ITEM 1. BUSINESS
GENERAL
Egghead, Inc. (Egghead or the Company), a reseller of personal computer (PC) software, hardware, and related products, serves small businesses and individuals through retail outlets and mail order. As of March 30, 1996, the Company operated 164 retail stores, a direct response group, and Elekom Corporation (ELEKOM), all of which are included in continuing operations.
The Company has also historically served corporate, governmental, and educational customers through its corporate, government, and education (CGE) division. On March 25, 1996, the Company announced the sale of the CGE Division to Software Spectrum, Inc. (SSI), a Texas corporation, for $45.0 million in cash which did not include the CGE division's receivables and inventory that Egghead is liquidating in an orderly manner, all of which are expected to result in total gross cash proceeds of approximately $90.0 million. The sale, which was effective, May 13, 1996 included a Fulfillment Agreement relating to the provision by Egghead to SSI of certain support services for a period not to exceed 120 days and a Call Center Lease detailing the lease for a period of three years of a portion of Egghead's Spokane facility to SSI. (Exhibits on Form 8-K filed May 23). Information contained in this filing excludes, unless otherwise stated, any data relative to the discontinued operations of the CGE division.
Egghead, a Washington corporation, was incorporated in 1988 and is the successor to a corporation which was incorporated in Washington in 1984. Egghead is the parent company of DJ&J Software Corporation, Eggspert Software, Ltd. (Eggspert), EH Direct, Inc., Egghead International, Inc. (Egghead International) and ELEKOM. Eggspert and Egghead International became inactive subsidiaries on May 13, 1996 following the sale of the CGE division to SSI. Unless the context indicates otherwise, references to "the Company" and "Egghead" include Egghead and its subsidiaries. Operating results of Eggspert and Egghead International are included in discontinued operations. See Note 8 of Notes to the Consolidated Financial Statements.
Egghead's retail stores offer a broad in-store selection of products at competitive prices, as well as special order capabilities for additional products. The Company employs a knowledgeable sales force to assist customers in selecting software, hardware, and related products. At fiscal year end, the Company was operating 19 of its retail stores under a new merchandising format which is approximately twice the size of original stores and is arranged in a more user-friendly format. The performance of these new stores has been mixed and management continues to evaluate results while refining the format. While assessing the overall contribution of the new merchandising format, management intends to open six new stores. Pending such evaluation and refinement of the new format, the Company does not intend to open more than the six new stores.
In December 1995, Egghead formed ELEKOM, a new subsidiary. ELEKOM was formed to develop electronic commerce applications and services which link customers and their suppliers. EleTrade, a product being developed by ELEKOM, uses Lotus Notes and other notes networks to provide large organizations an easy-to-use, cost-effective, secure and reliable product ordering and order management system for non-production goods and services. EleTrade allows companies to create customized electronic catalogs with multi-media product information and customer-specific pricing. ELEKOM is also developing additional enhancements which will automate the internal requisition and approval process and which may create better asset/inventory management and allow electronic software distribution. ELEKOM, a development stage company, incurred selling, general and administrative costs of approximately $1.1 million in fiscal 1996 and is not expected to make significant sales or distribution of products in fiscal year 1997.
MARKET OVERVIEW
The software industry is undergoing a noticeable degree of consolidation as large software publishers acquire either other software publishers or complete software product lines. Smaller software publishers are attempting to concentrate on specialized products in limited markets. Software resellers are also merging with or acquiring other software resellers.
Both businesses and individual consumers have shown an increasing preference for integrated software packages which combine word processing, spreadsheet, presentation, and database software. These integrated packages are appealing to the consumer for several reasons. The purchase cost of an integrated software package is lower than the individual components purchased separately. In addition, integration reduces some of the complexity and learning time involved in using software. Integrated software packages also help standardize the computing environment for local area networks, which are becoming more common in the business world. This shift toward integration and standardization is viewed by many companies as a way to significantly reduce the cost of supporting PC applications in their organizations.
Prices of microprocessor chips continue to fall due to increased competition among computer chip manufacturers, and the introduction of newer, faster microprocessor chips. The decrease in microprocessor chip prices has forced PC prices down, resulting in increased sales of PCs to businesses and individual consumers. Sales of home computers, especially those equipped for multimedia, have increased dramatically as consumers begin to use PCs for a variety of uses such as telecommuting, home productivity, entertainment, communications, and education.
Price performance improvements in microcomputer hardware and the availability of CD-ROM technology have a dramatic impact on the retail segment of the market. Sales of PC hardware accessories, such as hard drives and modems, have increased as consumers enhance their PCs. Multimedia capability has enabled home users to more effectively use microcomputers for educational and entertainment purposes.
Access to electronic communication networks, such as the Internet and commercially available on-line services, has become increasingly important to both businesses and individual consumers. These electronic communication networks have grown at a tremendous pace over the last year. The networks are expected to provide substantial opportunities both now and in the future for communications, commerce, and the exchange of data. Software publishers have recognized the significance of this trend, and have begun to integrate interfaces for these electronic communications networks into their operating systems and workgroup software.
PRODUCTS AND SERVICES
Egghead resells PC software, hardware and related products, computer- related magazines and books, tutorials, and selected peripheral devices and accessories. Egghead has approximately 2,000 software products (including both IBM-Registered Trademark--compatible and Apple-Registered Trademark- Macintosh-Registered Trademark- software) and other products in its retail stores, and thousands more available through 1-800-EGGHEAD's special order service.
The Company offers a broad array of customer support services to assist customers in the selection and administration of their software purchases, including the following:
CUSTOM UPDATES AND EGGSTRAS (CUE-SM-) PROGRAM - a preferred customer membership program providing discounts and other benefits in the retail stores and direct response. CUE-SM- also provides the Company with a valuable database of customers, their PC equipment profiles, and a history of their software purchases.
COMPUTER SELECT - a CD-ROM-based system updated monthly with information on most software and hardware products. Articles can be obtained from all major personal computer publications and sent to customers as requested.
INTERNET SITE - Egghead now maintains a site on the internet for information, customer support, and product sales. Egghead's page can be found at http://www.egghead.com. The site allows Egghead to reach customers through a new medium as an expanding consumer base purchases hardware and/or software that allows Internet access. The site uses the new merchandising format to display SKUs in a manner similar to the new format Egghead retail stores. Egghead plans to begin offering electronic delivery of software in the second quarter of 1997.
1-800-EGGHEAD - Egghead maintains a direct response unit which processes all telephone and mail orders. These orders are solicited through catalog distribution. Catalogs have been redesigned to use the merchandising format found in Egghead's new retail stores. 1-800- EGGHEAD also provides customer service for the 164 stores, as well as store referral to callers who would like to try a product. 1-800- EGGHEAD also allows customers access to products not available through retail outlets by offering a special order service.
MARKETING, ADVERTISING, AND PROMOTION
Egghead's marketing philosophy is to position itself as the reseller of choice by providing the customer with the best value in terms of competitive prices, selection, service, and convenience. In addition, Egghead strives to create primary demand for the products it sells. The Company's strategy to meet these objectives is to use aggressive advertising and marketing efforts.
The Company's advertising campaign emphasizes a broad selection of available merchandise and competitive prices. Advertising is also used to promote major new product launches.
Egghead's primary advertising medium is direct mail, which is used to target the highly identifiable segment of the population which owns and/or uses computers. In addition to a database of more than 3 million of its CUE customers, Egghead sends regular direct mail product promotions to purchased lists of computer owners. The Company also uses both local and national newspapers. Catalogs are designed to reflect the same layout as customers will find in Egghead's new format retail stores. These catalogs are updated and distributed throughout the year.
Egghead has entered into cooperative advertising and other promotional and market development fund agreements with numerous manufacturers and distributors. The funds obtained through these agreements assist the Company in achieving high visibility in the marketplace.
CUSTOMERS
Egghead has a diverse customer base comprised primarily of individuals and small businesses and uses specific marketing strategies to target different customer segments.
RETAIL OPERATIONS
Egghead's retail stores are designed to provide a pleasant shopping environment for walk-in customers, primarily individuals, who purchase PC software and hardware products for their personal use and/or for use in a small business. A knowledgeable sales force offers solutions-oriented assistance to customers selecting software, hardware, and related products.
Egghead's retail stores offer customers competitive prices, a wide selection of products, excellent service, and convenient store locations. In addition to stocking approximately 2,000 SKUs in the retail stores, Egghead customers have access to thousands more through 1-800-EGGHEAD's special order service. The Company also stocks selected PC hardware products, computer-related magazines and books, tutorials, and selected peripheral devices and accessories. Egghead also provides installation services in most of its stores.
