ITEM 1. BUSINESS.
General
The Company is primarily engaged in the business of designing, manufacturing and marketing marine engine and air-conditioning products. The Company was organized in 1932 and was re-incorporated in Delaware in 1986. The Company's marine products consist of diesel and gasoline engine-driven electrical generator sets, inboard propulsion engines, self-contained, reverse-cycle air-conditioners, and associated spare parts and accessories. In addition, the Company manufactures and markets electrical generator sets for use in non-marine applications. The Company markets its products throughout the United States and internationally principally for recreational marine applications. Accordingly, the market for the Company's products is dependent on the market for recreational boats, including auxiliary powered sailboats, powerboats, houseboats and other pleasure boats. The market for recreational boats, and consequently the Company's products, may be adversely affected by general economic conditions.
Products
The Company's marine engine product line consists of 17 models of electrical generator sets, 20 models of inboard propulsion engines, and associated spare parts and accessories. The Company also offers 11 models of non-marine generator sets.
The Company's diesel and gasoline engine-driven marine generator sets are installed in powerboats, houseboats, large sailboats and other pleasure and commercial boats to provide electricity for communication and navigational equipment, lighting, refrigeration and other galley services, and other safety, operating and convenience needs. The Company's present line of generator sets produce from 4.5 to 75 kilowatts of electricity. A generator set consists of an electrical generator and an attached diesel or gasoline engine used to drive the generator. These engines are fresh water cooled and range from two to eight cylinders and from nine to 46 horsepower.
The Company's propulsion engines are inboard engines, generally installed as auxiliary power systems for sailboats. The Company's propulsion engines are fresh water cooled and range from two to six cylinders and from 12 to 108 horsepower. Management believes that more than 90% of the propulsion engines produced by the Company are installed in sailboats of up to 50 feet in length. The Company's higher horsepower propulsion engines are also installed in powerboats of up to approximately 30 feet in length such as fishing boats, cruisers and work boats.
The Company's product line includes marine diesel auxiliary engines marketed under the Universal[register mark] name and associated spare and replacement parts and marine air-conditioning products marketed under the Rotary Aire[register mark] name. The Company manufactures and markets two self-contained, reverse-cycle air-conditioning units and accessories under the Rotary Aire[register mark] name. These units can be installed in powerboats, houseboats, sailboats and other pleasure and commercial boats.
The Company's product line includes 11 models of electrical generator sets which may be installed in bus-converted motor coaches, specialty vehicles, such as refrigeration trucks, and ambulances and other emergency vehicles to provide electricity for lighting, refrigeration and other safety, operating and convenience needs. These generators may also be used as stand-by or secondary power sources in the event of power outages or in locations where primary power is not readily available, such as construction sites, rural areas and less developed countries.
The Company offers a complete line of spare parts and accessories for its current product lines and for most discontinued models. The Company's line of spare parts includes oil and fuel filters, belts, thermostats, distributor caps, fuses, spark plugs, wiring, alternators, heat exchangers, circuit breakers, water and fuel pumps, starter motors and fuel solenoids. Many basic parts are packaged and sold as spare part kits. Accessories offered by the Company include various control and instrument panels, exhaust silencers and generator sound enclosures.
The Company provides its distributors, dealers and final customers with documentation covering operation, maintenance and repair procedures for its products. Management believes that the provision of current and comprehensive documentation enhances the Company's marketing and competitive effectiveness. See "Marketing and Sales" and "Competition" below.
Each of the Company's products is covered by a one-year limited warranty covering parts and authorized labor. In addition, the Company offers a five-year limited warranty on certain marine generator sets. Many of the Company's suppliers also warrant their products for parts and labor. Some of the Company's major suppliers warrant their products for the duration of the Company's warranties. The Company has not experienced any unusual warranty claims during any of the last three fiscal years. The Company's distributors are generally responsible for administering the Company's warranties through the dealer network. See "Marketing and Sales" below.
Governmental Regulation
In May and November 1994, the Environmental Protection Agency (the "EPA") proposed emission standards for new gasoline and diesel powered marine engines and marine and industrial generators of the types manufactured by the Company. The emission standards are intended to reduce the emissions of hydrocarbons, nitrogen oxides, carbon monoxide, particulates and smoke. As proposed, the emission standards for gasoline and diesel powered engines and generators of the types manufactured by the Company would phase in over the period beginning August 1, 1996 and ending January 1, 1999. The proposed regulations include manufacturer testing requirements, selective enforcement auditing by the EPA, mandated warranty periods of up to five years or 3,000 hours of operation for emission-related parts and recall and repair authority for up to ten years or 6,000 hours of operation. Over the past year, the Company has worked with the EPA in an attempt to obtain relief from some of the proposed requirements, given what the Company believes will be the disproportionate impact these requirements would have on small businesses such as the Company. Final regulations have not yet been issued covering all of the Company's products, and, accordingly, the full impact of the final regulations on the Company cannot be assessed. In addition, effective August 1, 1995, regulations went into effect in the State of California establishing emissions standards covering most of the Company's generators and mandating certain warranty conditions and production testing requirements. In both the case of the proposed EPA regulations and the State of California regulations, if the Company cannot effect the required modifications of its products to meet the required emissions levels within the time frames allowed, the Company could be materially adversely affected. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" below.
Design and Development
The Company has an ongoing product improvement and development program intended to enhance the reliability, performance and longevity of existing products, and to develop new applications for existing products. A significant portion of the Company's senior management's time, as well as the efforts of the Company's six person product engineering department, is spent in this area. In prior years, the Company's product development program resulted in the introduction of the Company's line of gasoline engine-driven generator sets and propulsion engines. As part of the Company's ongoing product development program, the Company upgrades its engine products and periodically adds models to its product line. For example, as and when improvements in component parts allow, the Company may manufacture smaller or more light-weight versions of existing models. In fiscal 1995, the product engineering department focused principally on the modernization of the Company's existing product line and modifications which the Company believes will be required as a result of the emissions standards discussed above. In addition, in response to demand, the Company may expand its engine product line by manufacturing generator sets or propulsion engines with different kilowattage or horsepower than its existing models. The Company intends to introduce upgraded and new models as and when developed.
The Company's design and engineering focus is on reliability, ease of maintenance, compactness, operating smoothness, safety and longevity, among other technical and performance factors. The Company's technical and performance specifications are utilized by the Company's suppliers in producing certain component parts, metal and nonmetal fabrications and other peripheral equipment that the Company manufactures and assembles into finished products. Generally, the Company retains title to Company-developed plans, patterns and specifications used by these suppliers.
For the three fiscal years ended October 1995, the Company incurred expenses of approximately $1,549,600 for design and development activities as follows: 1995 - $678,700, 1994 - $488,300 and 1993 - $382,600. All these activities were conducted and sponsored by the Company and the major portion of these expenses was applied toward salaries and other expenses of the Company's product design and engineering personnel.
Manufacturing and Sources of Supply
The Company's manufacturing activities are conducted in an approximately 37,500 square foot facility owned by the Company. See "Item 2

ITEM 2. PROPERTIES.
The Company's executive and administrative offices and manufacturing operations are located in Avon, Massachusetts in an approximately 37,500 square foot facility owned by the Company. The Company also leases a warehouse of approximately 16,000 square feet. Management believes that the Company's present facilities are sufficient for the production of its products in the foreseeable future. Any future expansion will be dependent upon future growth in demand for the Company's products. Annual warehouse rent was approximately $71,300 in fiscal 1995 and $76,200 in fiscal 1994. See Notes 8 and 10 of Notes to Consolidated Financial Statements included in "Item 8 - Financial Statements and Supplementary Data."
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS.
From time to time, the Company is party to certain claims, suits and complaints which arise in the ordinary course of business. Currently, there are no such claims, suits or complaints which, in the opinion of management, would have a material adverse effect on the Company's financial position.
ITEM 4.

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

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded in the over- the-counter market on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") under the symbol WTBK. On January 22, 1996, there were approximately 190 shareholders of record. The following table sets forth the range of high and low bid quotations per share of the Company's Common Stock from October 31, 1993 through October 28, 1995, on the NASDAQ. High and low bid quotations represent prices between dealers and do not reflect retail mark-ups, mark-downs or commissions and may not represent actual transactions.
