and future years.  To
mitigate foreign currency transaction losses, international contracts are
denominated in U.S. dollars and large standard product contracts are generally
secured by irrevocable letters of credit.  The Company also receives
substantial deposits on many large contracts with international customers.

OTHER INCOME

Other income, for the periods presented, is comprised principally of rental
fees for equipment.  The level of such income is dependent on the requirement
for equipment owned by the Company.  The Company does not expect significant
other income for fiscal 1998.

MAJOR CUSTOMERS
<TABLE>
<CAPTION>
                                                                 FISCAL YEAR ENDED JULY 31,
                                                                -------------------------------
                                                                1997        1996        1995
                      CUSTOMER  DESCRIPTION                     (000)       (000)       (000)
     ------------------------------------------------------------------------------------------
     <S>                                                          <C>          <C>       <C>
     Asian standard product customer                              $1,144       $562
     European standard product customer                                        $436      $1,152
     European standard product customer                                        $186        $917
     European product development customer                                                  $90
     U.S. government agencies                                     $1,625       $618      $1,228
</TABLE>


The customers to whom the Company sells change from year-to-year.  No single
customer has generated a majority of the Company's revenue during any
consecutive years during this period.  Revenue from U.S. government agencies
accounted for approximately 54%, 30% and 34% of revenue for fiscal 1997, 1996
and 1995, respectively.   Asian customers are an important source of revenue
for the Company, generating 38% and 29% of operating revenue for fiscal years
ended July 31, 1997 and 1996, respectively.  Italian customers were an
important source of revenue for the Company in fiscal year 1995 (28%), but no
significant orders were received in fiscal 1997 and fiscal 1996 as the Italian
market for the Company's current products is near saturation.   See "New Orders
and Backlog".

NEW ORDERS AND BACKLOG

In fiscal 1997, the Company received orders in the amount of approximately
$2,629,000 as compared to approximately $2,517,000 in fiscal 1996.
Approximately $2,459,000 of the  bookings received by the Company in fiscal
1997 were for standard products, with the remainder for product development
orders. The Company's backlog at the end of fiscal 1997 was approximately
$652,000, compared to approximately $1,014,000 at the end of fiscal 1996.
Approximately $369,000 of the fiscal 1997 backlog is for standard products,
with the majority of the balance being related to the two Phase II Small
Business Innovation Research (product development) contracts awarded during
fiscal 1996.


                                      13


<PAGE>   14

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

The Company is engaged in negotiations for several standard product orders
which have not yet been finalized and there can be no assurance that these
orders will be received. The Company has some high value components in
inventory that will enable the Company to immediately recognize revenue upon
receiving one of these standard product orders.

One of the large standard product contracts that the Company has pursued for
more than three years was not awarded to the Company due to final price
concessions and contract terms requested by the customer to which the Company
could not agree.  A second large international standard product program has
encountered export licensing problems which now seem to threaten the viability
of the program.  The current economic crisis in several Asian countries has
delayed several programs that the Company expected to be awarded in late 1997
or early 1998.

The Company has received new orders at a level below that required for the
Company to be profitable in the last several fiscal years.  Therefore, the
Company's ability to retain its line of credit and continue operations depends
upon the receipt of additional significant orders during fiscal 1998.
Management is hopeful that such orders will be received although no assurances
can be given. See "Liquidity and Sources of Capital".  The results of
operations for future periods are dependent upon the receipt and timing of
future orders and the success of management's growth strategy.

COST OF REVENUE

The following table sets forth for the three most recent fiscal years, cost of
standard product revenue as a percentage of standard product revenue, cost of
product development revenue as a percentage of product development revenue and
cost of operating revenue as a percentage of operating revenue.

<TABLE>
<CAPTION>
                                                       AS % OF
                               -----------------------------------------------------
                                 STANDARD            PRODUCT             OPERATING 
                                 PRODUCT           DEVELOPMENT            REVENUE
     -------------------------------------------------------------------------------
     <S>                            <C>                 <C>                  <C>
     1997                           61                  80                   66
     1996                           63                  92                   69
     1995                           50                  66                   56
</TABLE>


In fiscal 1997, cost of standard product revenue, cost of product development
revenue and overall cost of revenue decreased as a percentage of related
revenue compared to the previous fiscal year due primarily to economies of
scale resulting from the higher revenues in fiscal 1997 and more efficient
operations with a reduced work force.

In fiscal 1996, cost of standard product revenue and cost of product
development revenue increased as a percentage of related revenue compared to
the previous fiscal year due primarily to the Company operating significantly
below its capacity during the fiscal year, causing overhead rates to increase
substantially.  Contributing to the high cost of revenue in fiscal 1996 were
increases in the Company's provision for obsolete and excess inventory caused
by the reappraisal of excess inventory due to the recent low level of contracts
received for standard products.

The cost of revenue percentage for fiscal 1998 will be dependent upon the
timing and mix of future contracts.  See "New Orders and Backlog".



                                      14

<PAGE>   15

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


RESEARCH AND DEVELOPMENT

<TABLE>
<CAPTION>
                                           COST         % OF
                                          (000)        REVENUE
     ----------------------------------------------------------
     <S>                                      <C>        <C>
     1997                                     $102        3
     1996                                     $469       22
     1995                                     $586       16
</TABLE>


Research and development in fiscal 1997 decreased from the comparable
period in the prior year primarily since the majority of the ADC enhancements
were  completed in fiscal 1996. Contributing to the fiscal 1997 research and
development expense were costs associated with the improvement of the Company's
current products and other areas of research.  The majority of the Company's
investment in research and development in fiscal 1996 was related to
enhancements to the ADC developed in fiscal 1995. The Company also shared costs
in a number of customer funded product development projects during fiscal 1997,
1996 and 1995 but did so to a lesser extent in fiscal 1997 and fiscal 1996 than
in the preceding years.  See Note G of Notes to Consolidated Financial
Statements.

Management's goal is to maintain research and development expense in the near
future at approximately the current levels, and then in the long-term have
research and development expense average approximately 5% of revenue so as to
continually improve its existing product line and develop new products that are
consistent with management's growth plan.  Management realizes that from time
to time it may be required to invest more than 5% of revenues into research and
development to develop the products and services that the Company will require
to meet its customers' needs and to establish steady growth in its level of
operations and profits.