During fiscal 1996, the Company introduced 19 stores based on a new merchandising format which is approximately twice the size of older format stores and is arranged in a more user-friendly environment. The performance of these new stores has been mixed and management continues to evaluate results while refining the format. While assessing the overall contribution of the new merchandising format, management intends to open six new stores. Pending such evaluation and refinement of the new format, the Company does not intend to open more than the six new stores. The balance of the Egghead stores contain approximately 2,500 square feet of retail selling space. Most stores are located in strip shopping centers. Store locations are researched and chosen to be in areas with high distribution of personal computers, high population density, and high mean income levels. Egghead provides in-store demonstration of software, with most stores having personal computers available for use by customers in evaluating software in the stores.
MERCHANDISING
Egghead purchases most of its products through a central merchandise buying department. Inventory levels and product mix are based upon rates of sale, seasonality, and store demographics and size. The Company also special orders non-inventoried software products to satisfy customers' special needs.
Egghead's decision to buy merchandise directly from manufacturers or through distributors is determined on a transaction-by-transaction basis depending on cost, availability, and potential product obsolescence. For certain products, Egghead has sufficient sales volume to purchase directly from manufacturers at volume discounts. The Company purchases software and other products directly from more than 250 manufacturers. Egghead minimizes the administrative overhead associated with buying products from hundreds of smaller manufacturers by using a limited number of distributors.
Egghead conducts business with major vendors including Microsoft and Western Digital. In fiscal years 1996 and 1995, sales derived from software programs supplied by Microsoft, Egghead's largest vendor, represented approximately 18% and 15% of total net sales, respectively.
Egghead has certain exchange and return privileges with many of its vendors, which typically include time, volume, and other limitations. These exchange and return privileges allow the Company to reduce the risk of loss resulting from obsolete and defective merchandise.
SUPPLY AND DEMAND FOR COMPUTER SOFTWARE, HARDWARE AND RELATED SUPPLIES
Sales by Egghead and other similar resellers are dependent upon the continued purchase and expanded use of home and home office personal computers, as well as the continued development of personal computer software. A long-term decline in the purchase or use of home or home office personal computers, or an interruption in the continued development of personal computer software, would have a material adverse effect on the Company's results of operations and financial position.
DISTRIBUTION
Most inventory that Egghead purchases is received in one of the Company's distribution facilities before it is sent to a customer or to a retail store. Some products are sent directly from vendors or distributors to stores or customers. The Company's distribution facilities also process most returned merchandise. The Company leases a 138,000 square foot facility in Sacramento, California and a 125,000 square foot facility in Lancaster, Pennsylvania.
The manner in which microcomputer software products are sold and distributed is changing rapidly. Other methods of distribution, such as electronic software distribution could have an impact on how the Company distributes products in the future.
COMPETITION
The business of selling microcomputer software and hardware is intensely competitive. The Company currently competes with other "direct sales" organizations, other software retailers, computer and office superstores, consumer electronic superstores, mass merchandisers, direct response companies, computer manufacturers, and software publishers that sell directly to end-users through traditional and electronic methods of distribution.
Other software retail competitors include mall-based stores such as Electronics Boutique, Babbages, and Software Etc.
Computer and office superstores, such as CompUSA, Computer City, Micro Center, and Office Depot provide significant competition for Egghead's retail stores in the markets in which they are located. These stores are very price competitive. Computer superstores typically offer a wide product selection, while office superstores have a more limited selection. Large computer superstores, like Computer City, offer on-site installation of software and hardware upgrades. Some superstores also offer training and technical services.
Consumer electronic superstores, such as Best Buy, Future Shop, and Circuit City, are a growing source of competition for the Company's retail stores in the markets in which they operate.
Mass merchandisers, such as Wal-Mart, Incredible Universe, and Sears, and warehouse clubs such as SAM's and Price/Costco, generally concentrate on basic software products and carry relatively few titles.
Direct response businesses, such as MicroWarehouse, Programmers Paradise, and PC Connection, are another important channel for software sales. MicroWarehouse sells their products internationally, and has experienced significant growth in international markets.
Many superstores and computer manufacturers sell PCs to consumers with custom-installed hardware and pre-loaded software. This bundling of products is very convenient for the consumer, and eliminates many of the technical difficulties involved with the installation of software or hardware.
Software publishers continue to directly market and sell to end-users. It is also becoming more common for software publishers to distribute software over electronic communications networks. Such networks provide the convenience of allowing the customer to purchase software products directly from their home or office. However, distribution directly by a publisher does not provide the customer with a broad selection, personal assistance from the sales force, or a full demonstration of the product prior to purchase. There has also been a continuing trend of software publishers offering new software products at deeply discounted introductory prices.
Because the microcomputer software market is very competitive, software resellers typically have low gross margins and operating income as a percentage of sales. Therefore, the Company's profitability is highly dependent upon effective internal operating and cost control and the ability to adapt quickly and efficiently to changes in industry trends.
EMPLOYEES
At March 30, 1996, Egghead had approximately 2,300 employees, (including temporary employees) consisting of approximately 1,800 retail personnel (including direct response), 200 distribution center employees, and 300 headquarters personnel. Employees are not represented by a collective bargaining unit.
TRADEMARKS AND TRADENAMES
"EGGHEAD-Registered Trademark-", "EGGHEAD DISCOUNT SOFTWARE-Registered Trademark-", "EGG CARTON-Registered Trademark-", "EGGSPERT-Registered Trademark-", the "PROFESSOR EGGHEAD-Registered Trademark-" design, and "EGGCESSORIES-Registered Trademark-", are registered in the United States Patent and Trademark Office as service marks or trademarks of the Company. The Company also does business under the trade names "Egghead Software", "Egghead Discount Software", and "Mac's Place at Egghead." In addition, the Company is the owner of a number of common law trademarks and service marks, including "SOFTWARE ASSET MANAGEMENT-SM-", "SAM-SM-", "CUE-SM-", "EGGHEAD-Registered Trademark- EXPRESS-TM-", "ELEKOM-TM-", "EleTrade-TM-", and certain "EGG" combination words, "MAC'S PLACE-SM-," and "MAC'S PLACE AT EGGHEAD-SM-." The Company believes the strength of its trademarks and service marks benefits its business and intends to continue to protect and promote its registered and common law trademarks and service marks.
ENVIRONMENTAL LAWS
Compliance with federal, state, and local laws enacted for protection of the environment has had no material effect upon Egghead's capital expenditures, earnings, or competitive position. The Company does not anticipate any material adverse effects in the future based on the nature of its operations and the current focus of such laws.
ITEM 2.

ITEM 2. PROPERTIES
At March 30, 1996, Egghead operated 164 retail stores in 30 states and the District of Columbia. Most of the Company's stores are located in strip shopping centers to provide customers convenient access. The Company has not opened, nor does it intend to open, retail stores on a franchise basis. As of March 30, 1996, the Company's retail stores were located as follows:
Number of Retail Location Outlets -------- ------- Arizona 3 California 42 Colorado 4 Connecticut 2 District of Columbia 3 Florida 3 Georgia 1 Idaho 1 Illinois 15 Indiana 2 Kansas 1 Maryland 6 Massachusetts 8 Michigan 5 Minnesota 4 Missouri 2 New Jersey 7 New Mexico 1 New York 10 Nevada 2 North Carolina 4 Ohio 4 Oklahoma 1 Oregon 4 Pennsylvania 5 Tennessee 1 Texas 4 Utah 1 Virginia 7 Washington 9 Wisconsin 2 --- Total 164 --- ---
The Company leases 163 of its retail stores under leases expiring from fiscal 1997 to fiscal 2001. The Company expects those leases with terms expiring during fiscal year 1997 could be renewed under substantially similar terms. Substantially all of the Company's leases provide for a minimum monthly rent that is either constant or adjusts periodically throughout the lease term, including renewal periods.
The Company leases its distribution facilities in Lancaster, Pennsylvania and Sacramento, California; and an additional storage facility in Kent, Washington. The Company has a lease for a distribution facility in Wilmington, Ohio. The distribution from this facility will be discontinued following the CGE sale and management will attempt to sublease the facility. The lease terms on the Company's distribution facilities expire from fiscal 1998 to fiscal 2000, with renewal options available.