On January 22, 1996, the last bid and asked price quotations for the Company's Common Stock were $2.25 and $2.625, respectively.
No dividends have been paid or declared on the Common Stock of the Company and the Company does not expect to pay any dividends on its Common Stock in the foreseeable future.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
Five Year Comparison of Selected Financial Data
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations:
The following table sets forth, for the years indicated, the percentages which the following items in the Consolidated Statements of Operations bear to Net Sales.
Fiscal 1995 compared to Fiscal 1994 - -----------------------------------
Net sales increased $3,756,700 or 25.0% in fiscal 1995 as compared to fiscal 1994. The increase was attributable to higher unit sales of the Company's marine generators, diesel propulsion engines, and after-market parts revenues. The overall increase is primarily the result of more favorable economic conditions benefiting the pleasure boat industry.
International sales were $2,279,300 in 1995, representing 12.1% of net sales, as compared to $1,708,000 in 1994, or 11.4% of net sales. The increase in 1995 is the result of higher unit sales caused by improved economies in the European countries.
Gross profit increased $893,000 or 26.3% in fiscal 1995 as compared to fiscal 1994. Gross profit as a percentage of sales increased to 22.8% in fiscal 1995 as compared to 22.6% in fiscal 1994. The increase in gross profit percentage is primarily due to increased parts revenues and improved manufacturing productivity during the year.
Selling, general and administrative expense increased $291,200 or 13.1% in fiscal 1995 as compared to fiscal 1994. The Company incurred higher marketing and promotional expenses due to increased boat show and travel activity. Administration costs also increased primarily due to higher legal costs associated with the negotiation of supplier contracts. Employee compensation costs were also higher as a result of the Company's improved profitability.
Research and development expense increased $190,400 or 39.0% in fiscal 1995 as compared to fiscal 1994. The increase is due to additional engineering personnel and increased consulting costs associated with product enhancements. The Company has also realized increased costs due to the compliance with proposed federal and new state emission requirements.
In May and November 1994, the Environmental Protection Agency (the "EPA") proposed emission standards for new gasoline and diesel powered marine engines and marine and industrial generators of the types manufactured by the Company. As proposed, the emission standards would phase in over the period beginning August 1, 1996 and ending January 1, 1999. The proposed regulations include manufacturer testing requirements, selective enforcement auditing by the EPA, mandated warranty periods of up to five years or 3,000 hours of operation for emission-related parts and recall and repair authority for up to ten years or 6,000 hours of opeation. Final regulations have not yet been issued covering all of the Company's products and, accordingly, the full impact of the final regulations on the Company cannot be assessed. In addition, effective August 1, 1995, regulations went into effect in the State of California establishing emissions standards covering most of the Company's generators and mandating certain warranty conditions and production testing requirements. In both the case of the proposed EPA regulations and the State of California regulations, if the Company cannot effect the required modifications of its products to meet the required emissions levels within the time frames allowed, the Company could be materially adversely affected.
Net interest income was $42,900 in fiscal 1995 compared to $19,000 in fiscal 1994. The increase is primarily due to increased interest income earned on higher invested cash balances during the year.
The Company's income tax expense in fiscal 1995 was $444,400 as compared to $275,000 in fiscal 1994.
The Company's net income was $697,600 as compared to $633,000 in fiscal 1994. The increase is mainly attributable to higher unit sales throughout fiscal 1995. Net income for 1994 includes $201,300 resulting from the cumulative effect of adopting Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes ("Statement 109"). Statement 109 required a change from the deferred method under APB Opinion 11 to the asset and liability method of accounting for income taxes.
Effective October 30, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under this statement, the Company's marketable securities are classified as "available for sale" and are recorded at current market value with a offsetting adjustment to stockholders' equity.
Fiscal 1994 compared to Fiscal 1993 - -----------------------------------
Net sales increased $1,626,700 or 12.1% in fiscal 1994 as compared to fiscal 1993. The increase was attributable to higher unit sales primarily to OEM customers.
International sales were $1,708,000 in 1994, representing 11.4% of net sales, as compared to $1,950,100 in 1993, or 14.5% of net sales. The decrease in 1994 is the result of lower unit sales caused by a general economic slowdown in the European countries.
Gross profit increased 9.5% in fiscal 1994 as compared to fiscal 1993. Gross profit as a percentage of sales decreased to 22.6% in fiscal 1994 as compared to 23.1% in fiscal 1993. The decrease in gross profit percentage is primarily due to increased product costs as a result of price increases from key suppliers.
Selling, general and administrative expense increased $80,300 or 3.7% in fiscal 1994 as compared to fiscal 1993. The increase is mainly due to increases in product warranty costs and customer bad debt expenses.
Research and development expense increased $105,700 or 27.6% in fiscal 1994 as compared to fiscal 1993. The increase is due to additional engineering personnel and increased consulting costs associated with product enhancements.
Net interest income was $19,000 in fiscal 1994 compared to $9,600 in fiscal 1993. The increase is primarily due to lower interest expense costs associated with the Company's capital leases during the year.
The Company's income tax expense in fiscal 1994 was $275,000 as compared to $252,500 in fiscal 1993.
The Company's net income was $633,000 in fiscal 1994 as compared to $335,700 in fiscal 1993. Net income for 1994 includes $201,300 resulting from the cumulative effect of adopting Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes ("Statement 109"). Statement 109 required a change from the deferred method under APB Opinion 11 to the asset and liability method of accounting for income taxes.
Liquidity and Capital Resources
During fiscal 1995, net cash provided by operations was $336,700 as compared to net cash provided by operations of $877,800 in fiscal 1994. Cash flow provided by operations in fiscal 1995 was principally the result of net income of $697,600 and non-cash charges for depreciation and amortization of $402,500. Major uses of cash during fiscal 1995 include increases in inventories of $634,800, purchases of property, plant and equipment of $349,400, and investments in mutual funds of $313,000. The rise in inventories is primarily the result of increased demand and the timing of sales order shipments.
During fiscal 1995 and 1994, the Company purchased property, plant and equipment of $349,400 and $463,600, respectively. The Company plans capital spending of approximately $250,000 for emission testing and other related emission equipment during fiscal 1996.
On June 4, 1992, the Company entered into a $3,000,000 line of credit agreement (the "Credit Agreement") with State Street Bank and Trust Company, collateralized by inventory, accounts receivable and general intangibles of the Company. The Credit Agreement was renewed on March 31, 1995, and will expire on March 31, 1996. The Company believes that it will be able to continue to extend the term of the Credit Agreement on commercially reasonable terms. As of October 28, 1995, the Company had approximately $2,902,500 in unused borrowing capacity under the Credit Agreement and approximately $97,500 committed to cover the Company's reimbursement obligations under certain letters of credit.
Management believes cash flow from operations and borrowings available under the Credit Agreement will provide for working capital needs, principal payments on long-term debt, and capital and operating leases through fiscal 1996.
Domestic inflation is not expected to have a major impact on the Company's operations.
The costs of engine blocks and other components are subject to foreign currency fluctuations (primarily the Japanese yen). The weakening U.S. dollar relative to the yen in 1995 did result in cost increases to the Company.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
WESTERBEKE CORPORATION AND SUBSIDIARY
-------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
For the years ended October 28, 1995, October 29, 1994 and October 30, 1993
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Westerbeke Corporation:
We have audited the accompanying consolidated balance sheets of Westerbeke Corporation and subsidiary as of October 28, 1995 and October 29, 1994, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended October 28, 1995. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in Item 14(a)2. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Westerbeke Corporation and subsidiary as of October 28, 1995 and October 29, 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended October 28, 1995, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in note 1 to the consolidated financial statements, effective October 31, 1993, the Company changed its method of accounting for income taxes by adopting the provisions of Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes.
/s/ KPMG PEAT MARWICK LLP
Boston, Massachusetts December 21, 1995
WESTERBEKE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
WESTERBEKE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of the consolidated financial statements.
WESTERBEKE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Three years ended October 28, 1995
The accompanying notes are an integral part of the consolidated financial statements.
WESTERBEKE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of the consolidated financial statements.
WESTERBEKE CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS October 28, 1995, October 29, 1994 and October 30, 1993
1. Summary of Significant Accounting Policies:
Basis of Presentation
The consolidated financial statements include the accounts of Westerbeke Corporation (the "Company"), and its wholly owned subsidiary, Westerbeke International, Inc. (a foreign sales corporation). Westerbeke International, Inc. was inactive during fiscal years 1995, 1994, and 1993.
