ITEM 1. BUSINESS
OVERVIEW
Edmark is a leading developer and publisher of multimedia educational software and other educational products for the home and school markets. The Company's multimedia educational software products are targeted primarily for children 2 to 14 years of age and are designed to teach basic and complex thinking skills and to stimulate children's creativity and imagination. The Company's products are designed to be engaging for children by utilizing open-ended, exploratory environments that emphasize learning activities, humorous characters and interesting settings and themes. Edmark has created multiple product families, consisting of the Early Learning family, the Thinkin' Things family, the Mighty Math family and the Imagination Express family. The Company also has one product, Strategy Challenges Collection 1, in what is expected to become a new product family, and the Company has also created KidDesk Family Edition, a graphical front end designed to make computer use easier for young children. The Company believes that by creating product families, it encourages brand name recognition and repeat purchases. The Company has 16 multimedia educational software titles. The Company's software products generally have retail prices that range from approximately $25 to $45.
The Company's products have won over 100 industry awards since the introduction of the Company's first multimedia educational software title in 1992. These awards include the 1992, 1993 and 1995 MacUser Magazine Editors' Choice Award for Best Children's Program, the Software Publishers Association's Excellence in Software Award for Best Early Education Program (1993, 1994 and 1996) and Best Educational Tool Program (1993 and 1994), the 1995 New Media INVISION Gold and Silver Awards for Best Elementary Education Product and numerous other awards from consumer and education publications and organizations. The Company believes that it has garnered industry and customer recognition because of its commitment to high quality, educationally innovative products that focus on teaching children critical thinking and learning skills.
The Company also publishes and markets a special education product line that includes the Edmark Reading Program family of products and the Company's TouchWindow products, relatively low-cost touch screens used in special education and early childhood programs. The Company's special education products are sold through a dealer network, catalogs and direct mail.
Sections of this report either contained herein or incorporated by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in any forward-looking statement as a result of either the risk factors interspersed, where applicable, in the underlying discussion or by other factors, including anticipation of growth of the educational software market, the competitive environment in the consumer software industry, consumer confidence levels and dependence on other products such as Windows 95.
The Company was incorporated in the state of Washington in July 1970. Its executive offices are located at 6727 185th Avenue, N.E., Redmond, Washington 98052 and its telephone number is (206) 556-8400.
INDUSTRY BACKGROUND
The market for educational software is relatively small, but growing. It is often described in two market segments: consumer and education. The Company competes in both of these segments. The factors driving the growth in the market include increasing numbers of young children, increasing penetration of personal computers into homes, expanding distribution channels for educational software, growth in consumer and educational publications featuring educational software, increasing interest from parents in supplementing children's education and increasing awareness of the potential of multimedia as an effective educational tool. Link Resources Inc. estimates that in 1995, 45% of households with children owned personal computers and that by 1998 the penetration of personal computers into households with children will rise to approximately 55%.
The Company believes that success in the home educational software market requires software companies to produce software that will appeal to both parents and children. This requires products to incorporate a strong educational component, which is appealing for parents, as well as engaging content that holds the interest of children. The Company believes that the combination of these elements is a key component for success in the home market.
The distribution channels for consumer educational software products have expanded significantly in recent years. Traditionally, these products were sold through specialty software stores. Today, these products are increasingly sold through these and other distribution channels, including computer superstores, consumer electronics stores, mass merchants, office supply, discount warehouse stores, toy stores and bookstores, among others. While the number of distribution outlets has increased, competition for retail shelf space and customer awareness has also increased due to growth in the numbers of products and publishers competing for that shelf space and awareness. The Company believes that, with the proliferation of software titles, retailers have begun to select products and companies with proven reputations or brand identity, making it more difficult for other publishers to gain shelf space.
The educational software industry also has been characterized over the last few years by a high degree of consolidation, which favors companies with greater resources than the Company. This consolidation has provided certain of the Company's competitors with increased financial resources, marketing power and distribution capabilities. Larger companies that offer a wide range of products also may find it easier to gain access to shelf space than smaller companies, such as the Company, and they are more able to proliferate product offerings, including bundles and suites for a single low price. This strategy is used to dominate shelf space and may tend to reduce shelf lives and prices for individual products. In addition, consolidation may tend to result in increased price competition for educational software products.
The market for educational software for schools is also expanding and changing rapidly. School sales of educational software are being driven by growth in penetration of computers into schools, upgrades of the installed base to new multimedia computers, increases in the number of teachers trained to incorporate technology-based products into their curriculum and changes in state and federal funding authorizations to encourage the use of technology-based instructional materials. The Company believes that distributors and vendors marketing to the educational software market in schools choose products on the basis of their educational content and the reputation of the publisher and its products among teachers and other educational professionals.
PRODUCTS
MULTIMEDIA EDUCATIONAL SOFTWARE PRODUCTS
The Company's multimedia educational software products are targeted primarily for children 2 to 14 years of age and are designed to teach basic and complex thinking skills and to stimulate children's creativity and imagination. Edmark has created multiple product families, consisting of the Early Learning family, the Thinkin' Things family, the Mighty Math family and the Imagination Express family. The Company also has one product, Strategy Challenges Collection 1, in what is expected to become a new product family, and the Company has also created KidDesk Family Edition, a graphical front end designed to make computer use easier for young children. The Company believes that by creating product families, it encourages brand name recognition and repeat purchases. The Company has 16 multimedia educational software titles. The Company's software products generally have retail prices that range from approximately $25 to $45.
The Company's products have won over 100 industry awards since the introduction of the Company's first multimedia educational software title in 1992. These awards include the 1992, 1993 and 1995 MacUser Magazine Editors' Choice Award for Best Children's Program, the Software Publishers Association's Excellence in Software Award for Best Early Education Program (1993, 1994 and 1996) and Best Educational Tool Program (1993 and 1994), the 1995 New Media INVISION Gold and Silver Awards for Best Elementary Education Product and numerous other awards from consumer and education publications and organizations. The Company believes that it has garnered industry and customer recognition because of its commitment to high quality, educationally innovative products that focus on teaching children critical thinking and learning skills. The Company's products are designed to be engaging for children by utilizing open ended, exploratory environments that emphasize learning activities, humorous characters and interesting settings and themes.
Currently, the Company's products are designed for Macintosh, Windows 95 and Windows 3.1 operating environments. The Company's line of Windows 95 products retain the capability to run under Windows 3.1 and take advantage of several Windows 95 features that make launching and using the programs easier and more intuitive for consumers. For example, the products contain AutoPlay, a feature that allows children to directly launch an application by simply inserting the CD-ROM into the CD-ROM drive.
The Company's existing products are set forth in the table below. No single multimedia educational software title accounted for more than 10% of net revenues in fiscal 1996.
* Designed for Windows 95; compatible with Windows 3.1. +Runs on Windows 95 and Windows 3.1.
EARLY LEARNING FAMILY. Products in this family are designed for children 2 to 6 years of age. All instructions are spoken and accompanied by visual cues so nonreaders can explore the activities independently.
Millie's Math House, released in October 1992 and enhanced in August 1995, is an early math program designed to introduce and reinforce math skills. Through activities such as building bugs and creating patterns, children learn to count, name shapes, identify numbers and sets and develop sequencing skills. Millie's Math House has received 18 awards, including the 1993 Software Publishers Association Excellence in Software Award for Best Early Education Program and the 1992 MacUser Magazine Editors' Choice Award for Best Children's Program.
Bailey's Book House, released in June 1993 and enhanced in August 1995, is designed to introduce and reinforce a variety of early childhood language development and pre-reading curriculum skills. The program encourages children to learn letters, words, stories and rhyming. Bailey's Book House has received nine awards, including the 1994 Parent's Choice Award for Best Early Childhood Software.
Sammy's Science House, released in June 1994, is designed to encourage scientific exploration through five activities that develop observation, classification, comparison and problem-solving skills. Sammy's Science House has received nine awards, including the 1995 Family Channel Seal of Quality and the 1994 Parent's Choice Award for Software.