SELLING AND ADMINISTRATIVE EXPENSE


<TABLE>
<CAPTION>
                                          COST       % OF
                                         (000)      REVENUE
     -------------------------------------------------------                               
     <S>                                <C>           <C>
     1997                                 $932        32
     1996                                 $947        45
     1995                               $1,473        41
</TABLE>


Selling and administrative expense in absolute terms decreased slightly in
fiscal 1997 compared to fiscal 1996, due primarily to the Company's third
quarter staffing reductions which were offset by the Company's increased
commissions on international sales. The selling and administrative expense
decreased as a percentage of revenue due to the higher sales volume in fiscal
1997.  Selling and administrative expense in absolute terms decreased in fiscal
1996 compared to fiscal 1995, primarily due to the Company's 1996 third quarter
staffing reductions and also due to nonrecurring marketing research expenses
which were incurred in fiscal 1995.  The selling and administrative expense
increased as a percentage of revenue due to the lower sales volume in fiscal
1996.

INTEREST

Interest expense decreased over the last three fiscal years due principally to
the Company's reduced borrowings.  Interest expense for fiscal 1998 will be
dependent upon future interest rates and the extent to which the Company
utilizes its line of credit during the year.


                                      15


<PAGE>   16

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

PROVISION (CREDIT) FOR INCOME TAXES

The credit for income taxes in fiscal 1997 results primarily from a prior year
refund related to a Foreign Sales Corporation.  The Company's recognition of
income tax benefit was again limited in fiscal 1997 due to the uncertainty of
realizing the net operating loss carryforward.  See Note E of Notes to
Consolidated Financial Statements.  The provision for income taxes in fiscal
1996 results from the increase in the valuation allowance for deferred taxes.
Such increase is attributable to the effect of the taxable losses during the
three most recent fiscal years on the Company's liquidity and the resulting
uncertainty of realizing the net operating loss carryforward.  The fiscal 1996
provision reverses a portion of the income tax benefit recognized in the fiscal
1995 provision.

LIQUIDITY AND SOURCES OF CAPITAL

The Company's primary sources of liquidity were funds from operations and
borrowings under a line of credit secured by substantially all of the Company's
assets including real estate.  The Company's line of credit provides for
borrowings of up to $1,550,000 with availability subject to a formula, bearing
interest at one and one-half percent above the lending bank's prime rate.  The
formula permits borrowing up to $950,000 based on the value of the real estate,
with the remaining available borrowings based on 50% of the value of certain
receivables specified in the line of credit agreement.  As of  July 31, 1997,
borrowings under the line of credit formula were limited to approximately
$1,000,000 pursuant to the availability formula.  At that date, the Company had
an outstanding balance of zero under the line of credit with $59,000 of the
line reserved for a standby letter of credit.

The Company's mortgage indebtedness requires the Company to make monthly
payments of $3,685 for both principal and interest and to make a balloon
payment on November 1, 2000.   The mortgage bears interest at one and one-half
percent over prime.  The Company has classified its total mortgage liability as
current as the mortgage agreement is cross-collateralized and cross-defaulted
with the line of credit which is a secured master demand note.  See Note D of
Notes  to Consolidated Financial Statements.

In the event the lending bank believes that the prospect of payment of the
Company's indebtedness under the line of credit is impaired, the lending bank
is permitted under the agreement governing the line of credit to declare such
indebtedness due and payable.  The lending bank has indicated that it may limit
the amount which the Company is permitted to borrow under the line of credit in
the absence of continued improvement in the Company's business prospects or
progress toward the acquisition of a significant amount of equity capital.  If
the Company is unable to borrow amounts necessary to fund its operations, its
financial position would be materially and adversely affected and the Company
may have no choice but to cease operations if other sources of capital are not
available.  Moreover, the Company must increase its backlog during fiscal 1998
in order to generate sufficient cash flow to sustain its operations.

In order to provide additional working capital and retire current debt, the
Company is attempting to sell its building and lease back a portion of the
facility from the new owner.  There can be no assurance that the building can
be sold at a price acceptable to the Company or that an acceptable lease-back
agreement can be negotiated.  If the Company must relocate, management is
confident that a suitable facility can be found and that the Company's business
will not be materially disrupted.  The sale of the building is expected to
result in the termination of the existing line of credit.  Management believes
that a new line of credit supported by receivables and other assets of the
Company can be negotiated with


                                      16


<PAGE>   17

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

the current bank lender or a substitute bank which will be adequate to support
the Company's working capital needs provided that the Company's backlog
increases significantly over the current level.  The Company also can negotiate
a line of credit secured by the irrevocable letters of credit received on large
orders from international customers.  However, any new line of credit is likely
to permit substantially less borrowing than the current line of credit.  There
can be no assurance that the Company will be able to acquire a replacement line
of credit at all or that the level of borrowing permitted under any replacement
line of credit will be adequate for the Company's working capital needs.  The
Company is also actively pursuing additional equity financing through
discussions with potential investors possessing related technological and/or
marketing capabilities that can help the Company develop new markets for its
facility management information technology.  However, there can be no assurance
that such financing can be obtained.

Working capital increased to approximately $268,000 at July 31, 1997 from
approximately $213,000 at July 31, 1996, due primarily to the utilization of
inventory parts in stock for orders received in fiscal 1997 .  Funds from
billed receivable collections and from customer deposits were used for payments
on the line of credit.

Current liabilities decreased in fiscal 1997 largely due to the payment of the
line of credit.  Cash flow from operating activities was approximately $899,000
during fiscal 1996, primarily due to the approximately $537,000 reduction in
accounts receivable.

The Company expects to invest approximately $200,000 during fiscal 1998 for
capital expenditures, primarily for equipment and software relating to the
Company's growth plan.  Due to its current financial position, the Company
intends to reduce internal research and development and to keep marketing and
other administrative costs to a minimum until its financial condition improves
significantly.

The foregoing discussion and analysis contains a number of "forward-looking
statements", as that term is used in the Securities Exchange Act of 1934, with
respect to the Company's expectations for future periods.  Such statements are
subject to various risks and uncertainties, which are described in the
foregoing discussion and analysis.

ITEM 7A.  QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

      Not applicable



                                      17

<PAGE>   18

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL DATA

INDEPENDENT AUDITORS' REPORT


Board of Directors and Stockholders of
Daedalus Enterprises, Inc.
Ann Arbor, Michigan

We have audited the accompanying consolidated balance sheets of Daedalus
Enterprises, Inc. and subsidiaries as of July 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended July 31, 1997.  These
financial statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these financial statements based
upon our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements.  An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation.  We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Daedalus Enterprises, Inc. and
subsidiaries at July 31, 1997 and 1996, and the results of their operations and
their cash flows for each of the three years in the period ended July 31, 1997
in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern.  As discussed in Note K, the Company
is experiencing difficulty in generating sufficient cash flow to meet its
obligations and sustain its operations, which raises substantial doubt about
its ability to continue as a going concern.  Management's plans in regard to
these matters are also described in Note K.  The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.