The presentation 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 these estimates.
Cash Equivalents
All highly liquid investments with an original maturity of three months or less are considered to be cash equivalents.
Investments in Marketable Securities
Marketable investment securities at October 28, 1995 and October 29, 1994 consist of equity securities in various mutual funds. The Company adopted the provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (Statement 115) at October 30, 1994. Under Statement 115, the Company classifies its marketable securities in one of two categories: trading or available-for-sale.
Trading and available-for-sale securities are recorded at fair value. Unrealized holding gains and losses on trading securities are included in earnings. Unrealized holding gains and losses, net of related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders' equity until realized. Transfers of securities between categories are recorded at fair value at the date of transfer. Unrealized holding gains and losses are recognized in earnings for transfers into trading securities.
A decline in the market value of any available-for-sale security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security.
Dividend and interest income are recognized when earned. Realized gains and losses for securities classified as available-for-sale are included in earnings with cost determined using the specific identification method.
Marketable investment securities at October 28, 1995 include equity securities, principally mutual funds for which the Company has both intent and ability to hold. Equity securities are stated at the fair market value at October 28, 1995 and are stated at the lower of aggregate cost or market at October 29, 1994. The total cost of the marketable securities at October 28, 1995 was $414,900. The total cost of marketable securities at October 29, 1994 was $101,900. Gross unrealized holding gains in investment securities at October 28, 1995 and October 29, 1994 were $71,200 and $0, respectively.
Inventories
Inventories are valued at the lower of cost (determined on the last-in, first- out method) or market.
Depreciation and Amortization
The Company computes depreciation and amortization expense on a straight-line basis over the following estimated useful lives:
Intangible assets are classified in other assets. Maintenance and repairs are charged to expense in the period incurred. The cost and accumulated depreciation of assets retired or sold are removed from the accounts and any gain or loss is credited or charged to income.
Leasehold improvements are amortized on a straight-line basis over the shorter of the life of the lease or their estimated useful lives.
Revenue Recognition
The Company recognizes revenue upon shipment of product.
Product Warranty Cost
The anticipated costs related to product warranty are expensed at the time of sale of the product. Accrued warranty expense of $196,100 is included in accrued expenses and other liabilities at October 28, 1995 and October 29, 1994.
Income Taxes
Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, was issued by the Financial Accounting Standards Board in February 1992. Statement 109 requires a change from the deferred method under APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement 109, deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred taxes of a change in tax rate is recognized in income in the period that includes the enactment date.
Effective October 31, 1993, the Company adopted Statement 109 and has reported the cumulative effect of that change in the method of accounting for income taxes in the fiscal 1994 consolidated statement of operations.
Pursuant to the deferred method under APB Opinion 11, which was applied in 1993 and prior years, deferred income taxes are recognized for income and expense items that are reported in different years for financial reporting purposes and income tax purposes using the tax rate applicable for the year of the calculation. Under the deferred method, deferred taxes are not adjusted for subsequent changes in tax rates.
Net Income (Loss) Per Share
Net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents outstanding during each fiscal year. Common stock equivalents are not included in loss years because they are antidilutive.
2. Business Segment
The Company has one business segment; the designing, manufacturing and marketing of marine engines and related products. The profitability of the Company is directly tied to the marine industry. The industry is subject to fluctuations in economic conditions that may adversely affect the Company. Four customers accounted for approximately 58% and 52% of Company revenues for the fiscal years ended 1995 and 1994, respectively. Three customers totaled 41% of Company revenues for the fiscal year ended 1993. The loss of one of these customers could adversely affect the Company's profitability.
Net sales include export sales, primarily to customers in the Far East, Canada and Europe of approximately $2,279,300, $1,708,000 and $1,950,100 for fiscal years ended October 28, 1995, October 29, 1994, and October 30, 1993, respectively. In fiscal 1995, four customers accounted for sales in excess of 10% of net sales as follows: $3,993,600, $2,664,600, $2,171,900 and $2,011,700. In fiscal 1994, four customers accounted for sales in excess of 10% of net sales as follows: $2,667,900, $2,006,600, $1,572,000 and $1,525,300. In fiscal 1993, three customers accounted for sales in excess of 10% of net sales as follows: $2,308,100, $1,625,100 and $1,510,000.
At October 28, 1995, three customers accounted for trade accounts receivable in excess of 10% of net accounts receivable as follows: $267,400, $223,000, and $217,400. At October 29, 1994, three customers accounted for trade accounts receivable in excess of 10% of net accounts receivable as follows: $293,500, $288,600, and $188,200. The Company performs ongoing credit evaluations of its customers and therefore does not require collateralization of trade receivables.
3. Inventories
Inventories consist of the following:
The Company uses the last-in, first-out (LIFO) method to value inventory. The Company believes the LIFO inventory method results in a better matching of costs and revenues during periods of changing prices. Inventories would have been $1,204,000 and $1,113,000 higher at October 28, 1995 and October 29, 1994, respectively, if the first-in, first-out (FIFO) method had been used. In 1993, inventory was reduced resulting in liquidation of LIFO inventory layers carried at lower costs prevailing in prior years as compared with the current cost of inventory. The effect of the inventory reductions was to reduce cost of sales by approximately $156,000 in fiscal 1993. Inventory cost determined on the FIFO method approximates replacement or current cost.
The basic component of the Company's engine products is a "long block" engine, which is a complete engine block and head assembly without peripheral equipment. The Company purchases "long block" engines from five foreign manufacturers. While the interruption of supply of "long block" engines from existing suppliers would have a material adverse effect on the Company's operations until alternative services are secured, management believes that there are adequate alternative sources of supply of "long block" engines available to it.
4. Property, Plant and Equipment
Property, plant and equipment, at cost, consists of the following:
The Company incurred depreciation expense of approximately $377,300, $353,000, and $336,000 for fiscal years 1995, 1994, and 1993, respectively.
5. Other Assets
The Company has entered into a split-dollar insurance arrangement with John H. Westerbeke, Jr. as part of his employment agreement (see note 10), pursuant to which the Company will pay the premium costs of certain life insurance policies. Upon surrender of the policies or payment of the death benefit, the Company is entitled to repayment of an amount equal to the cumulative premiums previously paid by the Company, with all remaining payments to be made to Mr. Westerbeke Jr. or his beneficiaries. Included in other assets at October 28, 1995 and October 29, 1994 is $801,300 and $601,300, respectively, which represents the cumulative value of insurance premiums paid to date.
6. Note Receivable-Related Party
The Company holds a note receivable from John H. Westerbeke, Jr. the chairman, president and chief executive officer of the Company. The principal amount of the secured loan at October 28, 1995 and October 29, 1994 was $149,400 and $162,000, respectively. The loan was used by Mr. Westerbeke Jr. to purchase a 40 foot sailboat. The loan bears interest at 7-3/4% per annum, is secured by a security interest in the sailboat and is payable in monthly installments over a ten year period. The Company has leased the sailboat from Mr. Westerbeke, Jr. pursuant to a lease expiring in July 1999 at a rental of $2,660 per month (see Note 10). The Company makes use of the boat to evaluate the performance of its marine engines and products and for other corporate matters.
7. Revolving Demand Note Payable
On June 4, 1992, the Company entered into a $3,000,000 line of credit agreement (the "Credit Agreement") with State Street Bank and Trust Company, collateralized by inventory, accounts receivable and general intangibles of the Company. The Credit Agreement was renewed on March 31, 1995, and will expire on March 31, 1996. Borrowings outstanding under the agreement are limited to 80% of eligible accounts receivable and 40% of eligible inventories valued on a first-in, first-out basis with interest payable at the prime rate. At October 28, 1995, the Company had approximately $2,902,500 in unused borrowings under the Credit Agreement and approximately $97,500 committed to cover the Company's reimbursement obligations under certain open letters of credit and bankers' acceptances.
8. Long-Term Debt
Long-term debt consists of:
At October 28, 1995, the real estate mortgage note is collateralized by certain land and buildings with a net book value of approximately $711,000.
