MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Varitronic Systems, Inc.

RESULTS OF OPERATIONS
The following table sets forth selected information derived from the
Consolidated Statements of Operations.

Year Ended July 31, 1995 1994 1993

Net sales 100.0% 100.0% 100.0%
Cost of sales 67.5 61.0 60.6
Gross margin 32.5 39.0 39.4

Operating expenses:
Marketing and sales 14.1 15.0 15.2
General and administrative 11.4 13.2 13.2
Product development 5.1 5.0 3.0
Total operating expenses 30.6 33.2 31.4
Income from operations 1.9 5.8 8.0
Other (expense) income, net (0.7) (0.2) 0.7
Income before income taxes 1.2 5.6 8.7
Provision for income taxes 0.1 1.8 2.9
Net income 1.1% 3.8% 5.8%

In the fourth quarter of fiscal 1995, the Company recorded a charge to earnings
of $1,647,000 for asset valuation allowances and a reduction in work force. This
charge had a negative effect on gross margin, and increased general and
administrative expenses and marketing and sales expenses. See further discussion
regarding this charge below.

NET SALES: FISCAL 1995 VERSUS FISCAL 1994 Net sales in fiscal 1995 increased by
$4,707,000 or 10.5 percent from fiscal 1994 due to continued strong sales of the
EasyStep(R) 4000 and PosterPrinter(R) product lines. Sales of the EasyStep 4000
Label and Sign Maker product line increased by 46.0 percent over fiscal 1994
while sales of the PosterPrinter product line increased by 18.2 percent in that
same period. These two product lines represented over 66 percent of total net
sales in fiscal 1995 compared to 56 percent of total net sales in fiscal 1994.
The successful launch of the EasyStep(R) 2500/ProPartner(R) product line in
December 1994 also contributed to increased net sales. The VintageColor(TM)
graphics printing system, which was introduced late in the fourth quarter of
fiscal 1995, is a wide format, full-color printing system which produces output
in 24 or 36 inch widths up to 100 feet long. The VintageColor system includes an
inkjet printer, raster image processor software and other options including a
pre-configured color server, color calibrated scanners and a variety of print
media and inks. Sales of this product line were approximately $225,000 in fiscal
1995. The Company does not expect significant revenue in fiscal 1996 from the
VintageColor product line. Sales of the Company's mature product lines,
consisting primarily of sales of consumable supplies, decreased by 28.6 percent
from the previous fiscal year. The Company expects this trend to continue in
fiscal 1996.

Machine sales increased by 16.2 percent from the prior fiscal year. Sales of
the PosterPrinter and EasyStep 2500/ProPartner machines comprised the majority
of this increase. Sales of consumable supplies increased by 8.5 percent from
fiscal 1994. Increased sales of EasyStep 4000 and PosterPrinter supplies, and
initial sales of EasyStep 2500/ProPartner supplies offset the decrease in sales
of supplies used with older labeling and lettering systems. International sales
increased by $2,416,000 or 24.0 percent from the prior year due to increased
sales of the EasyStep 4000 and PosterPrinter product lines. International sales
represented 25.2 percent of current year sales compared with 22.5 percent in the
previous year.

The sales forecast for fiscal 1996 does not include the introduction of a
major new product but includes line extensions for two of the current machines
and a full year of sales of the EasyStep 2500/ProPartner and the VintageColor
product lines. In addition, fiscal 1996 revenues will include the benefit of
recently announced price increases for various products.

FISCAL 1994 VERSUS FISCAL 1993 Net sales in fiscal 1994 decreased
by $605,000 or 1.3 percent from fiscal 1993 due to a 10.5 percent decrease in
machine sales. Declining sales of mature lettering products were not offset by
anticipated sales of the EasyStep 2500/ProPartner product line due to
production-related issues which delayed the product launch into fiscal 1995.

Sales of the EasyStep 4000 product line increased by 51.3 percent over fiscal
1993. Fiscal 1993 net sales included only ten months of sales since the product
was launched in October 1992. Sales of the PosterPrinter product line increased
slightly in fiscal 1994 due to the second quarter introduction of the third
generation PosterPrinter, the ProImage(R). Overall, sales of mature thermal
lettering and labeling products declined by 21.2 percent in fiscal 1994 compared
to fiscal 1993.

Consumable supply sales increased by 4.1 percent. Increased sales of supplies
used with the PosterPrinter and EasyStep 4000 machines were offset by decreased
sales of supplies used with older labeling and lettering systems. International
sales decreased by $680,000 or 6.3 percent from the prior year due to decreased
sales of the mature products noted above, and represented 22.5 percent of fiscal
1994 net sales compared with 23.7 percent in fiscal 1993.

GROSS MARGIN: FISCAL 1995 VERSUS FISCAL 1994 Gross margin decreased from 39.0
percent in fiscal 1994 to 32.5 percent in fiscal 1995. Fiscal 1995 included an
inventory valuation charge of $1,270,000 (2.6% negative margin points) to cover
inventory that was obsolete, slow-moving or outside of current quality
specifications. Additional factors which contributed to the decline in gross
margin include the continued rising cost of imported inventory, an increase in
production costs, and the continuing decline in sales of high-margin mature
supply products. The cost of imported inventory continued to increase throughout
the year as the value of the dollar declined against the Japanese yen.
PosterPrinter machines and supplies, and supplies used in certain lettering
machines are imported from Japan and are purchased with Japanese yen. Although
the Company hedges these foreign purchases using forward exchange contracts, the
decline in the value of the dollar continued to have an adverse effect on gross
margins during the fiscal year. Production costs increased due to the Company's
investment in additional personnel and equipment to expand in-house
manufacturing capabilities. Expanded product testing and quality assurance
processes also added to the increase in production costs.