/s/DELOITTE & TOUCHE LLP
------------------------
Deloitte & Touche LLP
Ann Arbor, Michigan
September 23, 1997



                                      18

<PAGE>   19

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                                                      Years Ended July 31,
                                                                         -----------------------------------------------
                                                                            1997             1996             1995
------------------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>                <C>             <C>
OPERATING REVENUE

STANDARD PRODUCTS                                                          $2,199,756         $1,657,228      $2,339,540
PRODUCT DEVELOPMENT                                                           788,580            429,558       1,278,257
------------------------------------------------------------------------------------------------------------------------
                                                                            2,988,336          2,086,786       3,617,797
OTHER INCOME                                                                   13,122              3,437           6,574
------------------------------------------------------------------------------------------------------------------------
                                                                            3,001,458          2,090,223       3,624,371
COSTS AND EXPENSES
    Cost of revenue - standard products                                     1,342,561          1,036,539       1,179,648
    Cost of revenue - product development                                     629,357            395,107         839,159
    Research and development - Note G                                         101,651            469,369         586,466
    Selling and administrative                                                931,778            947,155       1,473,252
    Interest                                                                   63,800             76,638          82,619
------------------------------------------------------------------------------------------------------------------------
                                                                            3,069,147          2,924,808       4,161,144
------------------------------------------------------------------------------------------------------------------------
                                            LOSS BEFORE INCOME TAXES         (67,689)          (834,585)       (536,773)
PROVISION (CREDIT) FOR INCOME TAXES - Note E                                  (3,546)            132,000       (175,000)
------------------------------------------------------------------------------------------------------------------------
                                                               NET LOSS      (64,143)          (966,585)       (361,773)
========================================================================================================================
                                            NET LOSS PER SHARE - Note I       $(0.12)            $(1.85)         $(0.70)
========================================================================================================================

</TABLE>

 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                                                          ADDITIONAL
                                                                           COMMON           PAID-IN         RETAINED
                                                                            STOCK           CAPITAL          EARNINGS
------------------------------------------------------------------------------------------------------------------------
<S>                                                                            <C>            <C>             <C>
STOCKHOLDERS' EQUITY

BALANCES AT JULY 31, 1994                                                      $5,115         $1,104,145      $1,720,885
    Net loss                                                                                                   (361,773)
    Stock issued pursuant to  employee stock plans - 3,380 shares                  34              8,986
    Cash dividends - $.17 per share                                                                             (87,320)
------------------------------------------------------------------------------------------------------------------------
BALANCES AT JULY 31, 1995                                                       5,149          1,113,131       1,271,792
    Net loss                                                                                                   (966,585)
    Stock issued pursuant to employee stock  plans -  18,011 shares               180             49,208
------------------------------------------------------------------------------------------------------------------------
BALANCES AT JULY 31, 1996                                                       5,329          1,162,339         305,207
    Net loss                                                                                                    (64,143)
    Stock issued pursuant to employee stock  plans -  1,100 shares                 11              2,361
------------------------------------------------------------------------------------------------------------------------
BALANCES AT JULY 31, 1997                                                      $5,340         $1,164,700        $241,064
========================================================================================================================
</TABLE>

See Notes to Consolidated Financial Statements




                                      19
<PAGE>   20

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
                                                                                            July 31,
                                                                                  ----------------------------
                                                                                      1997            1996
--------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>              <C>
ASSETS - Note D


CURRENT ASSETS
    Cash and cash equivalents                                                         $39,068          $56,768
    Accounts receivable, less allowance of $2,500  - Note B                           239,703          259,079
    Unbilled accounts receivable - Note B                                              28,500          546,024
    Inventories - Note A                                                              601,462          640,213
    Other current assets                                                               18,075            7,829
--------------------------------------------------------------------------------------------------------------
                                                          TOTAL CURRENT ASSETS        926,808        1,509,913

PROPERTY AND EQUIPMENT - Note A
    Land                                                                              177,131          177,131
    Building                                                                        1,433,898        1,433,898
    Machinery and equipment                                                           831,767          817,640
    Special equipment                                                                 445,310          397,951
--------------------------------------------------------------------------------------------------------------
                                                                                    2,888,106        2,826,620
    Less accumulated depreciation                                                  (1,745,474)      (1,606,526)
--------------------------------------------------------------------------------------------------------------
                                                                                    1,142,632        1,220,094
OTHER ASSETS - Note C                                                                     250           39,446
--------------------------------------------------------------------------------------------------------------
                                                                                   $2,069,690       $2,769,453
==============================================================================================================

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
    Note payable to bank - Note D                                                  $        0       $  689,000
    Accounts payable                                                                  197,563          184,524
    Accrued compensation and related costs                                            103,369           97,936
    Accrued commissions                                                                     0            1,129
    Customer deposits                                                                  57,142                0
    Reserve for product warranties                                                     30,000           30,500
    Other accrued liabilities                                                          28,274           32,228
    Mortgage debt - Note D                                                            242,238          261,261
--------------------------------------------------------------------------------------------------------------
                                                     TOTAL CURRENT LIABILITIES        658,586        1,296,578


STOCKHOLDERS' EQUITY - Note F
    Common stock, $.01 par value
    Authorized - 2,000,000 shares
    Issued and outstanding - 534,024 shares (1996 - 532,924 shares)                     5,340            5,329
Additional paid-in capital                                                          1,164,700        1,162,339
Retained earnings                                                                     241,064          305,207
--------------------------------------------------------------------------------------------------------------
                                                                                    1,411,104        1,472,875
--------------------------------------------------------------------------------------------------------------
                                                                                   $2,069,690       $2,769,453
==============================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements


                                      20


<PAGE>   21

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


 CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                                         Years Ended July 31,
                                                                                 ---------------------------------------
                                                                                   1997           1996         1995
------------------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>           <C>           <C>
OPERATING ACTIVITIES