Aggregate maturities of long-term debt for each of the ensuing three years are as follows:
9. Income Taxes
As discussed in Note 1, the Company adopted Statement 109 as of October 31, 1993. The cumulative effect of this change in accounting for income taxes of $201,300 is determined as of October 31, 1993 and is reported separately in the consolidated statement of operations for the year ended October 29, 1994.
Income tax expense attributable to income from continuing operations consists of:
The Company has no available book or tax net operating loss carryforwards.
Federal income tax returns covering all taxable periods through October 31, 1984 have been examined by the Internal Revenue Service. The Internal Revenue Service has finalized a review of the Company's fiscal 1992 and 1993 tax returns. The results did not have a material effect on the financial condition of the Company.
Income tax expense was $444,400, $275,000, and $252,500 for the years ended October 28, 1995, October 29, 1994, and October 30, 1993, respectively, and differed from the amounts computed by applying the U.S. federal income tax rate of 34 percent to pretax income as a result of the following:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at October 28, 1995, and October 29, 1994 are presented below.
The valuation allowance for deferred tax assets as of October 29, 1994 was $0. There was no net change in the total valuation allowance for the year ended October 28, 1995. Management believes that the realization of net deferred tax assets is more likely than not because future operations of the Company are expected to generate sufficient taxable income.
10. Commitments and Contingencies
Lease Obligations
The Company has lease agreements for a warehouse and certain equipment (see note 6) expiring at various dates through 1999. Rental expense under operating leases was $91,500, $76,200, and $83,100 for the years ended October 28, 1995, October 29, 1994 and October 30, 1993, respectively.
Property, plant and equipment includes $116,600 of equipment under capital lease, net of accumulated amortization of $728,800 at October 28, 1995.
The future minimum lease payments required under capital and operating leases that have initial or remaining noncancelable lease terms in excess of one year are as follows:
Letters of Credit and Bankers' Acceptances
Certain foreign vendors require the Company to provide letters of credit at the time purchase orders are placed. As of October 28, 1995, the Company was contingently liable for open letters of credit and bankers' acceptances of approximately $97,500 (see note 7).
Royalty Arrangements
As a result of the acquisition of Rotary Marine, Inc. of Sarasota, Florida, on January 5, 1990, the Company is required to make contingent cash payments to the sellers based upon a percentage of sales of marine air conditioning products and accessories by the Company during the fiscal years ending 1992 through 1996. No payment was made in fiscal 1995, 1994 or 1993 as the sales criteria were not met.
Employment Agreements
In March of 1993, the Company entered into an Employment Agreement (the "Agreement") with John H. Westerbeke, Jr., the chairman of the board, president, and chief executive officer of the Company. The Agreement calls for Mr. Westerbeke, Jr. to be paid an annual salary of $141,750, subject to increases based upon the Consumer Price Index and at the discretion of the Company. The Agreement also provides for payment of a bonus at the discretion of the board of directors of the Company. Under the Agreement, Mr. Westerbeke, Jr. may elect to have all or any part of his base salary or bonus paid as deferred compensation. Payments of deferred compensation are to be made in cash and no special fund has been established to ensure the payment of deferred compensation. The Agreement also requires the Company to pay premiums for certain life insurance policies on the life of Mr. Westerbeke, Jr. In addition, in the event of a change in control of the Company, Mr. Westerbeke, Jr. may terminate his employment during the one year period following such change in control, and in such event, the Company is required to pay him a lump sum cash payment in an amount equal to three times his average annual cash compensation during the most recent five taxable years of the Company. In addition, in such circumstances, the Company is required to continue to carry group life and health insurance for Mr. Westerbeke, Jr. for a three year period and is required to pay any premiums payable on the life insurance policies on his life for a three year period.
Under an employment agreement between the Company and John H. Westerbeke, Sr., a director of the Company, Mr. Westerbeke, Sr. will be paid $35,000 per year. This agreement provides that following his retirement, Mr. Westerbeke, Sr. will act as consultant to the Company at an annual consulting fee of $30,000.
11. Stockholders' Equity
In June 1986, the board of directors and the stockholders of the Company adopted the Company's 1986 Stock Option Plan (the "Option Plan"), under which 300,000 shares of common stock have been made available. The Company has also reserved 250,000 shares of common stock for issuance in connection with a Supplemental Stock Option Plan (the "Supplemental Plan"). The Supplemental Plan permits acceleration of the exercisability of options in the event of a change in control of the Company with the Company retaining the right of first refusal with respect to shares issued under this plan.
Options under the plans may be either nonqualified stock options or incentive stock options. Options may be granted to eligible employees of the Company and members of the board of directors.
The price at which the shares may be granted may not be less than the lower of fair market value or tangible book value in the case of nonqualified options, or 100% of the fair market value in the case of incentive stock options. The options generally become excercisable in 20% annual increments beginning on the date of the grant and expire at the end of ten years.
Information for fiscal years 1993, 1994 and 1995, with respect to the Option Plan, is as follows:
The outstanding options expire on various dates through May 2003. Options for 122,500 shares of common stock were exercisable at October 28, 1995. Options for 92,500 shares are available for future grant under the Option Plan.
Information for fiscal years 1993, 1994, and 1995, with respect to the Supplemental Plan, is as follows:
The outstanding options expire on various dates through March 2003. Options for 120,300 shares of common stock were exercisable at October 28, 1995. Options for 94,700 shares are available for future grant under the Supplemental Plan.
Additionally, the Company has granted nonqualified options to a consultant to purchase 6,200 shares of common stock, all of which are exercisable at October 28, 1995.
Preferred Stock
As of October 28, 1995, October 29, 1994 and October 30, 1993, 1,000,000 shares of $1.00 par value Serial Preferred Stock were authorized; none were issued or outstanding.
12. 1986 Employee Stock Purchase Plan
In June 1986, the board of directors and the stockholders of the Company adopted the Company's 1986 Employee Stock Option Plan (the "Purchase Plan"). Under the Purchase Plan, an aggregate of 100,000 shares of common stock are available for purchase by eligible employees of the Company, including directors and officers, through payroll deductions over successive six-month offering periods. The Purchase Plan will become effective when so declared by the board of directors.
The Purchase Plan is intended to qualify as an "Employee Stock Purchase Plan" within the meaning of Section 423 of the Internal Revenue Code. The purchase price of the common stock under the Purchase Plan will be 85% of the average of the closing high bid and last asked prices per share in the over-the- counter market on either the first or last day of each six-month offering period, whichever is less. As of October 28, 1995, there has been no activity under the Purchase Plan.
13. Employee Benefit Plan
In 1994, the Company began an Employee Deferred Compensation Plan that covers all employees over 18 years of age who have completed at least 3 months of service with the Company. Contributions by the Company are discretionary and are determined by the Company's board of directors. The Company has made no contributions to the plan.
14. Quarterly Financial Data and Restatement of Fiscal 1994 First Quarter Information (Unaudited) (In thousands, except per share amounts)
Selected quarterly financial data for the years ended October 28, 1995 and October 29, 1994 is as follows:
SCHEDULE II WESTERBEKE CORPORATION AND SUBSIDIARY
VALUATION AND QUALIFYING ACCOUNT For the years ended October 28, 1995, October 29, 1994 and October 30, 1993
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.
Certain biographical information concerning the directors of the Company as of January 1, 1996 is set forth below. Such information was furnished by them to the Company.
For additional information concerning the management of the Company, see "Item 1 - Business - Executive Officers" contained in Part I hereof.
The Board of Directors of the Company consists of three classes of directors, Class A, Class B and Class C. Directors in each class are elected for a term of three years. The term of office of the Class A directors will expire at the Annual Meeting of Stockholders to be held in 1996. Class B and Class C directors will be elected at the Annual Meetings to be held in 1997 and 1998, respectively. Mr. Bench is a Class A director, Messrs. Haythe, Safford and Storey are Class B directors and Messrs. Westerbeke, Jr. and Westerbeke, Sr. are Class C directors.
The directors and officers of the Company other than Messrs. Bench, Haythe, Safford and Storey are active in the business on a day- to-day basis. Messrs. Westerbeke, Sr. and Westerbeke, Jr. are father and son. No other family relationships exist between any of the directors and officers of the Company.
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers, and persons who own more than ten percent of the Company's Common Stock, to file with the SEC initial reports of ownership and reports of changes in ownership of Common Stock. Officers, directors and greater than ten percent stockholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) reports they file.