Trudy's Time & Place House, released in September 1995, is designed to encourage children to enjoy exploring geography and time. Children build time-telling skills; develop mapping and direction skills; and "travel" the world learning about continents, oceans and landmarks. Trudy's Time & Place House has received four awards, including the 1996 Software Publishers Association Excellence in Software Award for Best Early Education Program.
Stanley's Sticker Stories, released in June 1996, is designed to help children strengthen reading and writing skills, improve spelling and build creativity while they create their own animated storybooks featuring Millie, Bailey, Sammy, Trudy and their other Edmark pals from the Early Learning family products.
THINKIN' THINGS FAMILY. Products in this family are designed to encourage the development of essential thinking skills. This family currently consists of three titles:
Thinkin' Things Collection 1, released in September 1993, is a program designed to develop thinking skills essential for learning success for children four to eight years of age. Six activities are designed to enhance problem solving, creativity, critical thinking and memory skills. Children explore musical patterns and build memory skills, develop predictive and investigative skills, recognize relationships and build their understanding of rule formation. Thinkin' Things Collection 1 has received 21 awards including the 1995 Newsweek Editors' Choice Award, the 1994 Software Publishers Association Excellence in Software Awards for Best Early Education Program and the 1993 MacUser Magazine Editor's Choice Award for Best Children's Program.
Thinkin' Things Collection 2, released in October 1994, is a program with five activities designed to develop memory, creativity, spatial awareness and other higher thinking skills for children six to twelve years of age. The program introduces the concept of musical notation through symbol and sound relationships and introduces three-dimensional thinking with an activity that allows two-dimensional images to be displayed in three-dimensional format. Thinkin' Things Collection 2 has received nine awards, including the 1995 New Media INVISION Gold Award for Best Elementary Education Product.
Thinkin' Things Collection 3, released in October 1995, is a powerful set of tools and activities designed to help children seven to thirteen years of age analyze and synthesize information, strengthen inductive and deductive reasoning and examine and interpret information. Thinkin' Things Collection 3 has received five awards including the 1996 Software Publishers Association Excellence in Software Awards for Best Education Software Program.
STRATEGY CHALLENGES COLLECTION 1, released in November 1995, is the first product in what the Company expects will become a product family. This program is designed to develop problem-solving strategies centered around three classic games that are fun and easy to learn--Mancala, Nine Men's Morris and Go-Moku. The program also features interactive Strategy Coaches, Real-World Videos and multimedia Game Guides and is for children from eight to fourteen years of age. Strategy Challenges Collection 1 has received two awards including the 1996 FamilyPC FamilyTested Recommended Award.
MIGHTY MATH FAMILY. Edmark plans to release a comprehensive series of math products that will consist of a total of six titles for children from five to fourteen years of age. The programs are designed to teach both basic skills and the conceptual underpinnings of curriculm-based math subjects from addition and subtraction to algebra and geometry. The six titles will be broken out into three groups comprised of two titles each. Each group covers the complete math curriculum for that specific age range and skill level. The products will offer a deep amount of math content, including hundreds of comprehensive problem sets. These products are all being developed under the Harcourt strategic alliance. See "Harcourt Relationship." The first two titles in this series were released in July 1996, and the Company expects to release an additional three titles in fall 1996, with the final title to be released in late fiscal year 1997.
Mighty Math Carnival Countdown, released in July 1996, is a program designed to develop problem solving and logic, place value, addition and subtraction, sorting and classification and early multiplication and division skills. The program is the first of two products for children from five to seven years of age. The second product in this age range is expected to be released in fall 1996.
Mighty Math Number Heroes, released in July 1996, is a program designed to develop conceptual and thinking skills required for math success. The program features four activities that focus on the following skill areas: problem solving, addition and subtraction, multiplication and division, fractions, geometry and graphs and charts. The program is the first of two products for children from eight to ten years of age. The second product in this age range is expected to be released in fall 1996.
IMAGINATION EXPRESS FAMILY. Products in this family are designed to encourage the development of language arts skills through a variety of interactive story-making activities. These products utilize richly painted background scenes in a variety of settings together with music, sound effects and numerous stickers to allow children ages six to twelve to create their own multimedia stories. Imagination Express also utilizes a proprietary auto-sizing technology developed by Edmark, which enables children to manipulate characters within an environment and maintain true-to-life perspective. Imagination Express titles are available for personal computers on CD-ROM. Imagination Express has received 18 awards, including the 1995 Newsweek Editors' Choice Award and the 1995 New Media INVISION Silver Award for Best Elementary Education Product.
Destination: Neighborhood, released in November 1994, has photo-realistic characters and provides children with numerous tolls to create interactive stories, poems and journals describing their real and make-believe experiences.
Destination: Castle, released in November 1994, features a rich watercolor art style, and utilizes a medieval kingdom where knights, jesters and wild boars become actors and props in interactive stories. Also included is the Castle Fact Book, which is replete with information about the many colorful characters, objects and scenes found in this destination.
Destination: Rain Forest, released in May 1995, is based on a real Panamanian rain forest that features exotic plants, trees, waterfalls and native dwellings. This product also includes the Rain Forest Fact Book, which contains information about rain forest ecology, the indigenous Kuna Indian people and exotic animals native to the region.
Destination: Ocean, released in October 1995, features a marine learning destination. This product also includes the Ocean Fact Book, which contains information about marine life and the ocean environment.
KIDDESK FAMILY EDITION. KidDesk Family Edition, released in November 1993, is the successor to KidDesk, originally released in October 1992. KidDesk Family Edition is a graphical user interface designed to make computer use easier for young children. In addition, KidDesk Family Edition is a utility that allows parents and teachers to prevent young children from accessing areas of the hard disk that contain valuable programs or data. KidDesk Family Edition contains nine desk accessories for young children, including a calendar, a calculator, an analog and digital clock, a voice messaging system and other accessories. KidDesk was originally released for MS-DOS and Macintosh computers, although the MS-DOS version has been discontinued. KidDesk Family Edition was released for the Windows operating environment and incorporates several enhanced features, including voice mail and e-mail for family members as well as an electronic card file. KidDesk and KidDesk Family Edition have received 14 industry awards, including the Software Publishers Association Excellence in Software Awards for Best Educational Tool Program (1993 and 1994) and Best User Interface in a New Program (1993).
SCHOOL VERSIONS
All of the Company's multimedia educational software products are also available in school versions. The school versions, which are packaged in three-ring binders, include teacher guides with lesson plan ideas designed to integrate the software into the classroom activities. The school versions also include enhanced customer support and an extended guarantee. School versions are generally priced 20-30% above the consumer versions, but are available with volume discounts for site licenses and lab packs.
SPECIAL EDUCATION PRODUCTS
The Company also publishes and markets a special education product line, which includes the Edmark Reading Program family of products and the Company's TouchWindow products, relatively low-cost touch screens used in special education and early childhood programs. The Company's special education products are sold through a dealer network, catalogs and direct mail.
The Edmark Reading Program family of products is the largest and most established of the Company's special education print and software products. It is a beginning reading and language development program used with low-functioning special education students and in a variety of programs with learning disabled, English as a second language and other special needs populations. The program is available in both print and Apple II software versions. The various levels and versions of the Edmark Reading Program have suggested list prices from $350 to $500, and discounts are available on combination packages.
The TouchWindow product is a resistive membrane touch screen that attaches to computer monitors with velcro and plugs into standard computer ports, allowing the monitor to be used as a touch-sensitive input device. Touch access is one of the most direct ways to interact with the computer and is especially effective for some developmentally delayed, learning disabled and physically handicapped students. The TouchWindow product is available for Macintosh, Windows, MS-DOS and Apple II computers. All of the Company's software products and many of its distributed software products are TouchWindow-compatible. The TouchWindow products have suggested list prices from $275 to $335, and is primarily sold through a dealer network and the Company's catalog. The Company provides a one year warranty on its TouchWindow products.