Net loss                                                                            $(64,143)    $(966,585)    $(361,773)
Adjustments to reconcile net income to net cash provided by operating
   activities
    Depreciation                                                                     138,948       180,280       168,584
    Amortization of software                                                          39,196        65,805        84,942
    Provision (credit) for deferred income taxes                                           0       128,000      (135,000)
    Net book value of special equipment sold                                         149,842       152,451             0
    Loss on disposal of property and equipment                                             0             0         2,553
    Decrease (increase) in accounts receivable                                       536,900       596,881      (627,429)
    Decrease (increase) in inventories                                                38,751        (4,672)      476,096
    Decrease in income taxes receivable                                                    0             0       223,946
    Decrease (increase) in deposits and  other assets                                (10,246)      165,473      (133,392)
    Increase (decrease) in accounts payable and accrued liabilities                   12,889      (259,768)       44,031
    Increase (decrease) in customer deposits                                          57,142        (9,652)     (146,447)
------------------------------------------------------------------------------------------------------------------------
                             CASH PROVIDED BY (USED IN)  OPERATING ACTIVITIES        899,279        48,213      (403,889)
INVESTING ACTIVITIES
    Purchase of property and equipment                                              (211,328)     (143,283)     (134,844)
------------------------------------------------------------------------------------------------------------------------
                                            CASH USED IN INVESTING ACTIVITIES       (211,328)     (143,283)     (134,844)
FINANCING ACTIVITIES
  Proceeds from line of credit                                                     1,758,000     1,967,749     2,572,000
  Principal payments on line of credit                                            (2,447,000)   (1,920,749)   (2,055,000)
  Payments on mortgage debt                                                          (19,023)      (21,347)      (32,671)
  Proceeds of stock issued pursuant to warrants, stock options and
    Stock Purchase Plan                                                                2,372        49,388         9,020
     Dividends paid                                                                        0             0       (40,977)
------------------------------------------------------------------------------------------------------------------------
                              CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES       (705,651)       75,041       452,372
------------------------------------------------------------------------------------------------------------------------
Decrease in cash                                                                     (17,700)      (20,029)      (86,361)
Cash and cash equivalents at beginning of year                                        56,768        76,797       163,158
------------------------------------------------------------------------------------------------------------------------
                                     CASH AND CASH EQUIVALENTS AT END OF YEAR        $39,068       $56,768       $76,797
========================================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.



                                      21

<PAGE>   22

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A - SIGNIFICANT ACCOUNTING POLICIES

A summary of the significant accounting policies followed by Daedalus
Enterprises, Inc. (the "Company") in preparation of the consolidated financial
statements is set forth below.  Certain reclassifications were made to the July
31, 1996 financial statements to conform with the classification used in the
July 31, 1997 financial statements.

PRINCIPLES OF CONSOLIDATION.  The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries.  Upon consolidation,
all intercompany accounts, transactions, and profits are eliminated.

REVENUE RECOGNITION.  Revenue on major contracts is recognized using the
percentage-of-completion method based upon the cost incurred as a percentage of
the total estimated cost, whereby revenue and related costs are recognized
throughout the performance period of the contract.  If estimated total costs on
any contract indicate a loss, the entire amount of the estimated loss is
recognized immediately.

Contract research revenue from U.S. Government agencies (see Note J) generally
provides for reimbursement of costs plus fees.  Revenue, fees and profits on
such contracts are recognized as costs are incurred.  Reimbursable contract
costs (including overhead and general and administrative expenses) are subject
to audit and adjustment by negotiation between the Company and U.S. Government
representatives.  Revenue under these contracts is recorded at amounts that are
expected to be realized upon the final settlement with any adjustments to
revenue reflected in the year of settlement.  Some development contracts
involve cost-sharing by the Company.  The Company recognizes its share of these
costs, which are classified as research and development expense, as incurred.

CASH AND CASH EQUIVALENTS.  The Company considers all highly liquid securities
purchased with an original maturity date of three months or less to be cash
equivalents.

INVENTORIES.  Inventories, principally work-in-process and purchased parts,
are stated at the lower of first-in, first-out cost or market.  Inventory at
July 31, 1997 and 1996 included work-in-process of approximately $115,000 and
$104,000, respectively, with the remainder consisting of raw materials and
subassemblies.

PROPERTY AND EQUIPMENT.  Property and equipment is stated at cost and
depreciated over the useful life by the straight-line method.  Special
equipment includes construction-in-progress, relating to a multispectral
scanner system, in the amount of approximately $158,000 and $119,000 at July
31, 1997 and July 31, 1996, respectively.

Special equipment consists of equipment manufactured by the Company and
includes direct manufacturing costs and overhead.  Such equipment which is used
in manufacturing or research activities of the Company is normally made
available for sale by the Company.  Therefore, revenue from the sale of such
equipment, if any, is included in revenue and the depreciated cost is included
in cost of revenue.  During the fiscal years ended July 31, 1997 and July 31,
1996, the Company sold one such system in each year with a cost of
approximately $150,000 and $152,000, respectively.


                                      22


<PAGE>   23

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

CAPITALIZED SOFTWARE.  Capitalized software costs consist of costs incurred
for internally developed software to be sold as part of standard products or
used in customer-funded product development contracts.  Capitalization begins
upon the establishment of technological feasibility.  The ongoing assessment of
recoverability of capitalized software development costs requires considerable
judgment by management with respect to certain external factors, anticipated
future gross revenue, estimated economic life, and changes in hardware and
software technology.

Capitalized software is amortized on a product-by-product basis over the
related sales on a per-unit basis with minimum amortization based on the
straight-line method over an estimated five year useful life.

NEW FINANCIAL ACCOUNTING STANDARD.  The Company has not completed the process
of evaluating the impact that will result from adopting Statement of Financial
Accounting Standards ("SFAS") No. 128 "Earnings Per Share" ("No. 128"), No. 130
"Comprehensive Income" ("No. 130") and No. 131 "Disclsoures About Segments of
an Enterprise and Related Information" ("No. 131").  SFAS No. 128 is effective
for both interim and annual periods ending after December 15, 1997.  SFAS No.
130 and No. 131 are effective for fiscal years beginning after December 15,
1997.  The Company is, therefore, unable to determine the impact that adopting
SFAS No. 128, No. 130 and No. 131 will have on its financial statements when
such statements are adopted.

NOTE B - ACCOUNTS RECEIVABLE

At July 31, 1997 and 1996, respectively, accounts receivable included
approximately $6,000 in each year from agencies of the United States federal
government that will be paid upon the completion and audit of the cost plus
fixed-fee contracts between the Company and the government agencies.

Unbilled accounts receivable represent  revenue recognized using the
percentage-of-completion method, which are not yet billable under the terms of
the contract.  These amounts become billable based on contract terms either
upon shipment of the items, presentation of invoices, or completion of the
contract.  The cost of such revenue is determined generally by separate job
cost accounts and involves no deferral of costs.