To the Company's knowledge, based solely on a review of the copies of such reports furnished to the Company and representations that no other reports were required, during the fiscal year ended October 28, 1995 all Section 16(a) filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were complied with.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION.
The following table sets forth information for the fiscal years ended October 28, 1995, October 29, 1994 and October 30, 1993 concerning the compensation paid or awarded to the Chief Executive Officer and the other executive officers of the Company.
SUMMARY COMPENSATION TABLE
The Company did not grant any stock options to the executive officers named in the Summary Compensation Table during the fiscal year ended October 28, 1995.
The following table sets forth the number and value of options held by the executive officers named in the Summary Compensation Table at October 28, 1995. During the fiscal year ended October 28, 1995, none of the executive officers named in the Summary Compensation Table exercised any options or warrants to purchase Common Stock.
OPTION VALUES AT OCTOBER 29, 1994
Employment Agreements - ---------------------
The Company has an Employment Agreement (the "Agreement") with John H. Westerbeke, Jr., the Chairman of the Board, President and Chief Executive Officer of the Company, which provides for his employment by the Company at an annual salary of $141,750, subject to increases based upon the Consumer Price Index and at the discretion of the Company. The Agreement also provides for payment of a bonus at the discretion of the Board of Directors of the Company. Under the Agreement, Mr. Westerbeke may elect to have all or any part of his base salary or bonus paid as deferred compensation in five annual installments commencing in March following the year in which he retires or ceases to be actively employed by the Company. Payments of deferred compensation are to be made in cash and no special fund has been established to ensure the payment of deferred compensation. The Agreement also requires the Company to pay premiums for certain life insurance policies on the life of Mr. Westerbeke as described below. The Agreement may be terminated by the Company upon the disability of Mr. Westerbeke, by the Company with or without cause, and by Mr. Westerbeke in the event there has occurred a constructive termination of employment by the Company. In addition, in the event of a change in control of the Company, as defined in the Agreement, Mr. Westerbeke may terminate his employment during the one year period following such change in control, and in such event, the Company will be required to pay him a lump sum cash payment in an amount equal to three times his annual cash compensation during the most recent five taxable years of the Company, less $1,000. In addition, in such circumstances, the Company is required to continue to carry group life and health insurance for Mr. Westerbeke for a three year period and is required to pay any premiums payable on the split-dollar life insurance policies on his life for a three year period. Under the Agreement, Mr. Westerbeke has agreed not to compete with the Company for a period of one year following termination of his employment.
The Company has entered into a split-dollar insurance arrangement with Mr. Westerbeke, Jr., pursuant to which the Company will pay the premium costs of certain life insurance policies that pay a death benefit of not less than $2,419,153 in the aggregate upon the death of Mr. Westerbeke. Upon surrender of the policies or payment of the death benefit thereunder, the Company is entitled to repayment of an amount equal to the cumulative premiums previously paid by the Company, with all remaining payments to be made to Mr. Westerbeke or his beneficiaries. See footnote (1) to the "Summary Compensation Table" above for further information on premium payments made by the Company.
The Company has an agreement with Carleton F. Bryant, III, the Executive Vice President, Treasurer and Chief Operating Officer of the Company, which provides for his employment by the Company at an annual salary of $94,500. Under a related agreement Mr. Bryant agrees not to compete with the Company for a period of three years following the termination of his employment.
The Company has an agreement with John H. Westerbeke, Sr., a director of the Company, which provides for his employment by the Company at an annual salary of $35,000 until Mr. Westerbeke, Sr. retires. This agreement also provides that following his retirement, Mr. Westerbeke, Sr. will act as a consultant to the Company at an annual consulting fee of $30,000. The Company paid Mr. Westerbeke, Sr. $35,000 during fiscal 1995.
Compensation Committee Interlocks and Insider Participation - -----------------------------------------------------------
Thomas M. Haythe, a director of the Company and a member of the Compensation Committee, is a partner of the New York City law firm of Haythe & Curley, which firm acted as legal counsel to the Company during the past fiscal year. It is expected that Haythe & Curley will continue to render legal services to the Company in the future.
Compensation of Directors - -------------------------
The Company pays its directors a fee of $1,000 for attending each meeting of the Board of Directors of the Company.
Termination of Employment and Change of Control Arrangements - ------------------------------------------------------------
See "Employment Agreements" above for information concerning certain change of control arrangements with respect to John H. Westerbeke, Jr., the Chairman of the Board, President and Chief Executive Officer of the Company.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The shareholders (including any "group" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) who, to the knowledge of the Board of Directors of the Company, owned beneficially more than five percent of any class of the outstanding voting securities of the Company as of January 1, 1996, each director and each executive officer named in the Summary Compensation Table of the Company who owned beneficially shares of Common Stock and all directors and executive officers of the Company as a group, and their respective shareholdings as of such date (according to information furnished by them to the Company), are set forth in the following table. Except as indicated in the footnotes to the table, all of such shares are owned with sole voting and investment power.
To the Company's knowledge, there have been no significant changes in stock ownership or control of the Company as set forth above since January 1, 1996.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company leases a 40-foot sailboat from Mr. Westerbeke, Jr., the Chairman of the Board, President and Chief Executive Officer of the Company, pursuant to a lease expiring in July 1999. The Company pays an annual rental to him of $31,920 and also pays approximately $10,000 to $15,000 of annual expenses in connection with the operation and maintenance of the sailboat. The Company makes use of the sailboat to evaluate the performance of its marine engine products and for other corporate purposes. In July 1994, Mr. Westerbeke, Jr. executed a promissory note payable to the Company in the principal amount of $165,000. The proceeds of the loan were used by Mr. Westerbeke, Jr. to purchase the sailboat which is leased to the Company as described above. The loan, which is due June 1, 2004, is payable in equal monthly installments which commenced on July 1, 1994, together with interest at 7.75% per annum and is secured by the sailboat. Management of the Company believes that the terms of the lease and of the secured loan are no less favorable to the Company than it could obtain from an unrelated party.
Thomas M. Haythe, a Class B director of the Company, is a partner of the New York City law firm of Haythe & Curley, which firm has acted as legal counsel to the Company (and its predecessor) for several years. It is expected that Haythe & Curley will continue to render legal services to the Company in the future.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements:
Schedules other than those listed above are omitted because they are not required or are not applicable, or the required information is shown in the Consolidated Financial Statements or Notes thereto. Columns omitted from schedules filed have been omitted because the information is not applicable.
3. Exhibits:
The exhibits required to be filed as part of this Annual Report on Form 10-K are listed in the attached Index to Exhibits.
(b) Current Reports on Form 8-K:
During the fiscal quarter ended October 28, 1995, the Company did not file any Current Reports on Form 8-K.
* * *
Copies of the exhibits filed with this Annual Report on Form 10-K or incorporated by reference herein do not accompany copies hereof for distribution to stockholders of the Company. The Company will furnish a copy of any of such exhibits to any stockholder requesting the same for a nominal charge to cover duplicating costs.
POWER OF ATTORNEY
The registrant and each person whose signature appears below hereby appoint John H. Westerbeke, Jr. and Thomas M. Haythe as attorneys-in-fact with full power of substitution, severally, to execute in the name and on behalf of the registrant and each such person, individually and in each capacity stated below, one or more amendments to this Annual Report on Form 10-K, which amendments may make such changes in this Annual Report as the attorney-in-fact acting in the premises deems appropriate and to file any such amendment(s) to this Annual Report with the Securities and Exchange Commission.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: January 25, 1996
WESTERBEKE CORPORATION
By /s/ John H. Westerbeke, Jr. John H. Westerbeke, Jr. Chairman and President
Pursuant to the requirements of the Securities and Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Dated: January 25, 1996
By /s/ John H. Westerbeke, Jr. John H. Westerbeke, Jr. Chairman and President and Principal Executive Officer
Dated: January 25, 1996 By /s/ Carleton F. Bryant III Carleton F. Bryant III Executive Vice President, Chief Operating Officer and Principal Financial and Accounting Officer
Dated: January 25, 1996 By /s/ Gerald Bench Gerald Bench Director
Dated: January 25, 1996 By /s/ Thomas M. Haythe Thomas M. Haythe Director
Dated: January 25, 1996 By /s/ Nicholas H. Safford Nicholas H. Safford Director
Dated: January 25, 1996 By /s/ James W. Storey James W. Storey Director
Dated: January 25, 1996 By /s/ John H. Westerbeke, Sr. John H. Westerbeke, Sr. Director
Index to Exhibits


Item 1. Business Background
Span-America Medical Systems, Inc. (the "Company" or "Span-America"), was incorporated under the laws of the state of South Carolina on September 21, 1970. The Company manufactures and distributes a variety of polyurethane foam products and contract packaging products for the medical, consumer and industrial markets.