DISTRIBUTED PRODUCTS
The Company distributes products developed and published by other companies to the special education market. These products include both print and software products designed to teach basic skills or provide a variety of test, assessment or skill-building activities.
PRODUCT DEVELOPMENT
The Company's products are purchased primarily by adults but are used by children. To appeal to the child, the product must be engaging and easy to use. The Company's research and development process involves substantial input at various stages of development from parents, teachers, other professional educators and children. Each product is tested for educational and developmental appropriateness, technical quality, compliance with product specifications, adherence to user interface standards and operability on a broad variety of hardware configurations.
The Company develops products using teams of Company employees experienced in education, programming, music, digitized speech, sound, graphics, quality assurance, marketing, finance and project management. The Company employs several educators with advanced degrees and several other employees with teaching credentials and teaching experience. Millie's Math House and Bailey's Book House were designed by an outside contract developer and developed using a com-
bination of both internal and contract resources with project management, educational content, design control and other involvement and ownership by the Company. KidDesk Family Edition was designed internally and developed using both internal and contract resources. Except for these early products, all of the Company's multimedia software products have been designed and developed internally by the Company. The Company's internal development teams are often supplemented by outside technical and education professionals, designers, artists, engineers, authors and others on a contract basis.
The Company utilizes sophisticated technological tools and develops proprietary technologies to create interfaces and environments that enhance the educational experience. For example, the Company has developed a proprietary three-dimensional technology in the Thinkin' Things family to help children develop spatial awareness thinking skills, and a proprietary "auto-sizing" technology in the Imagination Express family to help children learn about visual perspective.
The Company's success is largely dependent on its ability to develop new products. The Company also depends on product upgrades and enhancements to lengthen the life cycle of its products. The development of new products and the incorporation of new technologies into its existing products may require greater development time and expense in the future than the Company has experienced to date. The Company has increased, and anticipates that it will continue to increase, the resources devoted to new product development. Also, the emergence of new technologies and increasing competition are expected to cause the Company to invest significantly more time and resources in establishing technological and market feasibility of its products.
In the past, the Company has experienced delays in the introduction of its products, and may experience such delays in the future. A significant delay in the introduction of a new product could adversely affect the success of the product and the Company's operating results. There can be no assurance that the Company will be able to introduce successful new products in the future, nor any assurance that products will be introduced on schedule.
The Company must manage its software development efforts to anticipate and adapt to changes in popular computer operating environments and other evolving technologies. The Company's multimedia educational software products are designed for use on Macintosh and Microsoft Windows operating environments. The Company will continue to evaluate other computer platforms and operating environments for its products as they may become available. There can be no assurance that the Company will be able to anticipate and adapt to changes in computer platforms and other evolving technologies in a timely manner.
Technological advances are providing opportunities for improvement in the sophistication, technical capability and performance of educational and other software products. The Company expects that these trends will result in increased demand for consumer software utilizing the sound, graphics and data capabilities of the latest hardware technology, and may also result in increased development costs, shorter life cycles and the need for increasingly sophisticated development teams and tools. There can be no assurance that the Company will be able to meet these demands in a competitive or cost-effective manner.
HARCOURT RELATIONSHIP
On December 15, 1994, the Company entered into a strategic alliance (the "Agreement") with Harcourt Brace School Publishers, a publisher in the educational market and a division of Harcourt Brace & Company, to develop new multimedia educational software products. Pursuant to the Agreement, Harcourt has agreed to co-fund the development of products in the Imagination Express family and in the Mighty Math family. However, Harcourt has the right to
terminate the Agreement or to terminate its commitment to co-fund these products at any time, subject to payment of certain fees. If Harcourt chooses to exercise its termination rights, the Company's operating results would be adversely affected. Harcourt also has certain rights to distribute co-developed products to the school channel.
SALES AND MARKETING
The Company sells its software products in both the consumer and school markets and uses multiple channels of distribution, including distributors, specialty software stores, retail chains, computer superstores, mass merchants, discount warehouse stores, educational dealers, catalogs and direct mail. The Company has distribution relationships with several major independent software distributors, including ABCO, GT Interactive Software, Ingram, Navarre and Merisel. The Company also has direct selling relationships with several of the major computer and software retailing and dealer organizations in the United States, including Egghead Software. Sales are generally based on individual purchase orders submitted by customers or pursuant to distribution agreements that are generally terminable by the Company or the distributor on 30 days notice. Sales to the top customers represented 61%, 72% and 61% of the Company's net sales of its multimedia software products in the consumer market for fiscal 1994, 1995 and 1996, respectively. Sales to distribution accounts represented 80%, 72% and 69% of the Company's net sales of its multimedia software products in the consumer market for fiscal 1994, 1995 and 1996, respectively. Sales of the Company's products to Ingram accounted for 40% and 27% of the Company's consumer channel net sales in fiscal 1995 and 1996, respectively. The loss of, or significant reduction in sales volume attributable to, any of the Company's principal distributors or accounts sold through distributors or retailers could have a material adverse effect on the Company's business, operating results and financial condition.
The Company maintains a stock balancing policy that allows distributors and retailers to return products according to negotiated terms or pursuant to any promotional terms that may be in effect. The Company attempts to monitor and manage the volume of its sales to distributors and retailers to avoid their overstocking of the Company's products, but is not able to exercise significant control over such entities. The Company also accepts returns of defective, shelf-worn and damaged products at any time in accordance with negotiated terms. At the time of product shipment, the Company establishes allowances, including allowances for stock balancing, price protection and returns of defective, shelf-worn and damaged products, and for estimated potential future returns of products. Product returns that exceed the Company's allowances could materially adversely affect the Company's business and operating results. Furthermore, it may be difficult for the Company to accurately estimate allowances for products sold through new distribution channels, such as general mass merchandisers, with which the Company has limited past sales history or from which the Company receives little or no infomation regarding sales to end users.
The Company uses various marketing techniques designed to promote brand awareness and to support the sales efforts of its distributors and direct accounts. The Company promotes its products directly to teachers and consumers through public relations activities; presentations and exhibits at major trade shows, conferences and users group meetings; direct mailing of catalogs, brochures and product offerings and advertising in targeted publications. The Company supports the sales efforts of its distributors and direct accounts through sales support programs, the provision of market development and cooperative advertising funds, specific promotional efforts and in-store displays. The Company also licenses a limited number of its products to be bundled with products sold by hardware vendors.
The Company has an agreement with an Ireland-based company for manufacture and distribution of localized versions of the Company's multimedia educational software products for sales in
western Europe and Japan. The agreement is renewable biannually. The Company also has an exclusive relationship for the distribution of its software products in Australia and New Zealand.
Products are generally shipped within three days of the time orders are received, and, accordingly, the Company has historically operated with little or no backlog. Because of the generally short cycle between order and shipment, the Company does not believe that its backlog as of any particular date is meaningful.
CUSTOMER AND TECHNICAL SUPPORT
The Company provides a variety of customer and technical support services to purchasers of its software products. End users are able to consult with support personnel regarding software use, hardware problems and peripheral needs. Support services are available via telephone, facsimile response and a variety of voice mail and online service options. The Company offers a 30-day unconditional guarantee for its consumer software products.
For all of its products sold to the school market, the Company provides a toll-free customer support service and access to trained educational professionals. The Company provides a variety of preview, sample and demonstration options and allows a teacher to preview a product and return it within 30 days if the product does not meet the teacher's needs. The Company's education products are sold with a variety of lesson plans, recordkeeping tools and other materials to support teachers.