To prevent foreign currency transaction losses, international sales are
contracted in U.S. dollars and large standard product contracts are generally
secured by irrevocable letters of credit.  The Company also receives
substantial deposits on large sales to international customers.

NOTE C - CAPITALIZED SOFTWARE

There was no unamortized software at July 31, 1997.  Other assets include
approximately $39,000 of unamortized software AT July 31, 1996.  No software
was capitalized in fiscal years 1997 and 1996.

NOTE D - NOTE PAYABLE AND LONG-TERM DEBT

On July 31, 1997, the Company had a $1,550,000 line of credit, with
availability subject to a formula, bearing interest at one and one-half percent
above the lending bank's prime rate (effective rate of 10%).  The formula
permits borrowing up to $950,000 based on the value of the real estate, with
the remaining


                                      23


<PAGE>   24

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

available borrowings based on 50% of the value of certain receivables specified
in the line of credit agreement.  As of July 31, 1997, total availability was
approximately $1,000,000 pursuant to the formula.  The Company had an
outstanding balance of zero under this line of credit agreement at July 31,
1997 with $59,000 of the line of credit reserved for a standby letter of
credit.  This compares to a balance of $689,000 (effective rate of 9.75%) under
the prior line of credit agreement and an additional $258,000 reserved for a
standby letter of credit at July 31, 1996.

The Company had a maximum balance outstanding of $689,000 and $747,000 during
fiscal 1997 and 1996, respectively.  The average outstanding balance and
interest rate in fiscal 1997 and 1996 was $385,505 and 9.69% and $480,186 and
9.75%, respectively.

The Company has a mortgage with a balance of $242,238 and $261,261 as of July
31, 1997 and 1996, respectively, bearing interest at one and one-half percent
over prime (effective rate of 10% and 9.75% at July 31, 1997 and 1996,
respectively).   Monthly payments on the mortgage are $3,685 for both interest
and principal with the mortgage being due on November 1, 2000.  The Company has
classified its total mortgage liability as current as the mortgage agreement
is cross-collateralized and cross-defaulted with the line of credit which is a
secured master demand note.

Aggregate annual maturities of long-term debt based on the refinanced mortgage
interest rate of 10% are as follows:

<TABLE>
<CAPTION>
             FISCAL YEAR               MATURITY
     -------------------------------------------
     <S>                                <C>
     1998                                $20,934
     1999                                 23,125
     2000                                 25,547
     2001                                172,632
     -------------------------------------------
                                        $242,238
     -----------------------------------========
</TABLE>

Interest paid on all debt was approximately $64,000, $77,000 and $83,000 in
fiscal 1997, 1996 and 1995, respectively.

NOTE E - INCOME TAXES

The credit for income taxes in fiscal 1997 results primarily from a prior year
refund related to a Foreign Sales Corporation.  The Company has limited its
recognition of income tax benefit due to the  uncertainty of realizing the net
operating loss carryforward.  Provision (credit) for income taxes is made up of
the following components:

<TABLE>
<CAPTION>
                                                             1997           1996            1995
     ----------------------------------------------------------------------------------------------
     <S>                                                    <C>            <C>           <C>
     Current                                                $(3,500)         $4,000       $(40,000)
     Deferred:
                    Tax provision (benefit)                       0         128,000       (135,000)
     ----------------------------------------------------------------------------------------------
                    PROVISION (CREDIT) FOR INCOME TAXES     $(3,500)       $132,000      $(175,000)
     ------------------------------------------------------========================================
</TABLE>


                                      24


<PAGE>   25

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


A reconciliation of the provision (credit) for income taxes and the amount
computed by applying the statutory federal income tax rates to earnings is as
follows:

<TABLE>
<CAPTION>
                                                                        1997         1996         1995
     -----------------------------------------------------------------------------------------------------
     <S>                                                              <C>          <C>          <C>
     Federal income tax on earnings  at statutory rates (35%
          in 1997, 1996 and 1995)                                      $(24,000)    $(292,000)   $(188,000)
     Effect of federal tax rate difference as the result of
          surtax exemptions                                                   0             0        6,000
     Foreign Sales Corporation tax (benefit).                                 0        (2,000)     (10,000)
     Other                                                               20,500       426,000       17,000
     -----------------------------------------------------------------------------------------------------
                                PROVISION (CREDIT) FOR INCOME TAXES     $(3,500)     $132,000    $(175,000)
     -------------------------------------------------------------------==================================
</TABLE>


No federal corporate tax payments were made in fiscal years 1997, 1996 and
1995.

The temporary differences that give rise to deferred tax assets and liabilities
at July 31, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                                        DEFERRED TAX ASSET (LIABILITY)
                                           ----------------------------------------------------------
                                                     1997                             1996
                                           ----------------------------------------------------------
                                           SHORT-           LONG-           SHORT-           LONG-
                                            TERM             TERM            TERM            TERM
     ------------------------------------------------------------------------------------------------
     <S>                                   <C>             <C>              <C>             <C>
     Net operating loss carryforward                        $385,000                         $379,000
     Accrued  personal leave                $14,300                          $14,000
     Inventory reserve                       24,700                           32,000
     Warranty reserve                         8,700                            8,900
     Capitalized software                         0                          (11,000)
     Depreciation                                            (26,000)                         (34,000)
     Valuation allowance                    (50,000)        (359,000)        (47,000)        (345,000)
     Other                                    2,300                            3,100
     ------------------------------------------------------------------------------------------------
                                                 $0               $0              $0               $0
     --------------------------------------==========================================================
</TABLE>




For the current fiscal year, the Company has limited the recognition of income
tax benefit for its current operating losses due to cumulative losses realized
in recent years.  The Company recorded a valuation allowance of $409,000 as of
July 31,1997 and $392,000 as of July 31, 1996.  The increase in the valuation
allowance during fiscal 1997 and 1996 was $17,000 and $392,000, respectively.
At July 31, 1997, the Company had approximately $1,328,000 of net operating
loss carryforward for tax purposes as follows:

<TABLE>
<CAPTION>
                    EXPIRATION DATE             NET OPERATING
                                                     LOSS
                   -------------------------------------------
                          <S>                      <C>
                          2009                        $42,000
                          2010                        506,000
                          2011                        775,000
                          2012                          5,000
                   -------------------------------------------
                                                   $1,328,000
                   -------------------------------============
</TABLE>


NOTE  F - STOCK OPTIONS AND STOCK PURCHASE PLANS

The Company reserved 100,000 shares of common stock for sale to eligible
employees through payroll deductions over six-month periods pursuant to the
1983 Employee Stock Purchase Plan (the "Purchase


                                      25


<PAGE>   26

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

Plan").  The purchase price is the lower of 90% of the fair market value of the
stock on the first or last day of the purchase period.  Under the Purchase
Plan, 1,100, 1,011, and 3,079 shares were issued during fiscal 1997, 1996 and
1995 at an average price of $2.16, $2.36 and $3.56 per share, respectively.  At
July 31, 1997 and 1996, there were 65,568 and 66,918 shares, respectively,
available for future purchase.