Span-America commenced operations in 1975 as a manufacturer of polyurethane foam patient positioners. During the next several years, the Company expanded its product lines to produce lapidus (flat foam) and convoluted foam mattress overlays for the decubitus care market. Decubitus care products aid in the treatment or prevention of decubitus ulcers, commonly known as bed sores or pressure ulcers. In the late 1970's the Company also began producing foam products for industrial applications, primarily to utilize excess manufacturing capacity. In 1985, the Company introduced its patented Geo-Matt mattress overlay in the health care market which became the Company's leading product. At the same time, the Company began selling its mattress overlay products to the consumer market segment. Span-America's foam products (including replacement mattresses described below) made up approximately 79% of the Company's total net sales in fiscal 1995.
To diversify its operations and to capitalize upon its familiarity and contacts within the health care industry, Span-America entered the contract packaging business in 1987. These initial contract packaging operations were based on a three-year commitment to supply Baxter Healthcare Corporation ("Baxter") with all of its contract packaging requirements. This agreement expired during the first quarter of fiscal 1991. The Company currently provides contract packaging services to a variety of customers throughout the United States. During fiscal 1995, contract packaging products accounted for approximately 21% of total net sales.
The Company entered the replacement mattress segment of the pressure ulcer care market in fiscal 1992 through the acquisition of Healthflex, Inc. The Company is currently marketing Healthflex's PressureGuard line of replacement mattresses directly to hospitals and long-term care facilities.
The Company's long-term strategy is to become a leading health care manufacturer specializing in products used in the prevention and treatment of pressure ulcers. A majority of the Company's medical products are currently directed toward pressure ulcer care applications, and the Company is actively seeking to develop or
acquire new products which are in this market segment. The Company also seeks to further develop and manufacture consumer and industrial applications of its medical products.
The Company's products are distributed primarily in the United States and to a lesser degree in several foreign countries. Total export sales during fiscal 1995 were approximately $954,000 or 3% of total net sales.
Industry Segment Data
The industry segment data included in Note 15 to the Company's audited consolidated financial statements for the year ended September 30, 1995, presented on page 24 of the 1995 Annual Report is incorporated herein by reference.
Medical Products
Span-America's principal medical products consist of polyurethane foam mattress overlays, therapeutic replacement mattresses, and patient positioners. These products are marketed primarily to hospitals but are also marketed to long term care facilities in the United States. The Company also sells these products on a limited basis in Canada. Sales of medical products represented 45%, 47%, and 55% of sales in 1995, 1994, and 1993 respectively.
Mattress Overlays. Span-America produces a variety of foam mattress overlays, including convoluted and lapidus foam pads and its patented Geo-Matt(R) overlay. Mattress overlays comprised approximately 22% of the Company's total net sales in fiscal 1995. These products are designed to provide patients with greater comfort and assist in treating patients suffering from burns or pressure ulcers. Span-America's overlay products are mattress pads as compared to complete mattresses and are marketed as less expensive alternatives to generally higher priced air and water mattresses. The mattress overlays are designed for single patient use.
The Geo-Matt mattress overlay, which was introduced in 1985, represents the Company's single largest product in terms of revenues. However, Geo-Matt sales have declined in each of the last three fiscal years. Geo-Matt was designed with computer-aided equipment in conjunction with clinical studies performed by the Institute for Rehabilitation and Research at the Baylor College of Medicine. The product's patented design includes over 800 individual cells which are cut to exacting tolerances on computer controlled equipment to create a sophisticated and clinically effective mattress surface.
The Company's mattress overlays disperse body heat, increase air circulation beneath the patient, and reduce moisture build-up in order to prevent the development
or promote the healing of pressure ulcers. Their convoluted or geometrically contoured construction also evenly distributes the patient's body weight, thereby minimizing the pressure that causes ulcers.
Replacement Mattresses. Span-America's replacement mattresses consist of its PressureGuard(R) mattresses, a line of therapeutic replacement mattresses (as distinguished from overlays), acquired through the acquisition of Healthflex in February 1992. The patented PressureGuard product combines a polyurethane foam shell and static air tubes to form a replacement mattress which incorporates the comfort and pressure relieving features of both mattress overlays and more sophisticated mattresses containing dynamic features. PressureGuard mattresses are designed to replace existing hospital or long-term care mattresses and to eliminate the need for mattress overlays. The PressureGuard mattress has preventative and therapeutic features, providing orthopedically correct positioning, equalized support and weight distribution, shear reduction, and pressure dispersion. The product line is now being sold primarily to acute care hospitals in the United States through the Company's direct sales force of approximately 20 representatives. The Company is also increasing its marketing efforts for this product in Canada. During fiscal 1995 replacement mattresses and related products made up approximately 9% of total net sales.
In November 1993, the Company received FDA 510K marketing approval for its PressureGuard IV (PGIV) mattress system. Building on the comfort and orthopedic support of the PressureGuard II design, PressureGuard IV is a sophisticated support system that provides pressure reduction and patient comfort in a powered, dynamic mattress with turning capabilities. The mattress automatically senses the patient's weight and adjusts to the appropriate support level for each patient to minimize surface pressures. The system slowly and quietly repositions patients at angles up to 30 degrees in cycles of up to two hours, providing continuous care for effective prevention and treatment of pressure ulcers. When disconnected from a power source, the system maintains proper inflation and optimum patient support until power is restored and rotation can resume. The simplicity of the PressureGuard IV mattress system makes it easy to use and virtually maintenance free. Standard operating modes are pre-programmed, with the flexibility to customize settings for each patient's care. During fiscal 1995, PGIV and related products made up approximately 6% of total net sales.
In November 1994, Span-America introduced the DynaGuard alternating pressure mattress. This powered, dynamic replacement mattress is being targeted to the home care market. In June 1995, the Company introduced the CustomCare(TM) therapeutic mattress system. The CustomCare mattress uses principles of "constant force technology" to create a new category of non-powered, self-adjusting mattress systems for the acute care and long-term care markets.
Patient Positioners. Span-America's specialty line of patient positioners is sold primarily under the trademark Span-Aids(R). Span-Aids accounted for approximately 8%
of the Company's net sales in fiscal 1995. This is the original product line of the Company and consists of over 300 different foam items which aid in relieving the basic patient positioning problems of elevation, immobilization, muscle contracture, foot drop and foot or leg rotation. Span-Aids patient positioners hold the patient's body in orthopedically correct positions, provide greater patient comfort and tend to promote healing for long-term comatose patients or those with a flaccid or immobilized condition. The positioners also aid in the prevention of pressure ulcers by promoting more effective dispersion of pressure, heat and moisture. Span-Aids are intended for single-patient use throughout the patient's entire treatment program. Among the Span-Aids products presently marketed are abduction pillows, body aligners, wheelchair cushions, cast elevators and various foot and wrist positioners.
Span-America's patient positioners are sold primarily to hospitals and long-term care facilities by several national medical products distributors. Span-Aids are believed by the Company to be one of the most effective patient positioning devices available in the health care market, as compared to pillows, rolled towels and other similar materials traditionally used by nursing personnel to position immobilized patients. Span-Aids are constructed of open-cell polyurethane foam which allows air to circulate next to the patient's skin, thereby reducing extensive heat and moisture build-up.
Most Span-Aids body positioners are pressure packaged to reduce the amount of storage space required by hospitals and other facilities which utilize them. This patented packaging method reduces the package size by as much as 75% while protecting the positioners from dust and contamination during transportation and storage.