The Company owns its administrative headquarters building in Spokane, Washington, its retail store in Issaquah, Washington and an office building in Kalispell, Montana. Approximately 51% of the Spokane facility is being leased to SSI pursuant to the Call Center Lease agreement entered into by Egghead and SSI in connection with the sale of the CGE division. The lease has a three year term with an option for renewal. The Company's direct response operation, 1-800-EGGHEAD is located in the Spokane, Washington building. The Company plans to sell or lease the building in Kalispell.
See Note 4 of Notes to Consolidated Financial Statements for additional information about the Company's leases.
ITEM 3.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders in the fourth quarter of fiscal 1996.
PART II
ITEM 5.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
MARKET AND MARKET PRICE FOR COMMON STOCK
Egghead's common stock, $0.01 par value, is traded over the counter under the symbol EGGS and is quoted as part of the Nasdaq National Market System.
The closing market prices per share of the Company's common stock during the fiscal years ended April 1, 1995, and March 30, 1996 are set forth below. The prices reflect last sale prices as reported by Nasdaq National Market System.
High Low ---- ---
Quarter ended July 2, 1994 $8.76 $6.81 Quarter ended October 1, 1994 7.63 6.19 Quarter ended December 31, 1994 11.81 7.00 Quarter ended April 1, 1995 11.75 8.50
Quarter ended July 1, 1995 $13.38 $8.88 Quarter ended September 30, 1995 13.75 7.88 Quarter ended December 30, 1995 8.75 5.88 Quarter ended March 30, 1996 10.69 5.13
HOLDERS
The approximate number of holders of record of Egghead's common stock as recorded on the books of Egghead's Registrar and Transfer Agent as of April 29, 1996, was 1,227.
DIVIDENDS
The Company has never paid cash dividends on its capital stock and does not plan to pay cash dividends in the foreseeable future.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
Statement of Operations Data (1):
(1) All amounts reflect the CGE activities as discontinued operations.
NOTE: Fiscal year 1993 had 53 weeks. All other fiscal years presented had 52 weeks.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
(1) Calculated by dividing the total number of store months open during the period by 12.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Selected financial data for each quarter of fiscal years 1996 and 1995 follows (in millions, except per share data). Each quarter consists of 13 weeks
CONTINUING OPERATIONS
DISCONTINUED OPERATIONS
Financial data for the CGE division for each quarter follows. This division was sold May 13, 1996 and is reported as discontinued operations in the consolidated financial statements included in this filing.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Egghead, Inc. (Egghead or the Company), a reseller of personal computer (PC) software, hardware, and related products, serves small businesses and individuals through retail outlets and mail order. Egghead's retail stores offer a broad in-store selection of products at competitive prices, as well as special order capabilities for additional products. On March 30, 1996, the Company operated 164 stores located throughout the United States. The Company employs a knowledgeable sales force to assist customers in selecting software, hardware, and related products. At the end of fiscal 1996 the Company was operating 19 of its retail stores under a new merchandising format which is approximately twice the size of predecessor stores and is arranged in a more user-friendly format. The performance of these new stores has been mixed and management continues to evaluate results while refining the format. While assessing the overall contribution of the new merchandising format, management intends to open six new stores. Pending such evaluation and refinement of the new format, the Company does not intend to open more than six new stores.
Egghead continues to implement changes to restructure the Company. The Company has historically served corporate, governmental and educational customers through its corporate, government and education sales (CGE) division. On March 25, 1996, the Company announced the sale of the CGE division to Software Spectrum, Inc. (SSI), a Texas corporation, for $45.0 million in cash which did not include CGE division's receivables and inventory that Egghead is liquidating in an orderly manner, all of which are expected to result in total gross cash proceeds of approximately $90.0 million. The sale, which was effective May 13, 1996, included a Fulfillment Agreement relating to the provision by Egghead to SSI of certain support services for a period not to exceed 120 days and a Call Center Lease detailing the lease for a period of three years of a portion of Egghead's Spokane facility to SSI. Information contained in this filing excludes, unless otherwise stated, any data relative to the discontinued operations of the CGE division. The sales and gross margin performance of the Company's CGE division had declined and selling, general and administrative expenses as a percentage of sales had increased in the months prior to the sale. The sale of the CGE division will allow management to focus on the Company's retail business. See "--Results of Operations--DISCONTINUED OPERATIONS."
In December 1995, Egghead formed Elekom Corporation (ELEKOM), a new subsidiary. ELEKOM was formed to develop electronic commerce applications and services which link customers and their suppliers. EleTrade, a product being developed by ELEKOM, uses Lotus Notes and other notes networks to give large organizations an easy-to-use, cost-effective, secure and reliable product ordering and order management system for non-production goods and services. EleTrade allows companies to create customized electronic catalogs with multi-media product information and customer- specific pricing. ELEKOM is also developing additional enhancements which will automate the internal requisition and approval process and which may create better asset/inventory management and allow electronic software distribution. ELEKOM, a development stage company, incurred selling, general and administrative costs of approximately $1.1 million in fiscal 1996 and is not expected to have significant sales or distribute products in fiscal year 1997.
Over the past twelve months, Egghead consolidated into a new corporate headquarters location in Spokane, Washington its direct response operations, formerly in Kalispell, Montana, and its administrative operations, previously located in Issaquah, Washington. The relocation, severance and related costs of approximately $4.6 million are included in the fiscal 1996 operating results. The Company implemented these changes to improve customer service and reduce future operating costs.
The Company uses a 52/53 week fiscal year, ending on the Saturday nearest March 31 of each year. Fiscal years 1996, 1995, and 1994 each had 52 weeks. All references herein to fiscal 1996, 1995, and 1994 relate to the fiscal years ended March 30, 1996, April 1, 1995, and April 2, 1994 respectively.
CERTAIN RISK FACTORS
In addition to other information contained in this filing, the following factors could affect the Company's actual results and could cause such results to differ materially from those achieved in the past or expressed in the Company's forward-looking statements. When used in this filing, the words "expects," "believes," "anticipates," and similar expressions are intended to identify forward-looking statements.
Competition - The personal computer software, hardware and other related products retailing industry is highly competitive. Egghead competes with other software specialty stores located in malls and in other locations, as well as with computer and office superstores, consumer electronic superstores, mass merchandisers, direct response businesses and software publishers. In addition, there can be no assurance that other methods of distribution will not emerge in the future which would result in increased competition for Egghead. Increased competition may lead to reduced profit margins on personal computer software, hardware and related products, which could have an adverse effect on Egghead's results of operations. Certain of Egghead's competitors have substantially greater financial and other resources than Egghead, which may give them certain competitive advantages. See "Business - Competition."
Seasonality and Quarterly Fluctuations - As is the case with many retailers, a significant portion of Egghead's sales will be generated in the fiscal quarter which includes the Christmas selling season. As a result, the annual earnings of Egghead will be heavily dependent on the results of that quarter. Egghead's quarterly results of operations may also fluctuate as a result of the amount of sales contributed by new stores, the timing of costs associated with the construction and opening of these stores, the timing of the closing of any stores, the timing of product releases and a variety of other factors.
Dependence on Suppliers - Egghead expects to purchase a significant number of its products from Microsoft and Western Digital. During fiscal 1996 and 1995, sales derived from products supplied by Microsoft and Western Digital accounted for 23.7% and 22.9%, respectively, of Egghead's total net sales. The Company believes the loss of Microsoft or Western Digital as a supplier could have a material adverse effect on Egghead's business and financial results. In addition, Egghead's financial performance is in a large part dependent on the terms it obtains from its suppliers. Such terms include unit prices, unsold product return policies, advertising and market development allowances, freight charges and payment terms. If Egghead is unable to maintain favorable terms with its suppliers, its results of operations could be materially adversely affected. See "Business - Merchandising."
New Merchandising Store Format - Egghead's ability to open and operate new stores profitably will depend upon the success of the recently opened new merchandising format stores, the availability of suitable store locations, the negotiation of acceptable lease terms, its financial resources and its ability to control the operational aspects of its growth. While assessing the overall contribution of the new merchandising format, management intends to open six new stores. Pending such evaluation and refinement of the new format, the Company does not intend to open more than the six new stores. See "Business - Retail Operations."
Dependence on Purchase and Use of Personal Computers and Software - Sales by Egghead of personal computer software, hardware and related products will be dependent upon the continued purchase and expanded use of home and home office personal computers, as well as the continued development of personal computer software. A long-term decline in the purchase or use of home or home office personal computers, or an interruption in the continued development of personal computer software, would have a material adverse effect on the Company's results of operations and financial position.