The Company has an incentive stock option plan established in 1983 and a
long-term incentive plan and a non-employee director stock option plan
established in 1995 (collectively the "Plans").  The long-term incentive plan
provides for the granting of options, restricted stock and/or performance
awards to key employees and the non-employee director plan provides for the
granting of options to outside members of the board of directors to purchase
common stock of the Company at the fair value at the date of the grant.  There
are 64,000 and 21,000 shares of common stock reserved under the 1995 long-term
incentive plan and the 1995 non-employee director stock option plan,
respectively.  There are 28,000 exercisable options outstanding and 3,000 stock
appreciation rights outstanding under the 1983 incentive stock option plan;
however, no additional options can be granted under this plan.  Options granted
pursuant to the Plans are generally exercisable ratably over a two to five year
period and expire after ten years.

Transactions under the Plans during fiscal years 1997, 1996 and 1995 were as
follows:

<TABLE>
<CAPTION>
                                                          NUMBER          OPTION           WEIGHTED
                                                        OF SHARES         PRICE             AVERAGE
                                                                                         OPTION PRICE
     --------------------------------------------------------------------------------------------------
     <S>                                                    <C>       <C>                    <C>
     Outstanding July 31, 1994                                71,250  $2.75 - $7.00          $4.18
     Options granted to non-employee directors                12,000      $3.94              $3.94
     Options exercised                                          (950)     $3.00              $3.00
     Options canceled                                         (5,100) $3.00 - $6.75          $4.10
     --------------------------------------------------------------------------------------------------
     Outstanding July 31, 1995                                77,200  $2.75 - $7.00          $4.16
     Options granted to employees                             15,000      $2.75              $2.75
     Options exercised                                       (17,000)     $2.75              $2.75
     Options canceled                                         (9,100) $2.75 - $6.75          $4.64
     --------------------------------------------------------------------------------------------------
     Outstanding July 31, 1996                                66,100  $2.75 - $7.00          $3.60
     Options granted to employees                             16,850      $2.25              $2.25
     Options canceled in connection with SARs                (11,850)  $5.00-$7.00           $6.63
     Options canceled                                         (3,750)  $2.75-$3.94           $3.70
     --------------------------------------------------------------------------------------------------
     Outstanding July 31, 1997                                67,350   $2.75-$4.00           $3.25
     -------------------------------------------------------===========================================
</TABLE>



Of the outstanding options at July 31, 1997 and 1996, 54,425 and 52,350 are
exercisable, respectively.  Of the 67,350 shares covered by outstanding options
at July 31, 1997, 3,000 were accompanied by stock appreciation rights.  In
addition to options granted under the Plans, non-qualified options to purchase
40,000 shares have been issued to two officers of the Company at $2.25 per
share which expire on December 10, 2006, options to purchase 3,000 shares have
been issued to the corporate secretary at $2.25 per share which expire on
December 10, 2006 and options to purchase 2,000 shares have been issued to an
employee at $4.00 per share which expire on September 1, 1999.

Total shares of common stock reserved pursuant to the Purchase Plan, the Plans
and the non-qualified options were 224,118.


                                      26


<PAGE>   27

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

The weighted average estimated fair value of options granted during fiscal 1997
and 1996 was $1.03 and $1.49 per share, respectively.  The Company applies
Accounting Principles Board Opinion No. 25 and related Interpretations in
accounting for its granted options.  Accordingly, no compensation cost has been
recognized for its granted options.  Had compensation cost for the Company's
granted options been determined based on the fair value at the grant dates
consistent with the method of Statement of Financial Accounting Standards No.
123 "Accounting for Stock-Based Compensation," the Company's net loss and loss
per common share for the year ended July 31, 1997 would have been increased to
the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                   1997               1996
     ---------------------------------------------------------------------------
     <S>                                           <C>                <C>
     Net loss to common shareholders
         As reported                                $64,143           $966,585
         Pro forma                                 $106,175           $977,768
     
     Net loss per share
         As reported                                  $0.12              $1.85
         Pro forma                                    $0.20              $1.87
</TABLE>


The fair value of options granted by the Company during 1997 and 1996 were
estimated on the date of grant using the Black-Scholes option pricing model
with the following weighted average assumptions used: no dividend yield,
expected volatility of 51.1% and 83.3%, risk free rate of 6.23% and 5.78% and
expected lives of five and ten years.

NOTE G - CUSTOMER-FUNDED PRODUCT DEVELOPMENT

The Company is engaged in customer-funded product development projects in which
the Company shares a portion of the cost of developing the technology and
retains all rights to the technology.  The Company earned product development
revenue of approximately $789,000, $430,000, and $1,278,000  while incurring
related cost of revenue of approximately $661,000,  $395,000, and $839,000 in
fiscal years 1997, 1996 and 1995, respectively.  In addition to these costs of
revenue, the Company performed internal research and development of
approximately $26,000 and $74,000 related to the customer- funded product
development projects in fiscal years ended July 31, 1996 and July 31, 1995,
respectively.  There was no internal research and development performed in
support of customer-funded product development projects in fiscal year 1997.

NOTE H - PENSION PLAN

The Company has a qualified defined contribution plan ("Pension Plan") and a
401(k) employee savings plan ("Savings Plan") covering all employees meeting
age and length of service requirements.  The Pension Plan provides only for
Company contributions of 10% of the active participants' eligible wages.
Pension expense, which is funded quarterly, was $99,000, $96,000 and $135,000
in 1997, 1996 and 1995, respectively.  The Savings Plan requires no Company
contributions; however, the Company may make contributions at the discretion of
the Board of Directors.  No contributions were made to the Savings Plan during
fiscal years 1997, 1996 or 1995.  The Company has no other postretirement
benefits.


                                      27


<PAGE>   28

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


NOTE I - EARNINGS PER SHARE

The Company uses the modified treasury stock method to calculate primary
earnings per share.  No adjustment was made to either the net loss or the
number of shares outstanding for common stock equivalents in calculating
earnings per share for fiscal 1997, 1996, and 1995 as such adjustments would
have been antidilutive.