Distributor Relationship. Approximately 27% of the Company's medical foam products are sold to Baxter which distributes these products to hospitals nationwide. Span-America has maintained a distribution relationship with Baxter (formerly American Hospital Supply) for 17 years. Sales of the Company's medical foam overlay products to Baxter Healthcare Corporation, have declined during the last two fiscal years due to Baxter's decision in February 1994 to begin carrying a competing line of foam products. A continued decline in sales to Baxter could have a negative effect on the Company's earnings in fiscal 1996. However, management believes that any negative earnings impact of the decline in foam overlay sales should be offset by increases in sales of these products to other national distributors and by sales increases in the Company's other product lines. The Company's foam overlay products are now available through a number of national distributors rather than exclusively from Baxter as was the case until early 1994. Sales of medical foam products to Baxter have declined by approximately $11 million since fiscal 1993. However, during the same period, sales of these products to other national distributors have increased by $6 million, offsetting more than half of the decline in sales to Baxter.
Consumer Products
Span-America's consumer products consist primarily of convoluted mattress overlays and specially designed pillows for the consumer bedding market. The Company's principal consumer mattress overlays are produced under private labels for J.C. Penney and Target Stores. The majority of the Company's consumer bedding products are marketed by Pillowtex, which sells the products to department stores and mass merchandisers throughout the United States.
In 1990, Span-America introduced its TerryFoam(R) comfort products which are designed to be used on all types of outdoor furniture. Formerly produced by contract manufacturers according to the Company's specifications, these products are now manufactured by the Company. They are being sold and distributed directly by Span-America to retailers nationwide.
Consumer products represented approximately 23% of the Company's total net sales in fiscal 1995 as compared to 21% in 1994 and 19% in 1993.
Industrial Products
Span-America's industrial products consist primarily of foam packaging and cushioning materials. The Company also produces foam products which are used for flotation, sound insulation and gasketing purposes. The majority of these products are made to order according to customer specifications instead of being made to stock. To date, most of the Company's industrial sales have been in the specialty packaging segment of the industrial foam market. The Company currently has two full-time sales representatives and several manufacturers representatives selling its foam fabrication capabilities to the industrial market. Its customers represent a wide variety of markets, including the defense, electronics and sports equipment industries. The industrial foam segment of the business made up approximately 12% of the Company's net sales in fiscal 1995 as compared to 9% in 1994.
Contract Packaging Products
Span-America's contract packaging products are principally single-use flexible packettes containing various chemicals which are used for cleaning, sterilizing or lubricating purposes. Approximately 21% of the Company's fiscal 1995 sales were contract packaging products as compared to 22% in 1994, and 20% in 1993. Contract packaging products are generally foil pouches containing a piece of non-woven cloth which has been saturated with substances such as alcohol or iodine. The Company markets its contract packaging capabilities principally to large health care and pharmaceutical companies. Since the Company's main function is that of a contract manufacturer, it primarily relies on the distribution networks of its customers.
The Company's contract manufacturing facilities include a high quality water filtration system, liquid/gel blending facilities and equipment which fills flexible packettes with a variety of chemicals, powders, gels, swab sticks and other products. Span-America utilizes high-speed horizontal and vertical "form, fill and seal" packaging machines to produce a significant portion of the contract packaging products. The Company also provides bottle (liquid) filling services to its customers.
Although Span-America functions primarily as a contract manufacturer of flexible packaging products, it also produces a line of such products under its own Span-Care brand, consisting principally of single-use towelettes, swabs and gels. The Company employs two sales representatives to sell this Span-Care line to hospitals and alternate site facilities, including long-term care facilities and home health care distributors.
The Company also manufactures contract packaging products for the consumer market segment. These items consist mainly of health and beauty aid products such as towelettes, lotions and powders. Span-America acts as a contract manufacturer of these products, blending and packaging them according to customer specifications. They are sold and distributed by Span-America's customers to a variety of retail outlets in the United States.
Competition
Medical. In the medical market segment, the Company faces significant competition for sales of its foam mattress overlays. The competition for convoluted mattress overlays is primarily based on price and delivery. For other foam mattress overlay products (such as the Geo-Matt overlay), the competition is based mainly on product performance and quality. However, to a lesser extent, the competition for Geo-Matt type overlays is also based on price and delivery. Competition with respect to the Company's Span-Aid products is primarily based on price. However, a secondary source of competition for patient positioners results from alternative methods such as the use of pillows and other devices to position patients.
The Company believes that it is among the top five suppliers of foam mattress overlays and patient positioners to the health care market. The Company's primary competitors in the health care market include Bio Clinic (division of Sunrise Medical), Dermacare, Gaymar, and DeRoyal.
The competition in the therapeutic replacement mattress market is based on product performance, price and durability. Potential customers typically select a product based on these criteria after conducting a formal clinical evaluation of sample mattresses for periods of one to six months. A secondary source of competition results from alternative products such as mattress overlays which are significantly less expensive than replacement mattresses.
The market for therapeutic replacement mattresses has developed principally during the last three years and is currently dominated by five suppliers: BG Industries, Hill-Rom, Comfortex, DermaCare, and Bio Clinic. BG Industries utilizes Baxter to distribute its mattresses primarily to hospitals. The other competitors use their own sales representatives to sell directly to hospitals, distributors, and long-term care facilities nationwide. The Company's entrance into the replacement mattress market in 1992 also placed it in direct competition with Baxter for sales of replacement mattress products. See "Distributor Relationship" on page 4 for further discussions regarding Baxter and the Company.
Many of the Company's competitors in the health care segment are larger and have greater resources than Span-America.
Consumer. In the consumer market segment, Span-America has encountered significant competition for its mattress pad and pillow products. The competition is principally based on price, which is largely determined by foam density and thickness. However, competition also exists due to variations in product design and packaging. There are presently a number of companies with the manufacturing capability to produce similar bedding products. The Company's primary competitors in this market are Comfort Clinic (a division of Sunrise Medical) and ER Carpenter, both of which are larger than Span-America.
Industrial. The Company also has a number of competitors in the industrial foam market, including United Foam, Hibco and Foam Design. Some of these competitors are larger and have greater resources than Span-America. The competition for industrial foam products is largely based on price. In some instances, however, design and delivery capabilities are as important as the price of the product.
Contract Packaging. A significant level of competition has been experienced in the markets into which the medical contract packaging products are sold. This competition is based mainly on price, quality and manufacturing capability. Many of the contract packaging products have the characteristics of commodity products and thus can be produced at several manufacturing facilities in the United States. The Company's chief competitors in this market are PDI/Nice Pak, Packaging Coordinators, Paco, Marietta Packaging and Clinipad.
There is also significant competition for the Company's contract packaging products sold in the consumer market. The main bases for this competition are quality, capacity and breadth of manufacturing capabilities. There are currently many companies, some larger and with greater resources than Span-America, which have the capability to produce equivalent products.
Major Customers
The Company has a business relationship with Baxter Healthcare Corporation ("Baxter") to distribute certain of its foam and contract packaging products. In fiscal 1995, sales to Baxter amounted to approximately 12% of the Company's total net sales and approximately 27% of the Company's sales to the medical foam segment. Span-America also has a relationship with Pillowtex Corporation to distribute certain of its consumer foam products. Sales to Pillowtex during fiscal 1995 made up approximately 15% of the Company's net sales and approximately 64% of sales in the consumer foam segment. The Company has a relationship with another customer to manufacture specific contract packaging products for the consumer market segment. Sales to this customer comprised approximately 5% of the Company's fiscal 1995 net sales and 25% of the contract packaging segment sales during the same period.
The loss of any of the customers described above could have a material adverse effect on the Company. See "Distributor Relationship" on page 4, "Consumer Products" on page 5, and "Competition" on pages 6 and 7 for more information on major customers. Seasonal Trends
Some seasonality can be identified in certain of the Company's medical foam, consumer foam and contract packaging products. However, the fluctuations have minimal effect on the Company's operations because of offsetting trends among these product lines. Span-America has not experienced any seasonal fluctuations in its industrial segment.
The most seasonal of the Company's products is the TerryFoam line of chaise and chair pads. Demand for shipments of these products generally is highest in January through April of each year as retail stores begin stocking their summer merchandise. The impact of this seasonality on the Company will depend largely on the volume of sales achieved for this product line. During previous fiscal years, the seasonality of TerryFoam products has had only a minor impact on the Company's operations.