COMPETITION
The educational software industry in which the Company operates is very competitive. Many competitors have substantially greater financial, technical, marketing and distribution resources than the Company. In the consumer market, the Company competes against a large number of companies of varying sizes and resources, including, but not limited to, Broderbund Software, Inc., Davidson & Associates, The Walt Disney Company, Maxis, Inc., GT Interactive Software, Inc., Microsoft Corporation, Sierra On-Line, Inc., and Softkey, as well as a number of other privately and publicly held companies. There is an increasing number of competitive products offered by a growing number of companies. Increased competition in the consumer market for educational software may result in a loss of retail shelf space, reduction in sell-through of the Company's products at retail stores, or additional price competition, any of which could have a material adverse effect on the Company's operating results. In the school market, the Company competes against many of these same companies and against other companies specializing in supplemental software and print products for the special education and early childhood market segments. Existing competitors may continue to broaden their product lines and potential competitors, including large computer or software manufacturers, entertainment companies and educational publishers, may enter or increase their focus on the educational market, resulting in greater competition for the Company.
The Company's TouchWindow product line competes with other touch-sensitive computer monitors and screens and other types of alternative input devices in the school market. Many of these products are offered by companies with greater resources than the Company. Management believes that companies with greater resources and economies of scale may seek to enter this market and provide substantial competition.
INTELLECTUAL PROPERTY
The Company regards its software and other education products as proprietary and relies primarily on a combination of copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and other methods to protect its proprietary rights. The Company does
not have any patents or patent applications pending with respect to any of its products. The Company does not include any mechanisms to prevent or inhibit unauthorized copying, nor does the Company currently rely on "shrink-wrap" licenses that restrict copying and use of its software products. The Company is aware that unauthorized copying occurs within the software industry, and if a significant amount of unauthorized copying of the Company's products were to occur, the Company's business, financial condition and operating results could be adversely affected. As the number of software products in the industry increases and the functionality of these products further overlaps, software developers may increasingly become subject to infringement claims. Although there are currently no infringement claims against the Company, there can be no assurance that third parties will not assert infringement claims against the Company in the future with respect to current or future products or that any such assertion will not require the Company to enter into royalty arrangements or costly litigation.
As the Company continues to introduce new products and to incorporate new technologies, it anticipates that some of its products may be subject to licenses of proprietary rights from third parties, which may include royalty arrangements.
PRODUCTION
For each software product, the Company prepares master software disks, user manuals and packaging. Disks are acquired in large quantities from various sources. User manuals are printed and related materials are manufactured to the Company's specifications by third parties. Completed packages are assembled by the Company or third parties. The Company utilizes the services of third party manufacturers for disk duplication and product assembly. To date, the Company has not experienced any material difficulties or delays in the manufacture or assembly of its products or any material number of returns due to product defects.
The Company contracts with a range of suppliers to print and supply components for software and print products. The Company utilizes a competitive bid process to purchase these product parts and orders components of its special education print products in quantities that minimize per unit costs. The Company orders sufficient quantities of distributed products to maintain between a 30-day and 60-day inventory of each product.
The Company assembles the TouchWindow on its premises. Most of the components are available from several suppliers and are sourced through a competitive bid process. The acrylic membrane panel for the TouchWindow is obtained from one supplier. Several alternative suppliers are available to supply the membrane panel, but the lead time to add suppliers for this component is four to six months. The Company generally maintains higher inventory levels of this component to minimize the supply risk.
EMPLOYEES
As of June 30, 1996, the Company had 209 full-time employees. Of these, 116 were primarily engaged in product development, 64 in sales and marketing and customer support, 13 in manufacturing and shipping, and 16 in finance and administration. None of the Company's employees are represented by a labor union. The Company believes its relationships with its employees are good.
The Company's future success greatly depends on the continued services of its key product development, technical, marketing, sales and management personnel, and its ability to continue to attract, motivate and retain highly qualified employees. In particular, the Company is highly dependent upon the management services of Sally G. Narodick, Chairman and Chief Executive Officer, and upon the product development services of Donna G. Stanger, Vice President -- Product Development. The Company does not have key person life insurance covering any of its
personnel. The Company's key personnel may voluntarily terminate their employment with the Company at any time. Competition for such employees is intense and the process of locating key technical, product development and management personnel with the combination of skills and attributes required to execute the Company's strategy is often lengthy. Accordingly, the loss of services of key personnel or an inabiltiy to attract additional personnel as needed could have a material adverse effect upon the Company. For example, in May 1996, the Company's Vice President -- Marketing resigned and this position is currently unfilled. A key position within the Company's senior management team, the Vice President -- Marketing is responsible for the overall market positioning and distribution strategies for the Company's multimedia products in the consumer channel. There can be no assurance that the Company will be able to recruit a qualified individual for this position in a timely manner.
ITEM 2.

ITEM 2. PROPERTIES
The Company's facilities in Redmond, Washington, include 92,600 square feet consisting of approximately 70,100 square feet of office space and 17,500 square feet of manufacturing and warehouse space. The leases for these facilities, representing four locations, expire at various dates from May 1998 to November 1998, and the Company has options to renew each of the leases for three years at the then-prevailing market rates.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
Power Industries, Inc., v. Edmark Corporation, described in Part II of Item 1 of the Company's Forms 10-Q for the quarters ended December 31, 1995, and March 31, 1996, was settled on August 9, 1996, for an insignificant amount. The complaint in that lawsuit alleged that the Company's use of Imagination Express as a product name infringed a trademark of Power Industries.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.

ITEM 5. MARKET PRICE FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated herein by reference to the information contained in the "Corporate Information" section of the Company's 1996 Annual Report to Shareholders, a portion of which section is included in Exhibit 13.1 hereto.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is incorporated herein by reference to the information contained in the "Selected Financial Data" section of the Company's 1996 Annual Report to Shareholders, which section is included in Exhibit 13.1 hereto.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information required by this Item is incorporated herein by reference to the information contained in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of the Company's 1996 Annual Report to Shareholders, which section is included in Exhibit 13.1 hereto.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The information required by this Item is incorporated herein by reference to the "Financial Statements" section of the Company's 1996 Annual Report to Shareholders, which section is included in Exhibit 13.1 hereto.
ITEM 9.

ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable. PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated herein by reference to the information contained in the "Executive Officers of the Company" and "Election of Directors" section of the Company's Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the close of the Company's fiscal year.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to the information contained in the "Executive Compensation" section of the Company's Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the close of the Company's fiscal year.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference to the information contained in "Security Ownership of Certain Beneficial Owners and Management" section of the Company's Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the close of the Company's fiscal year.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTION
Not applicable.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The Company's Annual Report to Shareholders for the year ended June 30, 1996 and the 1996 definitive proxy materials, which will be filed supplementally to this report, are not being filed as part of this report.
A. Financial Statements and Financial Statement Schedules:
1. Financial Statements (The financial statements listed below are incorporated herein by reference to the Company's 1996 Annual Report to Shareholders, which statements are included in Exhibit 13.1 hereto.): Independent Auditors' Report Balance Sheets as of June 30, 1996, and 1995 Statements of Operations for the years ended June 30, 1996, 1995 and 1994 Statements of Shareholders' Equity for the years ended June 30, 1996, 1995 and 1994 Statements of Cash Flows for the years ended June 30, 1996, 1995 and 1994 Notes to Financial Statements
2. Financial Statement Schedules: Independent Auditors' Report Schedule VIII -- Valuation and Qualifying Accounts
All other schedules are omitted because they are not required or because the information is presented in the financial statements or notes thereto.
B. Reports on Form 8-K: There were no reports on Form 8-K filed during the fourth quarter ended June 30, 1996.
C. Exhibits: Exhibits required by Item 601 of Regulation S-L.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Edmark Corporation (Registrant)
August 30, 1996 By: /s/ SALLY G.NARODICK ---------------------------------
Sally G. Narodick Chairman and Chief Executive Officer
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 Registrant and in the capacities and on the date indicated.


Item 1. Business.
(a) General development of business.
(a)(1) The registrant was incorporated on December 4, 1957. During the fiscal year ended September 30, 1996, there were no material changes or developments in the business done by the registrant or its subsidiaries or in the manner in which it conducted its business during the prior five fiscal years. (a)(2) Not applicable.