Weighted average number of shares outstanding and earnings per share for the
three years ended July 31 are computed as follows:

<TABLE>
<CAPTION>
                                                                    1997         1996        1995
     ------------------------------------------------------------------------------------------------
     <S>                                                           <C>         <C>        <C>
     Weighted average number of shares  outstanding                  533,464      522,597     513,287
     Additional shares using the modified
         treasury stock method                                             0            0           0
     ------------------------------------------------------------------------------------------------
                                       AVERAGE NUMBER OF SHARES
                                    OUTSTANDING AND EQUIVALENTS      533,464      522,597     513,287
     ================================================================================================
     Net loss                                                       $(64,143)   $(966,585)  $(361,773)
     ================================================================================================
     
                                                 LOSS PER SHARE       $(0.12)      $(1.85)     $(0.70)
     ================================================================================================
</TABLE>


NOTE J - SEGMENT INFORMATION

The Company manufactures products for, and performs development projects in,
the field broadly described as "remote sensing".  Remote sensing is defined as
the detection or measurement of various physical parameters of an object or
system without direct contact with the object or system being observed.  The
principal products manufactured by the Company are airborne imaging systems
which are installed in aircraft for acquisition of data on environmental
parameters.  A principal application of the Company's remote sensing products
has been the measurement of environmental parameters in support of pollution
control programs and environmental impact studies.

The Company is also engaged in customer-funded projects for the development of
advanced systems in the remote sensing field.  Some of these projects lead to
the incorporation of newly developed technology into the standard product line.
These two portions of the business are conducted by the same pool of personnel
using the same operating space and equipment and constitute a single industry
segment.


                                      28


<PAGE>   29

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


The following table sets forth information with respect to domestic and
international sales of the Company's products and services:

<TABLE>
<CAPTION>
                                                1997          1996          1995
     --------------------------------------------------------------------------------
     <S>                                      <C>            <C>           <C>
     International
       Government agencies
         Asia                                 $1,145,330             $0            $0
         Europe                                  125,668        540,173     2,255,232
         Other                                         0              0        43,299
     --------------------------------------------------------------------------------
                                               1,270,998        540,173     2,298,531
       Industry                                   61,255        836,147         7,377
     --------------------------------------------------------------------------------
                                               1,332,253      1,376,320     2,305,908
     Domestic
       U.S. Government agencies                1,625,433        617,842     1,228,389
       Other                                      30,650         92,624        83,500
     --------------------------------------------------------------------------------
                                               1,656,083        710,466     1,311,889
     --------------------------------------------------------------------------------
                                              $2,988,336     $2,086,786    $3,617,797
     ================================================================================
</TABLE>


The Company's revenue each year is derived from a small number of high dollar
value equipment sales and contracts with a relatively small number of
customers.  These customers change from year-to-year and no single customer has
generated a majority of the Company's revenue during any consecutive years.
Sales to major customers in each of the three years ended July 31, 1997 are as
follows:


<TABLE>
<CAPTION>
                                                               FISCAL YEAR ENDED 
                                                                     JULY 31,
                                                          -------------------------------
                     CUSTOMER  DESCRIPTION                   1997      1996     1995
                                                             (000)     (000)    (000)
     ------------------------------------------------------------------------------------
     <S>                                                      <C>        <C>
     Asian standard product customer                          $1,144     $562    $    0       
     European standard product customer                       $    0     $436    $1,152
     European standard product customer                       $    0     $186    $  917
     European product development customer                    $    0     $  0    $   90
     U.S. Government                                          $1,625     $618    $1,228
</TABLE>


NOTE K - GOING CONCERN MATTERS

The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business.  As shown in the financial
statements during the years ended July 31, 1997, 1996 and 1995, the Company
incurred losses of $64,143, $966,585 and $361,773, respectively, and has
classified all of its debt as current for the years ended July 31, 1997 and
1996.  These factors among others may indicate that the Company will be unable
to continue as a going concern for a reasonable period of time.

The financial statements do not include any adjustments relating to the
recoverability and classification of liabilities that might be necessary should
the Company be unable to continue as a going concern.  As described in Note D,
since the Company's debt facility is in the form of a secured master demand
note, the Company has classified the balance of its mortgage debt ($221,000
related to its mortgage) as a current liability.  The Company's continuation as
a going concern is dependent upon its ability to


                                      29


<PAGE>   30

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES

generate sufficient cash flow to meet its obligations on a timely basis, to
comply with the terms of its financing agreement, to obtain additional
financing or refinancing as may be required, and ultimately to attain
profitability.  The Company is also actively pursuing additional equity
financing through discussions with potential customers possessing related
technological and/or marketing capabilities that can help it develop the new
markets for its facility management information technology.

ITEM 9.  CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

        NONE


                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

The information included in the Company's definitive Proxy Statement for its
1997 Annual Meeting of Stockholders (the "Proxy Statement") under the captions
"Section 16(a) Beneficial Ownership Reporting Compliance" and "Election of
Directors" and under the subheading "Certain Information Regarding Nominees"
is incorporated herein by reference.

ITEM 11.  EXECUTIVE COMPENSATION

The information included in the Company's Proxy Statement under the caption
"Election of Directors - Compensation of Executive Officers" is incorporated
herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information included in the Company's  Proxy Statement under the captions
"Principal Stockholders" and "Election of Directors - Stock Ownership of
Management" is incorporated herein by reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

NONE


                                      30


<PAGE>   31

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)  Financial Statements, Financial Statement Schedules and Exhibits

        1)  The following consolidated financial statements are included in 
response to Item 8 of this report.

            Independent Auditors' Report

            Consolidated Statements of Operations and Stockholder's Equity for
            the years ended July 31, 1997, 1996 and 1995

            Consolidated Balance Sheets--July 31, 1997 and 1996

            Consolidated Statements of Cash Flows for the years ended July 31, 
            1997, 1996 and 1995

            Notes to Consolidated Financial Statements

        2)  Schedules are omitted because of the absence of the conditions 
under which they are required or because the information called for is
included in the consolidated financial statements or notes thereto.

        3)  The exhibits filed herewith are set forth in the Index to Exhibits 
which is incorporated herein by reference.

(b)  Reports on Form 8-K

        No reports on Form 8-K were filed during the last quarter of the
Company's fiscal year ended July 31, 1997.


                                      31


<PAGE>   32

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the  Company has duly caused  this report  to be  signed on  its
behalf by  the undersigned, thereunto duly authorized.

                                          DAEDALUS ENTERPRISES, INC.