Patents and Trademarks
The Company holds 28 federally registered trademarks, including SPAN- AMERICA, SPAN-AIDS, GEO-MATT, SPAN-CARE AND PRESSUREGUARD. Other federal registration applications are presently pending. The Company believes that these trademarks are readily identifiable in their respective markets and add value to the Company's product lines.
The Company also holds 44 United States patents and 8 foreign patents relating to various components of its patient positioners, mattress overlays, and replacement
mattresses. Additional patent applications have been filed. Management believes that these patents are important to the Company. However, while the Company has a number of products covered by patents, there are competitive alternatives available which are not covered by these patents. Therefore, the Company does not rely solely on its patents to maintain its competitive position in the marketplace.
Span-America's principal patents include the patents on its PressureGuard and CustomCare replacement mattress, its Geo-Matt overlay and its Span-Aids patient positioners. The Company's Geo-Matt and PressureGuard patents have remaining lives of 12 and 14 years, respectively. The Company's Span-Aids patents have remaining lives ranging from 1 to 14 years.
Certain of the Company's patents have been assigned or exclusively licensed to the Company by Donald C. Spann, the Company's founder and former chairman, until January 1, 1996. In connection with such assignments, the Company is obligated to pay Mr. Spann royalties equal to 3% of net sales on all products covered by such patents. In the event that the Company defaulted on these royalty payments, such patents would revert to Mr. Spann. On January 1, 1996, all patents assigned or licensed to the Company by Mr. Spann will become the property of the Company, and the Company will have no further obligation to make the royalty payments.
Raw Materials and Backlog
Polyurethane foam, foil packaging, various chemical solutions and non-woven cloth account for approximately 80% of Span-America's raw materials. In addition, the Company uses corrugated shipping cartons, polyethylene plastic packaging material and hook-and-loop fasteners. The Company believes that its basic raw materials are in adequate supply and are available from many suppliers at competitive prices.
As of September 30, 1995, Span-America had unshipped orders of approximately $2.6 million which represents a 10% decrease compared to a backlog of $2.9 million at fiscal year end 1994. All orders in the current backlog will be filled in the 1996 fiscal year.
Employees
On September 30, 1995, the Company had full-time employment of 250 persons, including 5 officers. Of these employees, 25 were executive or management personnel, 12 were administrative and clerical personnel, 19 were sales personnel and 189 were manufacturing employees. The Company is not a party to any collective bargaining agreement, and has never experienced an interruption or curtailment of operations due to labor controversy. Management believes that its relations with its employees are good.
Supervision and Regulation
The Federal Food, Drug and Cosmetic Act, and regulations issued or proposed thereunder, provide for regulation by the Food and Drug Administration (the "FDA") of the marketing, manufacture, labeling, packaging and distribution of medical devices, including the Company's products. These regulations require, among other things, that medical device manufacturers register with the FDA, list devices manufactured by them, and file various types of reports. In addition, the Company's manufacturing facilities are subject to periodic inspections by regulatory authorities and must comply with "good manufacturing practices" as required by the FDA and state regulatory authorities. The Company believes that it is in substantial compliance with applicable regulations and does not anticipate having to make any material expenditures as a result of FDA or other regulatory requirements.
Environmental Matters
The Company's manufacturing operations are subject to various government regulations pertaining to the discharge of materials into the environment. Span-America believes that it is in compliance with applicable regulations. The Company does not anticipate that continued compliance will have a material effect on the Company's capital expenditures, earnings or competitive position.
Item 2.

Item 2. Properties
The Company's principal office and manufacturing facility is owned by the Company and located in Greenville, South Carolina. This facility contains approximately 125,000 square feet and is located on a 13 acre site. The Company also leases approximately 60,000 square feet of warehouse space in Greenville for $13,672 per month until the lease expires in May 1997.
The Company produces foam mattress overlays for the medical and consumer markets in a 40,000 square foot facility in Norwalk, California. The lease rate is $14,196 per month and increases annually over the term of the lease to $15,615 per month until the lease expires in December 1997. The Company closed its Vermont manufacturing plant in July 1994 and consolidated the operation into the South Carolina facilities.
The South Carolina and California facilities are considered suitable and adequate for their intended purposes.
Item 3.

Item 3. Legal Proceedings
The Company and its subsidiaries are from time to time parties to various legal actions arising in the normal course of business. However, management believes that as a result of legal defenses and insurance arrangements with parties believed to be financially capable, there are no proceedings threatened or pending against the Company that, if determined adversely, would have a material adverse effect on the business or financial position of the Company.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the Company's 1995 fiscal year.
PART II
Item 5.

Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters
The stock price information contained under "Quarterly Financial Data" within the table and the information set forth below the table on page 11 of the Company's 1995 Annual Report is incorporated herein by reference. In addition, the information under "Stock Information" on the inside back cover of the Company's 1995 Annual Report is incorporated herein by reference.
Item 6.

Item 6. Selected Financial Data
The information contained in the "Selected Financial Information" on page 10 of the Company's 1995 Annual Report is incorporated herein by reference.
Item 7.

Item 7. Management's Discussion and Financial Analysis
Management's Discussion and Financial Analysis on pages 12 through 15 of the Company's 1995 Annual Report are incorporated herein by reference.
Item 8.

Item 8. Financial Statements and Supplementary Data
The financial statements of the Company included on pages 16 through 26 of the Company's 1995 Annual Report are incorporated herein by reference.
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant
Item 11.

Item 11. Executive Compensation
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13.

Item 13. Certain Relationships and Related Transactions
Information required under Items 10, 11, 12 and 13 of Part III is incorporated herein by reference to portions of the definitive Proxy Statement filed or to be filed with the Securities and Exchange Commission on or prior to 120 days following the end of the Company's 1995 fiscal year under the headings "Election of Directors," "Business Experience of Nominees and Directors," "Executive Officers," "Compensation of Directors and Executive Officers," "Certain Transactions," and "Security Ownership of Certain Beneficial Owners and Management."
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) and (2) Financial Statements and Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate section of this report beginning on page.
(3) Listing of Exhibits
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.
SPAN-AMERICA MEDICAL SYSTEMS, INC.
By: /s/ Brien Laing December 20, 1995 Brien Laing, Chairman of the Board
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 on the date indicated.
/s/ Charles B. Mitchell President, Chief Executive Officer and Charles B. Mitchell Director (Principal Executive Officer)
/s/ Richard C. Coggins Chief Financial Officer and Director Richard C. Coggins (Principal Financial Officer)
/s/ Gwendolyn L. Randolph Controller Gwendolyn L. Randolph
/s/ Thomas F. Grady, Jr. Director Thomas F. Grady, Jr.
/s/ Douglas E. Kennemore Director Douglas E. Kennemore, M.D.
/s/ Brien Laing Director Brien Laing
/s/ W. Marcus Newberry Director W. Marcus Newberry, M.D.
/s/ James M. Shoemaker, Jr. Director James M. Shoemaker, Jr.
/s/ Raymond M. Tortolani Director Raymond M. Tortolani
/s/ Robert A. Whitehorne Director Robert A. Whitehorne
15 December 20, 1995
Annual Report on Form 10-K
Items 14 (a) (1) and (2), (c) and (d)
List of Financial Statements and Financial Statement Schedules
Certain Exhibits
Financial Statement Schedules
Year Ended September 30, 1995
Span-America Medical Systems, Inc.
Greenville, South Carolina
Span-America Medical Systems, Inc.
Form 10-K - Item 14(a)(1) and (2)
List of Financial Statements and Financial Statement Schedules
The following consolidated financial statements of Span-America Medical Systems, Inc., included in the annual report of the registrant to its shareholders for the year ended September 30, 1995 are incorporated by reference in Item 8:
Consolidated Balance Sheets - September 30, 1995 and October 1, 1994
Consolidated Statements of Income - Years ended September 30, 1995, October 1, 1994 and October 2, 1993
Consolidated Statements of Shareholders' Equity - Years ended September 30, 1995, October 1, 1994 and October 2, 1993.
Consolidated Statements of Cash Flows - Years ended September 30, 1995, October 1, 1994 and October 2, 1993
Consolidated Notes to Financial Statements - September 30, 1995
The following consolidated financial statement schedule of Span-America Medical Systems, Inc. is included in Item 14(d):
Schedule VIII - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
Schedule VIII - Valuation and Qualifying Accounts
Span-America Medical Systems, Inc.