Dependence on Key Personnel - The success of Egghead will also be dependent upon its ability to attract, motivate and retain key management personnel involved in store operations, merchandising, marketing and administration. The loss of services of key personnel could have a material adverse effect on Egghead's business and financial results. As of June 28, 1996, the Company did not have employment agreements with any officers or directors.
Development Stage Subsidiary - In December 1995, the Company formed ELEKOM, a subsidiary, which is developing electronic commerce applications and services which link customers and their suppliers. Selling, general and administrative costs of approximately $1.1 million and $407,000 were incurred by ELEKOM in fiscal 1996 and 1995, respectively. ELEKOM is expected to continue to incur costs in development of these products and is not expected to make significant sales or distribution of products in fiscal 1997. There can be no assurance that ELEKOM will complete development of these products, or if completed, that the products will have a market or that another similar product will not be already be introduced by a competitor. See "Business - General
Readers are cautioned not to place undue reliance on the Company's forward- looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly release the results of any revisions to such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
OVERVIEW
Egghead reported a total net loss for continuing and discontinued operations of $10.7 million for fiscal 1996 compared to net income of $2.7 million and a net loss of $514,000 for fiscal years 1995 and 1994, respectively. The net loss during fiscal 1996 was due primarily to a decrease in sales due to a reduction in the average number of stores in full operation during the year, one-time costs of approximately $4.6 million associated with the relocation of the corporate headquarters, costs of rolling out the new format retail stores, and investments of approximately $1.1 million in ELEKOM. Fiscal year 1995 net income included a one-time theft insurance recovery of $1.65 million, pre-tax, related to inventory stolen from retail stores in prior years. Earnings (loss) per share for the fiscal years 1996, 1995, and 1994 was $(0.62), $0.15, and $(0.03), respectively.
CONTINUING OPERATIONS
Income (loss) from continuing operations includes the results of the Company's retail division, direct response divisions, and ELEKOM as well as selling, general, and administrative expenses related to these operations. The following table shows the relationship of certain items relating to continuing operations included in the Company's Consolidated Statements of Operations expressed as a percentage of net sales:
NET SALES in fiscal 1996 were $403.8 million, a decrease of $30.2 million or 7% from fiscal 1995 net sales of $434.0 million. Fiscal 1995 sales increased $60.5 million or 16% from fiscal 1994 sales of $373.5 million. Fiscal 1996 sales decreases were affected by a reduction in the average number of stores in full operation, which was 166 during fiscal 1996, compared to 178 stores during the previous year. Comparable retail store sales increased 0.1% in fiscal 1996 compared to fiscal 1995. Comparable store sales for the third and fourth quarters of fiscal 1996 decreased 6.6% and 12.5%, respectively, as compared to the fiscal 1995 third and fourth quarters. Comparable store sales performance in the fiscal 1997 months of April and May have continued this trend with decreases of 7.4% and 6.1% over the same periods in fiscal 1996. In fiscal 1995, comparable retail store sales increased 21% compared to fiscal 1994. Comparable store sales measure sales for stores which were open in both periods being evaluated. Because new format stores were opened during fiscal 1996, their sales will not impact comparable store sales statistics until they have been active during all periods evaluated.
During fiscal 1996, the Company opened 10 stores, remodeled 10 stores, and closed 15 stores, operating a total of 164 stores at March 30, 1996. This compares to the 169 stores open at fiscal year end 1995 and 189 stores open at fiscal year end 1994. At the end of fiscal 1996, the Company was operating 19 of its retail stores under a new merchandising format which is approximately twice the size of older format stores and is arranged in a more user-friendly format. The performance of these new stores has been mixed and management continues to evaluate results while refining the format. While assessing the overall contribution of the new merchandising format, management intends to open six new stores. Pending such evaluation and refinement of the new format, the Company does not intend to open more than the six new stores.
GROSS MARGIN (net sales minus cost of sales, including certain buying, occupancy, and distribution costs) as a percentage of net sales was 11.5% in fiscal 1996, compared to 12.3% and 13.7% in fiscal years 1995 and 1994, respectively. During 1996, gross margins were negatively affected by the Company's promotion of Microsoft Windows 95 and a clearance sale during the last quarter of the fiscal year. Gross margin as a percentage of sales continues to be affected by industry-wide pricing pressure related to both competitors' pricing and vendors' pricing.
SELLING, GENERAL, AND ADMINISTRATIVE (SG&A) EXPENSE as a percentage of net sales was 14.8% in fiscal 1996, compared to 12.4%, and 15.0% in fiscal years 1995 and 1994, respectively. The increased expenses in fiscal 1996 include $4.6 million incurred in connection with the relocation of the corporate offices to Spokane and $1.1 million related to development of products by ELEKOM. SG&A expense as a percentage of net sales not including relocation expense or ELEKOM would be 13.3% in fiscal 1996 and 12.3% in fiscal 1995. The improvement in the fiscal 1995 SG&A expense as a percentage of sales compared to fiscal 1994 was due mainly to sales increasing at a faster rate than expenses.
DEPRECIATION AND AMORTIZATION EXPENSE, NET OF AMOUNTS INCLUDED IN COST OF SALES, of $7.4 million in fiscal 1996, compared to $7.4 million and $7.6 million in fiscal years 1995 and 1994, respectively has remained constant.
PROVISION FOR SHAREHOLDER LITIGATION of $1.2 million in fiscal 1994 represents a charge for the settlement and related attorneys' fees, net of an insurance recovery, of a shareholders' lawsuit. See note 10 of Notes to Consolidated Financial Statements.
THEFT INSURANCE RECOVERY of $1.65 million in fiscal 1995 represents settlement of an insurance claim, net of expenses, for inventory stolen by members of a multi-state shoplifting ring from numerous retail stores during fiscal years 1991, 1992, and 1993.
DISCONTINUED OPERATIONS
Due to the subsequent sale of the CGE division, all results for the operations of the CGE division are reported as a discontinued operation. Certain general, administrative and distribution areas have traditionally supported all of the Company's business lines. The expenses reflected in the discontinued operations results reflect only those activities directly related to the CGE business.
NET SALES for the discontinued operations of CGE declined $65.2 million, or 15.2% from $428.5 million to $363.3 million in fiscal 1996. Fiscal 1995 net sales were $23.7 million, or 5.9% greater than net sales of $404.8 million in fiscal 1994.
GROSS MARGIN for CGE (net sales minus cost of sales, including certain buying, occupancy, and distribution costs) as a percentage of net sales was 10.1% in fiscal 1996, compared to 11.3% and 12.8% in fiscal years 1995 and 1994, respectively
SELLING, GENERAL, AND ADMINISTRATIVE (SG&A) EXPENSE as a percentage of net sales was 9.2% in fiscal 1996, compared to 8.6%, and 8.3% in fiscal years 1995 and 1994, respectively.
DEPRECIATION AND AMORTIZATION EXPENSE, NET OF AMOUNTS INCLUDED IN COST OF SALES, was $2.3 million in fiscal 1996, compared to $2.0 million and $1.1 million in fiscal years 1995 and 1994, respectively.
OPERATING INCOME, as a result of the foregoing factors, was $0.9 million in fiscal 1996, compared to $7.1 million and $12.8 million in fiscal years 1995 and 1994, respectively
INCOME BEFORE INCOME TAXES, was $0.6 million in fiscal 1996 compared to $9.8 million and $12.9 million in fiscal years 1995 and 1994, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased $7.0 million from $42.6 million at the end of fiscal 1995, to $49.6 million at the end of fiscal 1996. The increase was due principally to a $13.8 million decrease in inventory, a $14.9 million increase in accounts payable, all of which were partially offset by $16.2 million of additions to property and equipment. In addition, the Company had cash losses of $1.2 million in fiscal 1996, compared to cash income of $14.3 million in fiscal 1995.
Net accounts receivable increased $3.6 million from $20.5 million at April 1, 1995, to $24.1 million at March 30, 1996. The increase is due primarily to an increase of approximately $2.6 million in amounts due from vendors.
Merchandise inventories decreased $13.8 million, or 11%, from $98.5 million at the end of fiscal 1995, to $84.7 million at the end of fiscal 1996. The decrease is consistent with current sales declines and management's efforts to reduce inventory levels.
Assets of discontinued operations include all of the current assets of CGE as of March 30, 1996 and April 1, 1995, respectively. These amounts are primarily trade accounts receivable. See Note 8 of Notes to the Consolidated Financial Statements.