                                      By:      /s/THOMAS R. ORY
                                          ----------------------------------
                                          Thomas R. Ory, President
                                          October 20, 1997

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been  signed below  by the following persons on behalf of the
Company and in the capacities and on the dates indicated.

<TABLE>
<S>                                                <C>                                                 
    /s/THOMAS R. ORY                                   /s/CHARLES G. STANICH                           
------------------------------------------         --------------------------------------                                          
Thomas R. Ory                                      Charles G. Stanich                                  
President                                          Vice President-Research & Development               
(Chief Executive Officer)                          (Chief Operating Officer)                           
Director                                           Director                                            
October 20, 1997                                   October 20, 1997                                    
                                                                                                       
    /s/JANE E. BARRETT                                 /s/JOHN D. SANDERS                              
------------------------------------------         --------------------------------------                                          
Jane E. Barrett                                    John D. Sanders                                     
Vice President-Finance & Treasurer                 Chairman of the Board                               
(Principal Financial & Accounting Officer)         Director                                            
October 20, 1997                                   October 20, 1997                                    
                                                                                                       
                                                                                                       
    /s/WILLIAM S. PANSCHAR                             /s/PHILIP H. POWER                              
------------------------------------------         --------------------------------------                                          
William S. Panschar                                Philip H. Power                                     
Director                                           Director                                            
October 20, 1997                                   October 20, 1997                                    
</TABLE>


                                      32


<PAGE>   33

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


                               INDEX TO EXHIBITS

The Commission File Number for all reports filed on Forms 10-K, 10-Q or 8-K
filed by the Company is 0-8193.

<TABLE>
<CAPTION>
   Exhibit No.                                                  Description
   -----------        -----------------------------------------------------------------------------------------------
     <S>              <C>
      3.01            Certificate of Incorporation of the Company, with all amendments thereto, as presently in
                      effect (filed as exhibit 3.01 to the 1994 Form 10-K and incorporated herein by reference)

      3.02            Bylaws of the Company, with all amendments thereto, as presently in effect (filed as exhibit
                      3.02 to the 1994 Form 10-K and incorporated herein by reference)



      4.43            Real Estate Mortgage in the amount of $425,000 dated March 1, 1991, between the Company and
                      Manufacturers National Bank, Ann Arbor (formerly filed as exhibit 4.43, Term Note, to the
                      Company's Quarterly Report on Form 10-Q for the second quarter of fiscal 1991 and
                      incorporated herein by reference)

      4.46            First Amendment to Real Estate Mortgage dated December 23, 1991 between the Company and
                      Manufacturers Bank, N.A. (filed as exhibit 4.46 to the Company's Quarterly Report on Form
                      10-Q for the second quarter of fiscal 1992 and incorporated herein by reference)


      4.55            Mortgage Extension Agreement between the Company and Comerica Bank, dated October 30, 1995
                      (filed as exhibit 4.55 to the Company's Quarterly Report on Form 10-Q for the first quarter
                      of fiscal 1996 and incorporated herein by reference)

      4.57            Master Revolving Note and Advance Formula Agreement between the Company and Comerica Bank,
                      both dated October 25, 1996 (filed as exhibit 4.57 to the 1996 Form 10-K and incorporated
                      herein by reference)

      10.60           1983 Incentive Stock Option Plan (filed as exhibit 10.60 to the 1994 Form 10-K and
        *             incorporated herein by reference)


     10.607           Non-Qualified Stock Option Agreement with Mr. Thomas R. Ory, dated November 8, 1989 (filed as
        *             exhibit 10.607 to the 1993 Form 10-K and incorporated herein by reference)

     10.608           Non-Qualified Stock Option Agreement with Mr. Charles G. Stanich, dated November 8, 1989
        *             (filed as exhibit 10.608 to the 1993 Form 10-K and incorporated herein by reference)

     10.610           Long-term Incentive Plan (filed as exhibit 10.610 to the 1994 Form 10-K and incorporated
        *             herein by reference)


     10.611           Stock Option Plan for Nonemployee Directors (filed as exhibit 10.611 to the 1994 Form 10-K
       *              and incorporated herein by reference)


     10.612           Form of Senior Officer Severance Agreement with Messrs. Ory and Stanich, dated June 21, 1995
        *             (filed as Exhibit 10.612 to the 1995 Form 10-K and incorporated herein by reference)

     10.613           Form of Incentive Stock Option Agreement Under Long-Term Incentive Plan (filed as exhibit
        *             10.613 to the Company's Quarterly Report on Form 10-Q for the first quarter of fiscal 1997
                      and incorporated herein by reference)

     10.614           Form on Non-Qualified Stock Option Agreement Under Long-Term Incentive Plan  (filed as
        *             exhibit 10.614 to the Company's Quarterly Report on Form 10-Q for the second quarter of
                      fiscal 1997 and incorporated herein by reference)
</TABLE>

                                      33



<PAGE>   34

                  DAEDALUS ENTERPRISES, INC. AND SUBSIDIARIES


<TABLE>
<CAPTION>
   Exhibit No.                                                  Description
   -----------        -----------------------------------------------------------------------------------------------
     <S>              <C>
     10.901           Teaming agreement between the Company and Coastal Environmental Services, Inc., dated March
                      17, 1994. (filed as exhibit 10.901 to the 1994 Form 10-K and incorporated herein by
                      reference)


     10.902           Agreement between the Company and James W. Sewall Company, dated March 25, 1994, for the
                      development of the Airborne Digital Camera and related software for pipeline right-of-way
                      monitoring and other applications (filed as exhibit 10.902 to the 1994 Form 10-K and
                      incorporated herein by reference)

      10.903          Teaming agreement between the Company and Pacific Meridian Resources, dated August 17, 1994
                      (filed as exhibit 10.903 to the 1994 Form 10-K and incorporated herein by reference)

      11.01           Computation of Earnings Per Share (filed herewith)


      21.01           Subsidiaries of the Company (filed herewith)

      23.01           Consent of Deloitte & Touche LLP (filed herewith)

      27.01           Financial Data Schedule (filed herewith)
</TABLE>


   *Company's management contracts and compensatory plans and arrangements which
    are required to be filed as exhibits in this Form 10-K.

The Company will furnish to its stockholders a copy of any of the exhibits
listed above upon written request and upon payment of a reasonable fee (limited
to the Company's reasonable expenses in furnishing such exhibits).  Request for
exhibits may be directed to Jane E. Barrett, Treasurer, Daedalus Enterprises,
Inc., P.O. Box 1869 Ann Arbor, MI  48106.


                                      34