(b) Financial information about industry segments.
The registrant produces only apparel and, accordingly, information relative to industry segments is not applicable.
(c) Narrative description of business.
(c)(i) The registrant is engaged in the design, manufacture, and sale of apparel for men, women, and children including boys, girls, toddlers, and infants. The percentage of registrant's net sales in each of the foregoing categories in the last three fiscal years is as follows:
Percentage of Net Sales (years ended September 30)
1996 1995 1994 ---- ---- ----
Men's apparel 8% 10% 13%
Women's apparel 18 18 17
Children's apparel 74 72 70
The registrant produces apparel primarily sold to regional mass merchandisers, major national chain stores, department stores, and specialty stores. Sales are made primarily by the registrant's salaried sales staff.
(c)(ii) Not applicable.
(c)(iii) Raw materials essential to the registrant are readily available from various alternate sources of supply.
(c)(iv) The registrant distributes: children's apparel under various of its own trademarks including, principally, GARAN, GARANIMALS, and ROB ROY, men's apparel under various of its own trademarks including, principally, GARAN, and women's apparel under various of its own trademarks including, principally, GARAN. Sales of branded apparel under the registrant's own trademarks accounted for approximately 4%, 6%, and 9% of the registrant's net sales in fiscal 1996, 1995, and 1994, respectively.
Since 1975, registrant has been a non-exclusive licensee of professional sports leagues and teams for T-shirts, knit shirts, sweatshirts, and sweaters for boys and men, and since 1990, registrant has been a non-exclusive licensee of various colleges and universities for sweatshirts and knit shirts for boys and men. Sales of such apparel by registrant accounted for approximately 9%, 12%, and 19% of the registrant's net sales in fiscal 1996, 1995, and 1994, respectively. Since 1986, the registrant has been the exclusive licensee of the trademark BOBBIE BROOKS for girls' and women's apparel, and sales of apparel by registrant bearing the BOBBIE BROOKS trademark accounted for approximately 8%, 7%, and 3% of the registrant's net sales in fiscal 1996, 1995, and 1994, respectively. (The registrant also sublicenses the BOBBIE BROOKS trademark to non-affiliates.) Since fiscal 1991, registrant has been a non-exclusive licensee of Disney Enterprises, Inc. for various trademarks and for characters, scenes, and logos from various animated television series and motion pictures for children's apparel, and sales of apparel bearing such trademarks accounted for approximately 9%, 8%, and 11% of registrant's net sales for fiscal 1996, 1995, and 1994, respectively. In 1995, the registrant became the exclusive licensee of the trademark EVERLAST for men's, boys', and girls' activewear. Sales of apparel bearing the EVERLAST trademark commenced in fiscal 1996 and accounted for approximately .3% of registrant's net sales for that fiscal year. Total sales of apparel bearing licensed trademarks and logos, some of which apparel also bears the registrant's trademarks LONG GONE, TEAM RATED, GLORY DAYS, and G.T.S., accounted for approximately 28%,
27%, and 35% of the registrant's net sales in fiscal 1996, 1995, and 1994, respectively. The terms of the foregoing license agreements range from 1 to 3 years, royalty rates range from 2% to 14% of net sales, each license agreement has a minimum royalty commitment, and certain license agreements impose an advertising commitment. Shortfalls between earned royalties and minimum royalties have not been material. Except for certain license agreements with Disney Enterprises, Inc. for characters, scenes, and logos relating to motion pictures no longer in general release, the registrant, to the extent it desires to do so, will seek to renew each license agreement when it expires upon substantially the same terms.
(c)(v) The registrant operates primarily on the basis of two seasons - Spring/Summer and Fall/Holiday. Shipments for the Spring/Summer season are generally made from December through July and for the Fall/Holiday season from June through December. Registrant has been able to keep production levels relatively constant throughout the year. However, because of long production runs and short shipping periods, the registrant's inventory levels fluctuate during the year.
(c)(vi) Not applicable.
(c)(vii) Wal-Mart Stores, Inc. accounted for 66%, 63%, and 62% of the registrant's net sales during fiscal 1996, 1995, and 1994, respectively. During the same periods, J.C. Penney Company, Inc. accounted for 15%, 20%, and 18% of the registrant's net sales. The registrant has had a business
relationship with Wal-Mart Stores, Inc. for more than the past 19 years and with J.C. Penney Company, Inc. for more than the past 30 years. However, neither of these relationships involve long-term contractual commitments, and, accordingly, there can be no assurance as to the level of future business with either of these customers. The balance of the registrant's sales are made to approximately 3,800 accounts, none of which is responsible for more than 10% of the registrant's net sales.
(c)(viii) The registrant has been consistently able to secure substantial orders from its customers to insure that production levels are kept relatively constant throughout the year. As of December 2, 1996, firm backlog orders amounted to $31,600,000, and firm backlog orders as of December 1, 1995, amounted to $37,000,000. Registrant expects that all of its backlog orders at December 2, 1996, will be filled during the 1997 fiscal year. Registrant's firm backlog orders at any given time represent orders taken throughout the year and vary throughout the year. The registrant believes that year to year variations are immaterial to an understanding of its business.
(c)(ix) Not applicable.
(c)(x) The men's, women's, and children's apparel business in the United States is highly competitive primarily in price, style, and delivery and consists of many domestic and foreign manufacturers, importers, and distributors. The registrant does not compete solely on a price basis with low cost foreign sources; the registrant competes by relying on style,
programs, and delivery as well as price. No single enterprise sells more than a small portion of the total apparel sold in the United States, and there are no reliable figures available from which the registrant's relative position in the United States apparel industry can be determined or from which the effect of foreign competition can be assessed.
(c)(xi) No material expenditures are made by the registrant for research activities relating to the development of new services or products or the improvement of existing services or products.
(c)(xii) The registrant's compliance with Federal, state, and local environmental laws and regulations had no material effect upon its capital expenditures, earnings, or competitive position during the fiscal year ended September 30, 1996. The registrant does not anticipate any material capital expenditures for environmental control in either its present or succeeding fiscal years.
(c)(xiii) The registrant employed approximately 2,500 persons at September 30, 1996.
(d) Financial information about foreign and domestic operations and export sales.
The registrant has operated a manufacturing facility in Costa Rica since 1984, and in fiscal 1995, began operating manufacturing facilities in El Salvador, but it was not
otherwise engaged in business within any foreign country during the fiscal year ended September 30, 1996.
During fiscal 1996, 1995, and 1994, export sales by registrant amounted to less than 1% of total sales and are not considered to be significant to an understanding of registrant's business.
Item 2.

Item 2. Properties.
Expiration Location Use Sq. Ft. Estate Date
- -------- --- ------- ------ ----------
Adamsville, Tennessee Manufacturing 100,000 Fee Manufacturing 60,080 Lease 1999(1)
Carthage, Mississippi Manufacturing 105,300 Lease (1)(2)
Church Point, Louisiana Manufacturing 73,000 Lease 1999(1)
Clinton, Kentucky Manufacturing 52,000 Fee
Corinth, Mississippi Manufacturing 76,000 Fee
Eupora, Mississippi Manufacturing 96,742 Lease (1)(3)
Haleyville, Alabama Manufacturing 10,000 Fee
Jemison, Alabama Manufacturing 20,800 Lease 2001(1)
Kaplan, Louisiana Manufacturing 87,900 Lease (1)(4) 43,900 Fee (4)
Lambert, Mississippi Manufacturing 100,300 Fee (5)
Marksville, Louisiana Manufacturing 75,000 Lease 1999(1)
Expiration Location Use Sq. Ft. Estate Date - -------- --- ------- ------ ----------
New York, New York Showroom and Office 38,500 Lease 2011 Ozark, Arkansas Manufacturing 75,000 Lease 1997(1)
Philadelphia, Mississippi Manufacturing 107,920 Lease (1)(6)
Rainsville, Alabama Manufacturing 53,000 Fee
San Jose, Costa Rica Manufacturing 33,258 Fee
San Salvador, El Salvador Manufacturing 22,350 Lease 1999(7)
San Salvador, El Salvador Manufacturing 41,047 Lease 2000
San Salvador, El Salvador Manufacturing 24,200 Lease 2001
Starkville, Mississippi Manufacturing and Office 90,000 Lease 1998(1)
(1) The registrant or a wholly-owned subsidiary of the registrant has the option to purchase the facilities and/or to renew each of the current leases for terms which vary between 2 and 68 years.