Current and non-current deferred income taxes totaling $9.1 million and $8.4 million at March 30, 1996, and April 1, 1995, respectively, resulted from taxes paid on temporary differences which caused taxable income to exceed financial reporting income.
Net property and equipment increased $7.6 million, from $21.9 million at the end of fiscal 1995, to $29.5 million at March 30, 1996. The increase is principally due to the addition or remodel of 19 new format stores as well as improvements to the corporate headquarters building in Spokane.
Accounts payable increased $14.9 million, from $104.4 million at April 1, 1995, to $119.3 million at March 30, 1996. The increase in accounts payable is primarily attributable to merchandise purchases near the fiscal year end and outstanding vendor payables to be offset by product returns.
During fiscal 1996, the Company financed its working capital requirements and capital expenditures with cash provided by operations. Effective December 8, 1995, the Company entered into a revolving loan agreement with two banks providing for unsecured borrowings of up to $35 million through April 30, 1996. Each bank provided a $17.5 million line of credit and one bank served as agent for the agreement. The Company could elect interest rates on the notes based on the participating banks' rates on certificates of deposit, LIBOR, or prime rate. The agreement contained a number of covenants, including a restriction on the payment of dividends and compliance with certain financial ratios. The Company was not in compliance with the net worth covenant at March 30, 1996. The Company had no outstanding borrowings under the revolving loan agreement at March 30, 1996. The line was not renewed at expiration.
Capital expenditures in fiscal 1996 totaled approximately $16.2 million. Capital expenditures included leasehold improvements, fixtures, computer hardware, software and communications equipment, principally due to the remodel or addition of 19 new format stores and the relocation of the corporate headquarters. Capital expenditures in fiscal 1995 totaled approximately $14.7 million. Capital expenditures included land and a building in Spokane, Washington for the corporate headquarters. Other expenditures included computer software and communications equipment.
Cash and cash equivalents at March 30, 1996 were $49.6 million. On May 13, 1996, the Company also received $45.0 million of gross cash proceeds from the sale of CGE to SSI, which did not include the CGE division's receivables and inventory that Egghead is liquidating in an orderly manner, all of which are expected to result in total gross cash proceeds of approximately $90.0 million. The Company expects these balances will be adequate to meet future cash requirements for operations.
NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board (FASB) issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This new standard requires long- lived assets and certain identifiable intangible assets be evaluated to determine whether the carrying amount is recoverable based on estimated future cash flows expected from the use of the assets and/or cash to be received upon disposal of the assets. The Company will adopt this standard in the first quarter of fiscal year 1997 and anticipates the effect of the adjustment, primarily from goodwill associated with direct response to be a charge of approximately $1.3 million before income taxes.
In October 1995, the FASB issued Statement No. 123, Accounting for Stock- Based Compensation. This new standard requires entities to choose either a fair valued based method or an intrinsic value based method of accounting for all employee stock compensation plans. The Company currently uses and plans to continue to use the intrinsic value based method which requires no compensation cost to be recognized at the date of the stock compensation grant if the option is granted at the current market price. The Company will adopt this new standard during fiscal 1997 at which time additional footnote disclosure will be required.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Egghead, Inc.:
We have audited the accompanying consolidated balance sheets of Egghead, Inc. (a Washington corporation) and subsidiaries as of March 30, 1996 and April 1, 1995, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three fiscal years in the period ended March 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 financial statements referred to above present fairly, in all material respects, the financial position of Egghead, Inc. and subsidiaries as of March 30, 1996 and April 1, 1995, and the results of their operations and their cash flows for each of the three fiscal years in the period ended March 30, 1996, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Seattle, Washington, May 29, 1996
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Consolidated Balance Sheets (DOLLARS IN THOUSANDS)
SEE NOTES TO CONSODOLIDATED FINANCIAL STATEMENTS.
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Consolidated Statements of Operations (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Consolidated Statements of Shareholders' Equity (AMOUNTS IN THOUSANDS)
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Consolidated Statements of Cash Flows (DOLLARS IN THOUSANDS)
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Consolidated Statements of Cash Flows (CONTINUED)
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations totaling $0.7 million and $0.2 million were recorded in fiscal years 1996 and 1995 respectively, when the Company acquired new equipment.
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
All references herein to fiscal 1996, 1995 and 1994 relate to the fiscal years ended March 30, 1996, April 1, 1995, and April 2, 1994, respectively.
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS Egghead, Inc. sells personal computer software, hardware and related products through its wholly-owned subsidiaries, DJ&J Software Corporation (DJ&J, d/b/a Egghead Software) and Eggspert Software, Ltd. (Eggspert, a Canadian subsidiary), EH Direct, Inc. (EH Direct), Egghead International, Inc. (Egghead International), and Elekom Corporation (Elekom). References to "the Company" and "Egghead" include Egghead, Inc., its predecessors, and its subsidiaries. Eggspert and Egghead International became inactive subsidiaries May 13, 1996 following the sale of corporate, government, and education (CGE) division to Software Spectrum, Inc. (SSI) SEE NOTE 8.
CONSOLIDATION The consolidated financial statements include the accounts of Egghead, Inc. and its wholly-owned subsidiaries, DJ&J, Eggspert, EH Direct, Egghead International, and ELEKOM, and include all such adjustments and reclassifications necessary to eliminate the effect of significant intercompany accounts and transactions. Operating results for Eggspert and Egghead International are included in discontinued operations. SEE NOTE 8.
ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. The carrying amount of cash equivalents approximates fair value because of the short-term maturity of those instruments.
ACCOUNTS RECEIVABLE AND REVENUE RECOGNITION Company sales made on credit generally have terms of net 30 days. The sales and corresponding trade receivables for inventoried product are recorded upon merchandise shipment. The Company records provisions for doubtful accounts and sales returns and allowances based upon historical experience.
Certain advertising and promotional expenditures are reimbursable from suppliers under cooperative advertising and other promotional and market development fund arrangements. Amounts qualifying for reimbursement are recorded as receivables from the suppliers and as a corresponding reduction of net advertising expense in the period the expenditure occurs. Also included in accounts receivable are credit card receivables and amounts due from vendors for returned inventory and other programs. The Company records a provision for uncollectible vendor receivables based upon historical experience.
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MERCHANDISE INVENTORIES Merchandise inventories are accounted for using the moving weighted average cost method and are stated at the lower of cost or market. Egghead maintains reserves for the obsolescence of merchandise inventory. These reserves totaled approximately $6.7 million and $8.0 million at March 30, 1996 and April 1, 1995 respectively. Management has developed a plan to dispose of this obsolete inventory and believes the reserve is adequate to cover any losses on disposition. Inventories on the balance sheet are shown net of this reserve.
PROPERTY AND EQUIPMENT Property and equipment are stated at cost, net of accumulated depreciation. Depreciation of equipment, furniture, and fixtures is provided using the straight-line method over their estimated useful lives ranging from two to seven years. Depreciation of buildings is provided using the straight-line method over their estimated useful lives ranging from 20 to 30 years. Amortization of leasehold improvements is provided using the straight-line method over the lesser of the lease term or the assets' estimated useful lives.
GOODWILL Net assets of organizations acquired in purchase transactions are recorded at fair value at date of acquisitions. Unidentified intangibles are amortized straight line over the estimated life of the remaining long-term assets acquired. Unidentified intangibles at March 30, 1996 and April 1, 1995 were $998,000 and $1.4 million, respectively, net of accumulated amortization of $993,000 and $595,000, respectively.
ACCOUNTS PAYABLE Outstanding checks included in accounts payable were $9.0 million and $10.4 million at March 30, 1996 and April 1, 1995, respectively.
DEFERRED RENT Certain store lease agreements provide for scheduled rent increases or for rent payments to commence at a date later than the date of occupancy. In these cases, the Company recognizes the aggregate rent expense on a straight-line basis over the lease term beginning when the store opens.
INCOME TAXES The Company determines its income tax accounts in accordance with Statement of Financial Accounting Standards No. 109. Deferred income taxes result primarily from temporary differences in the recognition of certain items for income tax and financial reporting purposes.
EARNINGS (LOSS) PER SHARE Earnings per share amounts are computed using the weighted average number of common shares and dilutive common equivalent shares outstanding during each period using the treasury stock method. Common equivalent shares result from the assumed exercise of stock options and from the conversion of cash related to the employee stock purchase plan into common shares based upon the terms of the plan which would have a dilutive effect in years where there are earnings. Common equivalent shares had no material effect on the computation in fiscal years 1996, 1995, or 1994.
