Letter to CDI Holders regarding the EGM/AGM

20 October 2022

Fellow CDI Holders of Structural Monitoring Systems,

It has now been a few weeks since we sent out our last update and feel this is a good time to update everyone on what has been happened over the past few weeks. As the Company received a Notice of Requisition by Chess Depository on September 5, it is by statute required to call a meeting in 21 days and then hold it within 28 days or by October 24. As you are all now well aware, in violation of these rules, the Company is taking the extraordinary step of trying to hold the EGM and the AGM back-to-back on November 15 in an apparent effort to muddy the waters and cause confusion. In this letter, I hope to provide some clarity to the current SMS governance environment, but please let me know if you have any further questions.

To start, I think it is of the utmost importance that the company publicly state that Bryant Mclarty is the only Director who is using the ability, but not obligation, of the Board to defer director re-elections for up to 2 years as a means to avoid facing CDI holders in the AGM vote. This obfuscation of the situation has created confusion as nearly everyone we spoke to who reviewed the AGM materials believed Mr. Mclarty was honoring his October 2021 commitment to be a temporary Board member by stepping down. This is another example of Mr. Mclarty breaking his promises and, coupled with the unprecedented actions taken by the Board in of holding the EGM and AGM on the same day, has sown confusion with CDI holders who otherwise think he will be off the Board on November 16^th no matter how they vote in the EGM. None of this would be possible if the company was run to globally established corporate governance best practices, as all directors would be up for election every year. Instead, the company is clinging to antiquated practices that enable the persistence of entrenched power structures.

For some background, the practice of staggering a Board is typically done to avoid giving shareholders the ability to make wholesale changes and is an anachronistic practice in other developed markets. According to a 2018 study by State Street Global Advisors, only 4% of ASX 100 and 2% of ASX 300 companies held annual elections, yet that number was 98% for both FTSE 100 and FTSE 350 companies in the United Kingdom. In the United States, a full 88% of S&P 500 companies and 57% of Russell 3000 companies hold annual elections. As State Street says, “we have found that the shift to annual director elections in the United Kingdom has helped foster an engagement culture that emphasizes director’s accountability to shareholders by improving company responsiveness to investor demands.” Structural Monitoring Systems must move to an annual election schedule for directors, and it is something we intend to advocate for once my colleague, Andrew Roberto, joins the Board. This change should be part of an overall strategy to treat CDI holders as partners in running the company. It is time for this company to be a leader in its treatment of CDI holders, not a poster child for how to circumvent their rights.

Adherence to corporate governance best practices will lead to better outcomes for all of us. As part of that, it is imperative that we focus on properly incentivizing employees so that they vest into their equity when they have made meaningful contributions to the sustainable growth of a business. Equity incentives must be tied to both continued employment at Structural Monitoring Systems (and its subsidiaries) and the achievement of company performance thresholds that move CVM forward. This is, unfortunately, not the way that Structural Monitoring Systems’ Board believes it should incentivize all employees. Instead of time-based and performance-based vesting requirements for options and/or restricted stock, the company has a history of focusing on share price appreciation thresholds in the form of Performance Rights, that vest if the CDI price hits a threshold, and options grants that aren’t subject to ANY meaningful vesting requirements.

Resolution 9, where the Board is asking for the ability to grant 1.5 million options to Ross Love at strike prices from $0.593 to $1.20 is the perfect example of executive compensation at direct odds with building long-term shareholder value. As currently contemplated, Mr. Love will vest 100% of his shares on 13 January 2023 and be free to exercise and sell 100% of his shares on 13 July 2023. There is not a single performance based vesting requirement for Mr. Love to earn the $326,969 of “value” using the Black-Scholes model (see AGM proxy, Section 10.3 (h) released on 14 October 2022).

Instead of Mr. Love’s compensation being a base of $325,000 with the ability to earn more based on meeting long-term performance targets, his true fiscal 2023 compensation is $651,969 and he is not being properly incentivized to add long-term value to the company. As long as the stock pops to above his strike prices on 13 July 2023, he will be free to exercise and sell 100% of his fiscal 2023 award and come back to the Board asking for a refresh. If the stock were to only retake its intraday 52 week high, Mr. Love would walk away with over $620,000 in addition to his salary and pension, even if the stock collapsed back to current levels by 20 July 2023. You can see this below showing the intrinsic value of each option strike at various CDI prices, as well as the total exercise value if he were to sell.

This is an unacceptable structure for any company that is serious about properly incentivizing talent to add value for the long term, and we ask Mr. Love to commit to restructuring his compensation to a more traditional long-term operating target performance-based structure consistent with corporate governance best practices. In fact, we would suggest adhering to the core principles we laid out for Mr. Mclarty in an email on 11 July 2022 regarding the retainment of Rich Poutier. We discussed the plan with Mr. Love in July when he first joined and suggested to both Mr. Mclarty and Mr. Love that this type of incentive structure should form the basis of a company-wide long-term incentive plan. It is long past time that we move away from strictly market price-based vesting.