(2) One continuous building consisting of a 63,000 square foot section leased to 1999, a 22,500 square foot section leased to 2002, and a 19,800 square foot section leased to 2004.
(3) One continuous building consisting of a 15,000 square foot section leased to 1999, a 21,000 square foot section leased to 1997, a 41,000 square foot section leased to 1997, and a 19,742 square foot section leased to 2004.
(4) One continuous building consisting of a 72,000 square foot section leased to 1999 and a 15,900 square foot section leased to 2005, which was expanded by a 43,000 square foot section owned by a wholly-owned subsidiary of the registrant and financed with the proceeds of Industrial Revenue Bonds issued in September, 1990. The entire building is located on land owned by a wholly-owned subsidiary of the registrant.
(5) The registrant determined that it no longer required the manufacturing capacity of its plant in Lambert, Mississippi, and that facility was closed in 1995. The carrying value of the Lambert facility has been written down to its net realizable value.
(6) One continuous building consisting of a 78,000 square foot section leased to 2000 and a 29,920 square foot section leased to 2004.
(7) The registrant determined to transfer the operations of its first San Salvador, El Salvador, facility to a new facility, and the first facility was closed in 1996. The carrying value of that facility has been written down to its net realizable value.
The registrant believes that its facilities are suitable and adequate for its foreseeable needs, and except as otherwise noted, each was fully utilized during fiscal 1996.
Item 3.

Item 3. Legal Proceedings.
None.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
(a), (b), and (c) Market information, Holders, and Dividends.
The registrant's common stock is listed and traded on the American Stock Exchange under the symbol GAN. The high and low sales prices during each quarterly period for fiscal years 1996 and 1995 are set forth in the table below:
Sales Price of Common Stock ------------------------------------------ 1996 1995 Quarters High Low High Low - -------- ---- --- ---- ---
First . . . . . . . . . . . . $19 3/8 $16 3/8 $18 1/4 $15 1/2
Second . . . . . . . . . . . 17 15 1/8 18 14 7/8
Third . . . . . . . . . . . . 17 1/2 16 3/8 18 1/4 15 5/8
Fourth . . . . . . . . . . . . 18 16 3/8 17 3/4 15 7/8
Dividends paid during the last two fiscal years were as follows:
Dividends Paid per Share Quarters 1996 1995 - -------- ---- ----
First -Regular . . . . . . . $ .20 $ .20 -Special . . . . . . . .20 .20 Second -Regular . . . . . . . .20 .20 Third -Regular . . . . . . . .20 .20 Fourth -Regular . . . . . . . .20 .20 ----- ----- Total . . . . . . . . . $1.00 $1.00 ----- ----- ----- -----
As at December 2, 1996, there were 483 shareholders of record including Cede & Company in its capacity as nominee for the Depository Trust Company.
Item 6.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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Net Sales
Net sales in fiscal 1996 were $146,491,000, an increase of $5,161,000 over fiscal 1995 net sales of $141,330,000. The increase in fiscal 1996 was primarily a result of an increase in total units shipped.
Net sales in fiscal 1995 were $141,330,000, a decrease of $31,672,000 from fiscal 1994 net sales of $173,002,000. The sales decreases occurred primarily in the Sports Licensing divisions due to ongoing competitive conditions in the marketplace, in the Disney division as a result of not participating in a film property in 1995, and in the Women's Sweater division, which ceased operations early in fiscal 1995.
Gross Margin
Gross margin in fiscal 1996 was $31,747,000, or 22% of net sales, as compared to $29,876,000, or 21% of net sales, in fiscal 1995. The increase in gross margin was the result of improved absorption of manufacturing expenses as a result of the volume increase.
Gross margin for fiscal 1995 was $29,876,000, or 21% of net sales, as compared to $41,315,000, or 24% of net sales, in fiscal 1994. The decline in gross margin from year to year primarily resulted from (a) reduced volume in the Sports Licensing divisions, which historically maintain higher gross margins than the other divisions (the gross margin for the Sports Licensing divisions is higher than for other divisions, but net sales of these divisions are subject to a royalty expense which is included in selling and administrative expenses), which affected product mix, and (b) from customer orders taken at lower margins to maintain market share.
Selling and Administrative Expenses; Interest Income
Selling and administrative expenses in fiscal 1996 were $22,652,000, or 15% of net sales, as compared to $23,270,000, or 16% of net sales, in fiscal 1995. The decrease, both in absolute dollars and as a percentage of net sales, was the result of reduced general overhead expenses offset by increased advertising in the Everlast division.
Selling and administrative expenses in fiscal 1995 were $23,270,000, or 16% of net sales, as compared to $27,320,000, or 16% of net sales, in fiscal 1994. The decrease in dollar amount resulted primarily from reduced royalty and commission expenses associated with the reduced sales volume in the Sports Licensing divisions.
Management's Discussion and Analysis of Financial Condition and Results of Operations (Con't)
- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Interest income of $2,426,000 in fiscal 1996 decreased slightly from $2,534,000 in fiscal 1995 due to a decline in interest rates on investments.
Interest income in fiscal 1995 was $2,534,000, an increase from $1,491,000 in the previous year. The increase from 1994 to 1995 was the result of more favorable rates of return throughout the year and higher levels of investments.
Liquidity and Capital Resources
The Company's financial position remained strong throughout fiscal 1996. At September 30, 1996 working capital was $75,767,000, an increase of $7,319,000 from September 30, 1995 working capital of $68,448,000. As is noted in footnote 1, the Company adopted Statement of Financial Accounting Standards No. 115 (SFAS 115), which requires that investments held to maturity be classified based upon contractual maturities. As such, at September 30, 1996, $6,028,000 of investments were reclassified as short-term.
The Company's primary source of cash during the three years ended September 30, 1996 has been its operating activities. In 1996, 1995, and 1994, operating activities provided $20,453,000, $6,727,000, and $17,113,000, respectively.
The primary uses of cash during the three year period ended September 30, 1996, have been payment of dividends, additions to property, plant, and equipment, and repayment of capitalized lease obligations.
In fiscal 1996 the Company continued its year end special dividend payment which it initiated in fiscal 1988.
At September 30, 1996, shareholders' equity was $96,141,000 or $18.96 per share, up from $94,315,000, or $18.60 per share, at September 30, 1995. At September 30, 1994 shareholders' equity was $93,896,000, or $18.52 per share.
Management believes that the Company has sufficient working capital to finance its operations and projected growth. There were no short-term borrowings outstanding during fiscal years 1996, 1995 and 1994, and management does not anticipate the need for any such borrowings. If necessary, the Company has the ability to obtain funds from a number of sources to meet its seasonal and long-term requirements.
Item 8.

Item 8. Financial Statements and Supplementary Data. Consolidated Balance Sheets
- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Consolidated Statements of Earnings
- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Consolidated Statements of Shareholders' Equity
- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Consolidated Statements of Cash Flows
- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Notes to Consolidated Financial Statements - ----------------------------------------------------------- - -----------------------------------------------------------
Note 1--Summary of Significant Accounting Policies
a.PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All inter-company accounts and transactions have been eliminated in consolidation.
b.USE OF ESTIMATES
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
c.REVENUE RECOGNITION
Sales are recognized upon shipment of merchandise. The Company does not provide for allowances or return of goods except for cause. When an allowance or return occurs, it is accounted for as a reduction of sales. Sales allowances are not significant to the operations of the Company.
d.INVENTORIES
Inventories are stated at the lower of cost (principally standard cost which approximates actual cost on a first-in, first-out basis) or market.
e.PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are carried at cost. Depreciation and amortization for financial accounting purposes are provided by using the straight line method over the estimated useful lives of the assets.