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN CURRENCY TRANSLATION Balance sheet accounts of the Company's foreign operations are translated into U.S. dollars at the exchange rate on the balance sheet date. Results of operations are translated at the average exchange rate prevailing during the fiscal year. The results of unrealized exchange rate fluctuations on translating foreign currency assets and liabilities into U.S. dollars are recorded as a component of retained earnings. Realized gains and losses from foreign currency transactions are included in net income.
OTHER ACCOUNTING PRINCIPLES In March 1995, the Financial Accounting Standards Board (FASB) issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This new standard requires long- lived assets and certain identifiable intangible assets be evaluated to determine whether the carrying amount is recoverable based on estimated future cash flows expected from the use of the assets and cash to be received upon disposal of the assets. The Company will adopt this standard in the first quarter of fiscal year 1997 and anticipates the effect of the adjustment, primarily from goodwill associated with direct response, to be a charge of approximately $1.3 million before income taxes.
In October 1995, the FASB issued Statement No. 123, Accounting for Stock- Based Compensation. This new standard requires entities to choose either a fair valued based method or an intrinsic value based method of accounting for all employee stock compensation plans. The Company currently uses and plans to continue to use the intrinsic value based method which requires no compensation cost to be recognized at the date of the stock compensation grant if the option is granted at the current market price. The Company will adopt this new standard during fiscal 1997 at which time additional footnote disclosure will be required.
FISCAL YEARS The Company uses a 52/53 week fiscal year, ending on the Saturday nearest March 31 of each year. Fiscal quarters are such that the first three quarters consist of 13 weeks and the fourth quarter consists of the remaining 13/14 weeks. Fiscal years 1996, 1995 and 1994 each had 52 weeks.
EGGHEAD, INC. AND SUBSIDIARIES
- - -------------------------------------------------------------------------------- Notes to Consolidated Financial Statements (CONTINUED)
NOTE 2 PROPERTY AND EQUIPMENT
The components of property and equipment at March 30, 1996 and April 1, 1995 were as follows (in thousands):
March 30, April 1, 1996 1995 --------- --------- Land and buildings $ 8,547 $ 6,574 Equipment 38,814 33,559 Leasehold improvements 14,157 8,652 Furniture and fixtures 7,080 6,674 --------- --------- 68,598 55,459 Less accumulated depreciation and amortization (39,103) (33,534) --------- ---------
Property and equipment, net $ 29,495 $ 21,925 --------- --------- --------- ---------
NOTE 3 NOTES PAYABLE TO BANKS
Effective December 8, 1995, the Company entered into a revolving loan agreement with two banks providing for unsecured borrowings of up to $35 million through April 30, 1996. Each bank provided a $17.5 million line of credit and one bank served as agent for the agreement. The Company could elect interest rates on the notes based on the participating banks' rates on certificates of deposit, LIBOR, or prime rate. The agreement contained a number of covenants, including a restriction on the payment of dividends and compliance with certain financial ratios. The Company was not in compliance with net worth ratios as of March 30, 1996. The Company had no outstanding borrowings under the revolving loan agreement at March 30, 1996. The line was not renewed at expiration.
A summary of borrowings under the lines of credit follows (in thousands):
Fiscal year ----------- 1996 1995 1994 --------- --------- ---------
Maximum amount outstanding $ 11,275 $ - $ 5,950 Average amount outstanding $ 7,400 $ - $ 350 Weighted average interest rate 8.0% -% 3.9%
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 4 INCOME TAXES
The provision (benefit) for income taxes is comprised of the following (in thousands):
Fiscal year ----------- 1996 1995 1994 --------- --------- ---------
Current: Federal $ (4,383) $ (2,048) $ (3,545) State (1,917) (896) (990) --------- --------- --------- (6,300) (2,944) (4,535) --------- --------- ---------
Deferred: Federal (404) 730 (704) State (326) 108 (104) --------- --------- --------- (730) 838 (808) --------- --------- ---------
Total $ (7,030) $ (2,106) $ (5,343) --------- --------- --------- --------- --------- ---------
Deferred income taxes result primarily from temporary differences in certain items for income tax and financial reporting purposes. The tax effects of temporary differences giving rise to the deferred tax assets are as follows:
March 30, April 1, 1996 1995 --------- ---------
Accounts receivable $ 857 $ 868 Merchandise inventories 2,651 2,919 Property and equipment 3,625 2,385 Other assets 256 155 Accrued liabilities 1,442 1,717 Deferred rent 249 307 --------- ---------
Total deferred tax assets $ 9,080 $ 8,351 --------- --------- --------- ---------
The Company's income tax benefit differs from the amount computed by applying the statutory federal tax rate to loss from continuing operations before taxes as follows:
Fiscal year ----------- 1996 1995 1994 --------- --------- ---------
Statutory Federal tax rate (34.0)% (34.0)% (34.0)% State taxes, net of Federal benefit (4.6) (4.0) (4.4) Tax exempt interest income (1.8) (3.3) (0.7) Other, net 1.7 2.3 0.1 --------- --------- --------- (38.7)% (39.0)% (39.0)% --------- --------- --------- --------- --------- ---------
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 5 STOCK OPTION AND STOCK PURCHASE PLANS
EMPLOYEE STOCK PURCHASE PLAN
The Egghead, Inc. 1989 Employee Stock Purchase Plan currently provides options to acquire the Common Stock of the Company to substantially all full-time and certain other employees at the lesser of 85% of the fair market value of the Common Stock on August 1 of the first and second plan years and July 1 thereafter, or 85% of the fair market value on the following July 31 of the first plan year and June 30 of each plan year thereafter. Under the plan, a maximum of 650,000 shares were reserved for issuance. As of March 30, 1996, there were approximately 340,000 shares available for future issuance.
THE 1993 STOCK OPTION PLAN
In September 1993, the Company's shareholders approved the 1993 Stock Option Plan (the "1993 Plan"), under which 2,000,000 shares of the Company's Common Stock were reserved for issuance. The 1993 Plan replaced the 1986 Combined Incentive and Non-Qualified Stock Option Plan (the "1986 Combined Plan") under which 2,000,000 shares were originally reserved for issuance. The number of shares reserved for issuance under the 1993 Plan was increased by the shares reserved for issuance under the 1986 Combined Plan that were not subject to outstanding stock options. Shares presently subject to outstanding stock options under the 1986 Combined Plan, which subsequently are canceled or will expire, will increase the number of shares reserved for issuance under the 1993 Plan. No additional stock options will be granted under the 1986 Combined Plan.
Options granted, exercised, and canceled under the above Plans are summarized as follows:
Fiscal year ----------- 1996 1995 1994 --------- --------- ---------
Outstanding, beginning of year 1,513,089 702,322 1,184,338 Options granted 621,100 1,140,900 250,000 Options exercised (55,395) (2,625) - Options canceled (705,907) (327,508) (732,016) --------- --------- --------- Outstanding, end of year 1,372,887 1,513,089 702,322 --------- --------- ---------
Exercisable, end of year 359,277 293,139 237,497 --------- --------- --------- --------- --------- --------- Available for grant in future years 1,860,873 1,776,066 2,589,458 --------- --------- --------- --------- --------- ---------
Price of Options: Granted during year $9.50 - $10.75 $6.19 - $10.25 $7.50 - $8.13 Exercised during year $6.19 - $12.75 $9.88 - $10.75 - Canceled during year $6.19 - $17.00 $6.19 - $17.00 $8.37 - 17.00
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 5 STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
THE NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
In September 1993, the Company's shareholders approved the Non-employee Director Stock Option Plan, and in August 1995 the Company's shareholders approved amendments thereto (as amended, the "Director Plan") under which 450,000 shares of the Company's Common Stock were reserved for issuance. As of March 30, 1996, 315,000 shares were available for grant and 135,000 shares were subject to outstanding options which have been granted at prices ranging from $7.25 to $13.75. As of March 30, 1996, options for 90,000 shares were vested.
THE EXECUTIVE PLAN
In February 1989, the Board of Directors approved four-year employment agreements and stock option agreements for three executive officers who are no longer with the Company, Stuart Sloan, Ronald Weinstein, and Matthew Griffin, whereby the officers' compensation was based on equity incentives. Each drew an annual salary of $1 per year during their term of employment. Options to acquire up to 1,700,000 shares of common stock are authorized under the Plan. As of March 30, 1996, 325,000 shares were available for grant and 1,096,324 were subject to outstanding options which have been granted to the above named executive officers of the Company at prices ranging from $10.38 to $20.00. All outstanding options are vested and expire in February 1999. As of March 30, 1996, 278,676 of the options had been exercised at $10.38 per share.