Our incentive proposal focused on creating long-term sustainable value at SMS is based on 4 parts and we suggested it be reevaluated annually to make sure the proper incentives remain in place for executives.

1) Any direct equity or option grants have service based vesting requirements, with the first tranche vesting no sooner than 12-15 months after the original grant date

2) Annual bonuses for the CVM team may be accrued from a small percentage (initially mid-single digit) of CVM net revenue and would be paid out some time after the fiscal year is closed and audited. This percentage would scale down as CVM becomes established in the market.

3) One half of performance-based awards would be based off achieving an initial amount of new “Use Cases,” which would be defined as the number of Airworthiness Directives and/or STCs approved. Said another way, a “Use Case” would be an approval from a list of defined key aerospace OEMs, important global aerospace regulatory bodies (both civilian and military), major airlines and other potential end users that allows CVM to be used as an alternative means of inspection. Tranches of performance-base grants or options would vest as new CVM Use Cases were approved, with then-current in-process CVM programs excluded.

4) The second half of performance-based awards would be based on CVM revenue targets. Given the importance of creating a profitable CVM division, we continue to believe revenue thresholds are essential to creating long-term value for CDI holders. Then-current in-process CVM programs would be given credit at a 50% rate for each dollar they brought in, as both existing and new Use Cases are essential to establishing a healthy business. Tranches of performance-based grants or options would vest as CVM revenue thresholds are achieved.

Given Mr. Love’s contract achieves none of what we have laid out, we believe it is in the best interest of the company for CDI holders to vote against Resolution 9 and his option grant. If we intend to be taken seriously by the market, we need to start acting responsibly.

On 2 October, Andrew reached out to Mr. Love requesting Miro Miletic’s contact information so that we could make the connection to get to know him. Unfortunately, no contact information was ever provided and an attempt to reach out on LinkedIn ultimately failed when Mr. Miletic refused to provide contact information to facilitate the meeting, even after initially agreeing to a date and time for the call.

Mr. Miletic has been consulting for Structural Monitoring Systems since shortly after Mr. Love came on the Board, yet we have failed to find this disclosure anywhere in the company’s filings. This clear conflict of interest should have been disclosed to CDI holders, especially so because it is our understanding that Structural Monitoring Systems intends to continue to use MEMKO Pty Ltd, where Mr. Miletic is the Managing Director and Founder, as a paid consultant even after he may join the Board. This major issue is, among others, one of the primary reasons we wanted to speak to him and attempt to get to know him. If SMS is going to continue to pay his company for its aerospace expertise, why on earth should we also pay him to sit on the Board? This potential double dipping and the lack of disclosure is yet another example of poor governance and is a symptom of systemic breakdown in oversight and corporate culture. To be clear – this is not a judgement on Mr. Miletic’s character, nor the quality of the work his company performs as we are in no-position to judge given we cannot get an audience with him. This is, however, a major indictment on the way Structural Monitoring Systems is run as even the appearance of a conflict of interest such as this should raise major red flags. Instead, it is swept under the rug and remains seemingly undisclosed by the company. As such, we believe it is currently in the best interests of the company for CDI holders to vote against Resolution 6 appointing Mr. Miletic to the Board.

Andrew’s email did prove to be an opening for Andrew and Mr. Love to meet over coffee for two hours in New York City on 6 October, and led to a discussion about whether there was a potential compromise that could be achieved. On our end, I know Andrew left the meeting believing a compromise could be quickly reached, but cognizant that the success of it was very likely entirely in Mr. Mclarty’s hands. After conferring for about 48 hours, we proposed a solution that, among other things, would have required Mr. Mclarty to step down. We also asked for a number of CDI holder rights to be enshrined in the Company’s Articles of Association to make sure this type of situation would not happen again, certain protections for CDI holders and a strict policy regarding disclosure and recusal related to conflicts of interest for Board members. This offer was rejected when Mr. Mclarty refused to step down. What should have been a win for everyone – the Company, CDI holders and the Board – was stopped in its tracks by Mr. Mclarty’s bruised ego.

In hindsight, none of this should really surprise anyone. We have been fighting since July to get a copy of the company’s registry, and it took the legitimate threat of lawsuits against individuals to produce an electronic copy we could use (which we received the afternoon of 18 October. While the company claimed it had already complied with our request for one by sending me a USB stick in the post. However, when I finally received a package from Australia on 17 October, it turned out to be a CD-ROM that was unreadable.

At the end of the day, we continue to deal with members of the Company’s Board who believe they can play by their own set of rules. Structural Monitoring Systems is the epitome of poor corporate governance, and once Andrew is elected, we will do everything in our power to force SMS into compliance with modern Board best-practices. Now that we have a copy of the registry, we will be reaching out to CDI holders with more information and our recommendations for both the EGM and the AGM.

Sincerely,

Anthony Faillace

Drake Management & affiliates