Leases of manufacturing facilities which are in substance financing arrangements have been capitalized, with the corresponding liability included in capitalized lease obligations.
f.INCOME TAXES
Deferred income taxes are provided to reflect the tax effect of timing differences in reporting income and deductions for tax and financial statement purposes under SFAS 109 which provides for accounting for deferred income taxes using the liability method.
g.EARNINGS PER SHARE
Earnings per share are calculated on the basis of the weighted average number of common shares outstanding during the year.
h.CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
i.INVESTMENTS
Financial instruments, which potentially subject the Company to concentration of risk, consist of cash and investments. The Company places its investments in US Treasury obligations which limits the amount of credit exposure.
Effective December 31, 1994, the Company adopted Statement of Financial Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115), under which the Company's investments are designated as trading or held-to-maturity. Trading securities are reported at fair value, with changes in fair value included in earnings. When the Company has the intent and ability to hold the securities to maturity they are classified as held-to-maturity securities and reported at amortized cost. In accordance with SFAS 115, prior years' financial statements have not been restated to reflect the change in accounting method. There was no cumulative effect as a result of adopting SFAS 115 and the impact on net earnings for the year ended September 30, 1995 was not material.
- ----------------------------------------------------------- - -----------------------------------------------------------
Note 2--Investments
Investments in the trading category amounted to $6,540,000 at September 30, 1996 and consisted of U.S. Treasury Bills maturing from November 1996 through December 1996. Gross unrealized holding gains at September 30, 1996 were approximately $43,000.
Investments in the held-to-maturity category amounted to $13,031,000 at September 30, 1996 and consisted of U.S. Treasury Notes with contractual maturities as follows:
The estimated fair value of investments approximates the amortized cost, and, therefore, there are no unrealized gains or losses as at September 30, 1996.
Note 3--Inventories
INVENTORIES CONSIST OF THE FOLLOWING:
Note 4--Property, Plant and Equipment
PROPERTY, PLANT AND EQUIPMENT CONSIST OF THE FOLLOWING:
The net book value of the capitalized leased manufacturing plants was $4,025,000 at September 30, 1996 and $4,716,000 at September 30, 1995.
Note 5--Capitalized Leases
Substantially all of the Company's leases of manufacturing facilities have been capitalized. Future minimum lease payments of principal and interest under leases capitalized at September 30, 1996 are as follows:
- ----------------------------------------------------------- - -----------------------------------------------------------
Note 6--Income Taxes
The difference between the total statutory Federal income tax and the actual income tax expense is accounted for as follows:
Income tax expense consists of the following components:
Deferred income taxes are provided to reflect the tax effect of timing differences in reporting income and deductions for tax and financial statement purposes, principally depreciation, pension, employee benefits, deferred compensation and inventory.
Included in Other Current Assets at September 30, 1996 and 1995 is $1,504,000 and $1,478,000, respectively, of current deferred income tax debits, and included in Income Taxes Payable at September 30, 1996 and 1995 is $506,000 and $863,000, respectively, of current deferred income tax credits.
Note 7--Commitments
The Company is obligated under certain long-term leases which do not meet the criteria for capitalization. The annual minimum rental commitments (excluding escalation) of these leases are:
Total rental expense charged to operations in 1996, 1995 and 1994 amounted to $1,501,000, $2,474,000, and $2,421,000, respectively.
The Company is obligated under various licensing agreements for annual minimum royalty expense commitments, amounting to approximately $1,800,000, $1,400,000 and $200,000 for 1997, 1998 and 1999, respectively.
Total royalty expense charged to operations in 1996, 1995 and 1994 amounted to $3,433,000, $3,336,000, and $5,309,000, respectively.
Note 8--Stock Option Plan
In 1989, the Company adopted a plan for granting stock options to employees to purchase common stock at a price equal to its fair market value at the respective date of grant. Options expire five years after the respective date of grant.
For the years ended September 30, 1994, 1995 and 1996, there were 200,000 options available for grant, and there were no unexercised options for these respective periods.
- ----------------------------------------------------------- - -----------------------------------------------------------
Note 9--Pension and Retirement Plans
The Company contributes to defined benefit pension plans which cover all eligible employees. Pension costs are generally funded currently. Pension expense amounted to $606,385 in 1996, $391,055 in 1995 and $549,587 in 1994. Net pension costs under FASB No. 87 included the following components:
The following table sets forth the funded status for the Company's defined benefit pension plans:
The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation for the Company's plans was 8.0% in 1996, 7.0% in 1995 and 7.5% in 1994. The expected long-term rate of return on assets used for the Company's plans was 9.5% in 1996 and 7.5% in 1995 and 9.5% in 1994.
The Board of Directors adopted on April 1, 1989 a Supplemental Executive Retirement Plan for certain executive employees to restore pension benefits which have been reduced by legislative action. The Company purchases annuity contracts to fund its obligation for the four participants (three officers-directors and one employee-director of the Company) under such plan and reimburses the participants for the current tax recognition resulting from such purchases. The respective costs are being amortized over the remaining estimated employment lives of the participants. The 1996, 1995 and 1994 expense for such plan was $705,000, $705,000 and $736,000, respectively.
The Board of Directors adopted on January 1, 1995, a Supplemental Benefit Restoration Plan for certain employees not covered by the Supplemental Executive Retirement Plan to restore certain pension benefits which have been reduced by legislative action. The Company is currently funding its obligations to the five participants, and the 1996 and 1995 expense for such plan was $68,000 and $75,000, respectively.
Note 10--Major Customers
The Company operates within one industry segment - the manufacture of apparel. The Company performs ongoing credit evaluations of its customers and generally does not require collateral or
- ----------------------------------------------------------- - ----------------------------------------------------------- other security to support customer receivables. Sales to one national retail chain accounted for approximately 66% of the Company's net sales in 1996, 63% in 1995 and 62% in 1994. Another national retail chain accounted for approximately 15%, 20% and 18% of the Company's net sales in 1996, 1995 and 1994, respectively. No other customer accounted for more than 10% of the Company's net sales in each of the three years ended 1996. The Company routinely assesses the financial strength of its customers and, as a consequence, management believes that its trade receivable credit risk exposure is limited. Historically, the Company has not experienced significant losses related to receivables.
Note 11--Shareholders' Equity
Pursuant to the Company's Rights Plan, each shareholder holds one right for each share of common stock, and in the event any person acquires 20% of the Company's common stock, each right will give the holder the option to purchase one share of the Company's common stock for $90, subject to adjustment. The rights expire May 16, 2003, and may be redeemed by the Company for $.01 per right. As of September 30, 1995, 5,069,892 shares of the Company's common stock were reserved for issuance under the Company's Rights Plan.
Note 12--Employment Agreements
The Company maintains employment agreements with four directors, three of whom are also officers of the Company. The employment agreements contain change in control provisions that would entitle each of the four directors to receive up to 2.99 times his five year average annual salary plus continuation of certain benefits if there is a change in control in the Company (as defined) and a termination of his employment. The maximum contingent liability under these agreements in such event is approximately $6,500,000. The employment agreements also provide for severance benefits, disability and death benefits and, as to one officer-director, consulting services under certain circumstances.
Note 13--Quarterly Financial Data (Unaudited)
Financial data for the interim periods of 1996 and 1995 were as follows:
Independent Auditors' Report - ----------------------------------------------------------- - -----------------------------------------------------------
Board of Directors and Shareholders Garan, Incorporated
We have audited the accompanying consolidated balance sheets of Garan, Incorporated and its subsidiaries as at September 30, 1996 and 1995 and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the three fiscal years in the period ended September 30, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the aforementioned financial statements present fairly, in all material respects, the consolidated financial position of Garan, Incorporated and its subsidiaries as at September 30, 1996 and 1995, and the results of consolidated operations, changes in shareholders' equity and cash flows for each of the three fiscal years in the period ended September 30, 1996 in conformity with generally accepted accounting principles.