NOTE 6 401(K) PLAN
The Company has a 401(k) retirement plan for the benefit of its employees. After six months of full-time employment (more than 1,000 hours), an employee is eligible to participate in the plan. Employee contributions are matched by the Company at 50% of each employee's contribution up to 4% of their compensation. The Company's contributions are fully vested upon the completion of two years of service. The Company's contributions were approximately $228,000, $446,000 and $571,000 in fiscal years 1996, 1995, and 1994, respectively.
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 7 COMMITMENTS AND CONTINGENCIES
Significant supplier In fiscal 1996 and 1995, one supplier accounted for sales aggregating approximately $71.6 million and $61.0 million, respectively. The loss of this supplier could have a material adverse effect on the Company's business and financial results and condition.
Leases The Company leases retail stores and distribution facilities under operating leases with remaining lives on most leases ranging from one to five years. Some leases contain renewal options of one to five years which the Company may exercise at the end of the initial lease term. The leases generally require the Company to pay taxes, insurance, and certain common area maintenance costs.
Aggregate rental expense, including common area maintenance charges, for all operating leases for the fiscal years ended 1996, 1995, and 1994 was approximately $15,990,829, $16,769,000 and $18,012,000, respectively. As of March 30, 1996, future minimum rental payments under non-cancelable operating and capital leases for retail stores and distribution facilities, and equipment consisted of the following (in thousands):
Capital Operating Fiscal Year leases leases ---------------------------------------------- 1997 330 13,261 1998 306 9,251 1999 - 5,446 2000 - 2,404 2001 1,157 Thereafter - - ------ ------ Total minimum payments 636 $31,519 ------ ------ Less interest (61) ------ Present value of minimum lease payments 575 Less current portion (295) ------ Capital lease obligations, less current portion $280 ------ ------
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Notes to Consolidated Financial Statements (CONTINUED)
NOTE 8 DISCONTINUED OPERATIONS AND SUBSEQUENT EVENTS
Effective May 13, 1996, the Company sold its CGE division to SSI, a Texas corporation, for $45 million in cash pursuant to the terms of an asset purchase agreement entered into on March 23, 1996. Egghead and SSI also entered into a Fulfillment Agreement and a Call Center Lease relating to the provision of certain support services by Egghead to SSI and to the lease for a period of three years of a portion of Egghead's facility previously used by the CGE division. The assets, liabilities, and results of discontinued operations of the CGE division are presented separately in the accompanying financial statements.
The income from discontinued operations for 1996, 1995, and 1994 is comprised of the following (in thousands):
Fiscal year ----------- 1996 1995 1994 -------- -------- --------
Net sales $ 363.3 $ 428.5 $ 404.8 Costs and expenses 362.7 418.7 391.9 -------- -------- -------- Income before provision for income taxes 0.6 9.8 12.9 Income tax expense 0.2 3.8 5.1 -------- -------- -------- Income from discontinued operations $ 0.4 $ 6.0 $ 7.8 -------- -------- -------- -------- -------- --------
The net assets of discontinued operations for 1996 and 1995 consist of the following (in thousands):
1996 1995 -------- -------- Accounts receivable - trade, net of allowance $ 61.7 $ 64.0 Merchandise inventory, net 9.3 4.4 Deferred taxes 0.8 1.7 -------- -------- Net current assets of discontinued operations $ 71.8 $ 70.1 -------- -------- -------- --------
NOTE 9 THEFT INSURANCE RECOVERY
Theft insurance recovery of $1.65 million in fiscal 1995 represents settlement of an insurance claim, net of expenses, for inventory stolen from numerous retail stores during fiscal years 1991, 1992, and 1993, by members of a multi-state shoplifting ring.
EGGHEAD, INC. AND SUBSIDIARIES - - --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 10 SHAREHOLDER LITIGATION
On June 9, 1994, the Company announced that it had settled a shareholders' lawsuit originally filed against the Company and two former officers who were also directors. The action, originally entitled FINUCAN V. EGGHEAD, ET AL., was filed in federal court in Seattle in September 1993 and was alleged to be brought on behalf of all purchasers of the Company's common stock between February 11, 1992, and November 18, 1992, (other than the individual defendants and other individuals and entities otherwise affiliated with the Company). The settlement called for a cash payment by the Company of $2.625 million. Payment was made during fiscal 1995. This settlement was approved by the United States District Court for the Western District of Washington on January 12, 1995. Net of insurance recovery, the settlement and related attorneys fees resulted in a pretax charge of $1.2 million in fiscal year 1994 ($0.04 per share, net of income tax impact).
ITEM 9.

ITEM 9. CHANGES IN 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 Part III, Item 10, is incorporated by reference from Egghead, Inc.'s definitive Proxy Statement relating to Egghead, Inc.'s 1996 Annual Meeting of Shareholders, which will be filed pursuant to Regulation 14A within 120 days of March 30, 1996.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The information required by Part III, Item 11, is incorporated by reference from Egghead, Inc.'s definitive Proxy Statement relating to Egghead, Inc.'s 1996 Annual Meeting of Shareholders, which will be filed pursuant to Regulation 14A within 120 days of March 30, 1996.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Part III, Item 12, is incorporated by reference from Egghead, Inc.'s definitive Proxy Statement relating to Egghead, Inc.'s 1996 Annual Meeting of Shareholders, which will be filed pursuant to Regulation 14A within 120 days of March 30, 1996.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Part III, Item 13, is incorporated by reference from Egghead, Inc.'s definitive Proxy Statement relating to Egghead, Inc.'s 1996 Annual Meeting of Shareholders, which will be filed pursuant to Regulation 14A within 120 days of March 30, 1996.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
A) Documents filed as a part of this report: 1. Financial Statements The Consolidated Financial Statements, Notes thereto, Financial Statement Schedules (none), and Accountants' Report thereon are included in Part II, Item 8, of this report.
2a. Exhibits (i) 3.1 Restated Articles of Incorporation of the Company (vii) 3.2 Amended Bylaws of the Company (x) 10.1 * Microsoft 1995/1996 Channel Agreement dated July 1, 1995, as amended through January 1, 1996. 10.2 (Intentionally left blank.) 10.3 (Intentionally left blank.) 10.4 (Intentionally left blank.) (iv) 10.5 * Microsoft January - June, 1993 Reseller Rebate and Marketing Fund Agreement. (v) 10.6 * Microsoft 1993/1994 Channel Agreement dated July 1, 1993. (v) 10.7 * Rebate and Marketing Fund Addendum to the 1993/1994 Microsoft Channel Agreement dated November 1, 1993. (v) 10.8 * Amendment to the Microsoft 1993/1994 Channel Agreement (appointment as a Major Chain Reseller) dated November 10, 1993. (v) 10.9 * Reseller agreement with WordPerfect Corporation dated April 1, 1994. (vi) 10.10 * Microsoft 1994/1995 Channel Agreement dated July 1, 1994. (vi) 10.11 * Addendum to the Microsoft 1994/1995 Channel Agreement dated July 1, 1994. (vii) 10.11a Amendment No. 1 to the Addendum to the Microsoft 1994/1995 Channel Agreement (Appointment as a Large Account Reseller) dated July 1994. (vi) 10.12 * Follow up letter dated August 2, 1994, from Microsoft regarding Microsoft 1994/1995 Channel Agreement dated July 1, 1994. (vii) 10.13 * Addendum to the 1994/1995 Microsoft Channel Agreement dated January 1995. 10.14 (Intentionally left blank.) 10.15 Lease, as amended, dated June 9, 1988, between Sammamish Park Place I Limited Partnership as Landlord and DJ&J Software Corporation as Tenant regarding the Company's administrative headquarters. (Previously filed with registrant's Form 10-K for the fiscal year ended April 1, 1989, as Exhibit 10.46.) 10.16 First Amendment to June 9, 1988 lease between Sammamish Park Place I Limited Partnership and DJ&J Software Corporation dated October 4, 1989. (Previously filed with registrant's Form 10-K for the fiscal year ended March 31, 1990, as Exhibit 10.46a.)