Robbins, Greene, Horowitz, Lester & Co., LLP
New York, New York November 15, 1996
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant.
The information required to be set forth in this Item will be contained in registrant's 1997 Proxy Statement under the caption "Election of Directors" and is incorporated by reference into this Report.
Item 11.

Item 11. Executive Compensation.
The information required to be set forth in this Item will be contained in registrant's 1997 Proxy Statement under the caption "Executive Compensation" and is incorporated by reference into this Report.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required to be set forth in this Item will be contained in registrant's 1997 Proxy Statement under the caption "Election of Directors; Security Ownership of Certain Beneficial Owners and Management" and is incorporated by reference into this Report.
Item 13.

Item 13. Certain Relationships and Related Transactions.
The information required to be set forth in this Item will be contained in registrant's 1997 Proxy Statement under the caption "Transactions with Management" and is incorporated by reference into this Report.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules.
Page ----
(1) Consolidated Financial Statements.
Included in Part II, Item 8 of this Report:
Consolidated Balance Sheets as at 17 September 30, 1996, and September 30, 1995.
Consolidated Statements of Earnings - 18 years ended September 30, 1996, September 30, 1995, and September 30, 1994.
Consolidated Statements of Shareholders' 18 Equity - years ended September 30, 1996, September 30, 1995, and September 30, 1994.
Consolidated Statements of Cash Flows - 19 years ended September 30, 1996, September 30, 1995, and September 30, 1994.
Notes to Consolidated Financial Statements 20-24 for the years ended September 30, 1996, September 30, 1995, and September 30, 1994.
Page ----
Independent Auditors' Report dated 25 November 15, 1996.
(2) Consolidated Financial Statement Schedules.
Independent Auditors' Report on Schedules dated November 15, 1996, and Consent of Independent Certified Public Accountants dated December 23, 1996.
Supplemental Notes to Consolidated Finan- cial Statements for the years ended September 30, 1996, September 30, 1995, and September 30, 1994.
Schedules other than those listed above are omitted for the reason that they are not required, are not applicable, or the required information is shown in the Consolidated Financial Statements or Notes thereto.
Individual financial statements of the registrant and its subsidiaries are omitted because all subsidi- aries included in the Consolidated Financial Statements are 100% owned.
(b) No reports on Form 8-K have been filed by the registrant during the last quarter of the period covered by this Report.
Page ----
(c) Exhibits filed as part of this Report.
(3) Articles of Incorporation and by-laws.
(i) Restated Articles of Incorporation was reported and filed as an exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1988, and is in-corporated by reference into this report.
(ii) Articles of Amendment of the Restated Articles of Incorporation was reported and filed as an exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1988, and is incorporated by reference into this report.
(iii) Articles of Amendment of the Restated Articles of Incorporation dated November 9, 1992, was reported and filed as an Exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1992, and is incorporated by reference into this report.
(iv) By-laws, as amended through April 21, 1993, were reported and filed as an Exhibit in the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993, and are incorporated by reference into this report.
(4) Instruments defining the rights of security holders, including indentures.
Amended and Restated Rights Agreement dated as of April 21, 1993, between the registrant and Chemical Bank was reported and filed as an exhibit in the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993, and is incorporated by reference into this report.
Page ----
(10) Material Contracts.
(i) Employment Agreement as amended and restated on December 4, 1992,between the registrant and Rodney Faver, was reported and filed as an Exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1992, and is incorporated by reference into this report.
(ii) Amendment to Employment Agreement dated November 15, 1995, between the registrant and Rodney Faver was reported and filed as an Exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1995, and is incorporated by reference into this report.
(iii) Employment Agreement as amended and restated on December 4, 1992, between the registrant and Jerald Kamiel, was reported and filed as an Exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1992, and is incorporated by reference into this report.
(iv) Employment and Consulting Agreement as amended and restated on December 4, 1992, between the registrant and Seymour Lichtenstein, was reported and filed as an Exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1992 and is incorporated by reference into this report.
(v) Employment Agreement as amended and restated on December 4, 1992, between the registrant and William J. Wilson, was reported and filed as an Exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1992, and is incorporated by reference into this report.
(vi) Supplemental Executive Retirement Plan, effective April 1, 1989, was reported and filed as an exhibit in the
registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1989, and is incorporated by reference into this report.
(vii) Form of Indemnity Agreement dated August 9, 1993, between the registrant and each of its directors was reported and filed as an exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1993, and is incorporated by reference into this report.
(viii) Indemnity Agreement dated August 9, 1993, between the registrant and Alexander J. Sistarenik was reported and filed as an exhibit in the registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1993, and is incorporated by reference into this report.
(21) Schedule of Subsidiaries of registrant. 33
(27) Financial Data Schedule. 34
(d) The Consolidated Financial Statement Schedules Specified in Item 14(a)(2) are annexed.
INDEPENDENT AUDITORS' REPORT ON SCHEDULES
Board of Directors and Shareholders Garan, Incorporated
In connection with our audit of the Consolidated Financial Statements of Garan, Incorporated for the year ended September 30, 1996, incorporated into this Annual Report on Form 10-K in Part II, Item 8, we also have audited the supporting Consolidated Financial Statement Schedules listed in Item 14(a)(2) of this Report. In our opinion, those Consolidated Financial Statement Schedules present fairly, when read in conjunction with the related Consolidated Financial Statements, the financial data required to be set forth therein.
ROBBINS, GREENE, HOROWITZ, LESTER & CO., LLP
November 15, 1996 New York, New York
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
As independent certified public accountants, we hereby consent to the incorporation of our report dated November 15, 1996 included in, or incorporated by reference in, Registration Statement Nos. 2-72544 and 33-29054 on Form S-8 and the related Prospectuses.
ROBBINS, GREENE, HOROWITZ, LESTER & CO., LLP
December 23, 1996 New York, New York
GARAN, INCORPORATED AND SUBSIDIARIES
SUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 15 - INTEREST INCOME
Interest income is comprised of the following components:
1996 1995 1994 ---- ---- ----
Investments $1,999,000 $2,155,000 $1,066,000
Other 427,000 379,000 425,000 --------- --------- ---------
$2,426,000 $2,534,000 $1,491,000 --------- --------- --------- --------- --------- ---------
Note 16 - ACCRUED LIABILITIES
Accrued liabilities as at September 30, 1996 and September 30, 1995 consist of the following:
1996 1995 ---- ----
Payroll $ 3,236,000 $ 2,663,000
Payroll Taxes 132,000 67,000
Accrued Expenses 7,953,000 8,275,000
---------- ----------
$11,321,000 $11,005,000 ---------- ---------- ---------- ----------
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GARAN, INCORPORATED
December 23, 1996 By: /s/ William J. Wilson ---------------------------------------- William J. Wilson, Vice President Finance and Administration
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 registrant and in the capacities and on the dates indicated.
December 23, 1996 /s/Seymour Lichtenstein ---------------------------------------- Seymour Lichtenstein Principal Executive Officer, Director
December 23, 1996 /s/William J. Wilson ---------------------------------------- William J. Wilson Principal Financial Officer, Director
December 23, 1996 /s/Alexander J. Sistarenik ---------------------------------------- Alexander J. Sistarenik, Principal Accounting Officer
December 23, 1996 /s/Rodney Faver ---------------------------------------- Rodney Faver, Director
December 23, 1996 /s/Jerald Kamiel ---------------------------------------- Jerald Kamiel, Director
December 23, 1996 /s/Marvin S. Robinson ---------------------------------------- Marvin S. Robinson, Director