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (CONTINUED)
10.17 Lease dated March 23, 1992 between Sammamish Park Place II Limited Partnership as Landlord and DJ&J Software Corporation as Tenant regarding the Company's administrative headquarters. (Previously filed with registrant's Form 10-K for the fiscal year ended March 28, 1992, as Exhibit 10.47.) 10.18 Lease Termination and Rent Payment Agreement between Sammamish Park Place II Limited Partnership as Landlord and DJ&J Software Corporation as Tenant regarding the Company's administrative headquarters. (Previously filed with registrant's Form 10-Q for the first quarter of fiscal 1995 ended July 2, 1994.) (vi) 10.18a First Amendment to Lease Termination and Rent Payment Agreement between Sammamish Park Place II Limited Partnership as Landlord and DJ&J Software Corporation as Tenant. (vi) 10.18b Second Amendment to Lease Termination and Rent Payment Agreement between Sammamish Park Place II Limited Partnership as Landlord and DJ&J Software Corporation as Tenant. (iii) 10.19 Lease dated March 23, 1989, between The CHY Company as Landlord and DJ&J Software as Tenant regarding the Company's Sacramento distribution facility. (iii) 10.20 First amendment to lease between The CHY Company as Landlord and DJ&J Software, as Tenant regarding the Company's Sacramento distribution facility. 10.21 (Intentionally left blank.) (i) 10.22 Lease Agreement dated January 7, 1988, with Granite Properties, a limited partnership, as Landlord and DJ&J Software Corporation, as Tenant regarding Lancaster distribution facility. (i) 10.23 Master License Agreement dated February 12, 1988, with Staples, Inc. as Licensor and DJ&J Software Corporation as Licensee, regarding an exclusive right to sell items in Staples' discount stores. 10.24 First Amendment to Master License Agreement between Staples, Inc. and DJ&J Software Corporation dated November 14, 1990. (Previously filed with registrant's Form 10-K for the fiscal year ended March 30, 1991, as same Exhibit number.) (viii) 10.25 Asset Purchase Agreement by and among Software Spectrum, Inc., Egghead, Inc. and DJ&J Software Corporation dated as of March 23, 1996 with Exhibits 4.11 and 4.12 thereto 10.26 (Intentionally left blank.) 10.27 Form of Indemnification Agreement between the Company and its directors. (Previously filed with registrant's Form 10-Q for the third quarter of fiscal 1995 ended December 31, 1994.) 10.28 Form of Indemnification Agreement between DJ&J Software Corporation and its directors. (Previously filed with registrant's Form 10-Q for the third quarter of fiscal 1995 ended December 31, 1994.)
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (CONTINUED)
(vi) 10.29 Revolving Loan Agreement dated September 30, 1994, among Seattle-First National Bank and U.S. Bank of Washington, National Association, Egghead, Inc., and DJ&J Software Corporation.
10.30 Revolving Loan Agreement dated September 30, 1993 among Seattle-First National Bank and U.S. Bank of Washington, National Association, Egghead, Inc., and DJ&J Software Corporation. (Previously filed with registrant's Form 10-Q dated October 16, 1993, as same exhibit number.) 10.31 (Intentionally left blank.) 10.32 (Intentionally left blank.) 10.33 ** Executive employment agreement between Egghead, Inc. and Terence M. Strom dated June 28, 1993. (Previously filed with registrant's Form 10-Q dated October 16, 1993, as Exhibit 10.34.) (ii) 10.34 ** Egghead, Inc. 1989 Executive Retention Incentive Stock Option Plan. (ii) 10.35 ** Egghead, Inc. 1989 Executive Retention Incentive Stock Option Agreement between Egghead, Inc. and Stuart M. Sloan dated February 23, 1989. (ii) 10.36 ** Egghead, Inc. 1989 Executive Retention Non- Qualified Stock Option Agreement between Egghead, Inc. and Stuart M. Sloan dated February 23, 1989. (iii) 10.36a ** Amendment No. 1 to Egghead, Inc. 1989 Executive Retention Non-Qualified Stock Option Agreement between Egghead, Inc. and Stuart M. Sloan dated April 17, 1991. 10.37 (Intentionally left blank.) 10.38 (Intentionally left blank.) (ii) 10.39 ** Egghead, Inc. 1989 Executive Retention Incentive Stock Option Agreement between Egghead, Inc. and Ronald A. Weinstein dated February 23, 1989. (iii) 10.39a ** Amendment No. 1 to Egghead, Inc. 1989 Executive Retention Incentive Stock Option Agreement between Egghead, Inc. and Ronald A. Weinstein dated April 17, 1991. (ii) 10.40 ** Egghead, Inc. 1989 Executive Retention Non- Qualified Stock Option Agreement between Egghead, Inc. and Ronald A. Weinstein dated February 23, 1989. (iii) 10.40a ** Amendment No. 1 to Egghead, Inc. 1989 Executive Retention Non-Qualified Stock Option Agreement between Egghead, Inc. and Ronald A. Weinstein dated April 17, 1991. 10.41 (Intentionally left blank.) 10.42 (Intentionally left blank.) (ii) 10.43 ** Egghead, Inc. 1989 Executive Retention Incentive Stock Option Agreement between Egghead, Inc. and Matthew J. Griffin dated February 23, 1989.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (CONTINUED)
(ii) 10.44 ** Egghead, Inc. 1989 Executive Retention Non- Qualified Stock Option Agreement between Egghead, Inc. and Matthew J. Griffin dated February 23, 1989. (iii) 10.44a ** Egghead, Inc. 1989 Executive Retention Non- Qualified Stock Option Agreement between Egghead, Inc., and Matthew J. Griffin dated April 17, 1991. 10.45 (Intentionally left blank.) 10.46 (Intentionally left blank.) 10.47 (Intentionally left blank.) 10.48 ** Egghead, Inc. 1989 Employee Stock Purchase plan. (Previously filed with registrant's Form S-8 dated June 23, 1990, as Exhibit 10.) 10.49 ** Egghead, Inc. 1993 Stock Option Plan. (Previously filed with registrant's Form 10-Q dated October 16, 1993, as Exhibit 10.31.) (x) 10.50 ** Egghead, Inc. Restated Nonemployee Director Stock Option Plan. (x) 21.1 Schedule of subsidiaries. (x) 23.1 Consent of Independent Public Accountants. 24.1 Power of Attorney (See Page 44). (x) 27 Financial Data Schedule.
Footnotes
(i) Previously filed with registrant's Registration Statement on Form S-1, Registration No. 33-21472, as same Exhibit number. (ii) Previously filed with the registrant's Form 8-K dated February 23, 1989, as Exhibit numbers 10.1 to 10.13. (iii) Previously filed with registrant's Form 10-K for the fiscal year ended March 28, 1992, as same Exhibit number. (iv) Previously filed with registrant's Form 10-K for the fiscal year ended April 3, 1993, as same Exhibit number. (v) Previously filed with registrant's Form 10-K for the fiscal year ended April 2, 1994, as same Exhibit number. (vi) Previously filed with registrant's Form 10-Q for the second quarter of fiscal 1995 ended October 1, 1994. (vii) Previously filed with registrant's Form 10-K for the fiscal year ended April 1, 1995, as same Exhibit number. (viii) Previously filed with registrant's Form 8-K dated March 23, 1996, as Exhibit number 2.1. (x) Filed herewith. * Confidential portions of this exhibit have been omitted and filed separately with the Commission pursuant to an Application for Confidential Treatment under Rule 24b-2 under the Securities Exchange Act of 1934. Each exhibit has been marked to identify the confidential portions that are omitted. ** Designates management contract or compensatory plan or arrangement.
2b. Form 8-K
Egghead, Inc., filed one report on Form 8-K, dated March 23, 1996, during the fourth quarter of its fiscal year ended March 30, 1996, which reported on Items 5 and 7 of Form 8-K.
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, in the city of Liberty Lake, State of Washington, on June 28, 1996.
EGGHEAD, INC.
By ------------------------------------ Terence M. Strom President and Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Terence M. Strom and Edward S. Wozniak, or either of them, his attorneys-in-fact, with the power of substitution, for him in any and all capacities, to sign any amendments to this report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorneys-in-fact, or their substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on June __, 1996, on behalf of the Registrant and in the capacities indicated.
Signature Title --------- -----
------------------------------ President, Chief Executive Officer, Terence M. Strom and Director (Principal Executive Officer)
------------------------------ Vice President, Chief Financial Edward S. Wozniak Officer (Principal Financial and Accounting Officer)
------------------------------ Chairman of the Board, Director George P. Orban
------------------------------ Director Paul G. Allen
------------------------------ Director Richard P. Cooley
------------------------------ Director Steven E. Lebow
SIGNATURES (CONTINUED)
------------------------------ Director Linda Fayne Levinson
------------------------------ Director Samuel N. Stroum