Although the Company has taken steps to improve production efficiency and has
increased prices on the majority of its products, gross margin is not expected
to improve in fiscal 1996 over fiscal 1995. Even though the dollar has begun to
strengthen against the yen, the Company has inventory and purchase commitments
for foreign sourced product which was purchased and/or hedged at a weaker
dollar. This more costly inventory will continue to impact margins beyond the
first half of fiscal 1996. Additionally, continued anticipated declines in sales
of high-margin mature supply products will impact 1996 gross margins.

FISCAL 1994 VERSUS FISCAL 1993 Gross margin decreased from 39.4 percent in
fiscal 1993 to 39.0 percent in fiscal 1994. Consumable supply margins decreased
due to the increased cost of imported supplies for the PosterPrinter and certain
lettering machines. Additionally, increased sales of lower margin supplies used
with the Company's newer machines also reduced overall supply margins. Machine
gross margins improved due to higher gross margins on machines currently being
sold compared to the lower margin mature lettering and labeling machines sold in
fiscal 1993.

OPERATING EXPENSES: FISCAL 1995 VERSUS FISCAL 1994 Total operating expenses for
fiscal 1995 increased by $256,000 or 1.7 percent from fiscal 1994. The increase
in marketing and sales expenses was due to the launch of the VintageColor
printing system. In addition, $255,000 of the fourth quarter charge was recorded
in marketing and sales expenses to reflect a decrease in the value of certain
assets supporting the VintageColor product line. General and administrative
expenses decreased by $275,000. Fiscal 1995 included a $247,000 charge for the
reduction in work force. Fiscal 1994 included $341,000 in bad debt expense
principally due to the bankruptcy filing of one independent domestic dealer and
$250,000 in acquisition related costs. Product development expenses increased by
$281,000 compared to fiscal 1994, primarily due to final development of the
EasyStep 2500/ProPartner machine, in-house supply development projects, and
software development for the VintageColor printing system. The Company expects
that overall operating expenses for fiscal 1996 will be below fiscal 1995 levels
due to the reduction in work force and other decreases in planned operating
expenses.

FISCAL 1994 VERSUS FISCAL 1993 Total operating expenses for fiscal 1994
increased by $619,000 or 4.3 percent from fiscal 1993. General and
administrative expenses for 1994 included $341,000 in bad debt expense and
$250,000 of costs incurred in connection with acquisition discussions with Kroy,
Inc. Other general and administrative expenses decreased by $665,000 due to a
reduction in outside professional fees and certain compensation expenses. The
increase in product development expense of $857,000 was due to the development
efforts on the EasyStep 2500/ProPartner product line. Marketing and sales
expenses decreased by $165,000 due to a decrease in promotional spending.

OTHER (EXPENSE) INCOME, NET: Other expense was $313,000 in fiscal 1995 and
$90,000 in fiscal 1994 compared to other income of $334,000 in fiscal 1993.
Other expense in fiscal 1995 and 1994 consisted principally of interest expense
on borrowings under the line of credit. Other income in fiscal 1993 included
gains of $392,000 realized on the sale of Insignia Systems, Inc. common stock.

INCOME TAXES: The Company's effective income tax rates were 12.1 percent in
fiscal 1995, 32.1 percent in fiscal 1994 and 33.6 percent in fiscal 1993. As a
result of the lower level of pre-tax income, the current year's effective income
tax rate includes greater benefits realized from the Company's foreign sales
corporation and from research and experimentation tax credits. The research and
experimentation tax credit expired June 30, 1995. If the credit is not
reinstated, the Company's effective tax rate for fiscal 1996 will not include
this benefit.

INFLATION: To date, inflation has not had a material effect on the Company's
operations.

LIQUIDITY AND CAPITAL RESOURCES
FINANCIAL POSITION: The Company continues to maintain a strong financial
position. Cash provided by operating activities was $2,917,000 in fiscal 1995,
$3,287,000 in fiscal 1994 and $1,438,000 in fiscal 1993. In fiscal 1995 cash
provided by operating activities included $543,000 of net income and $3,168,000
of non-cash expenses. Working capital was $17,366,000 at July 31, 1995 and
$14,466,000 at July 31, 1994. The current ratio was 4.1 to 1.0 at July 31, 1995
and 3.0 to 1.0 at July 31, 1994. The improvement in the current ratio and
working capital as of July 31, 1995 was due to a restructuring of the Company's
$10,000,000 unsecured bank line of credit to a $6,000,000 unsecured line of
credit and a $4,000,000 term loan with varying principal installments due
through July 31, 1999. As of July 31, 1995, $3,300,000 of the term loan was
classified as long-term debt.

The Company believes cash from operations as well as its line of credit
facility will be adequate to meet its operational, capital expenditure and share
repurchase needs for at least the next 12 months.

CAPITAL EXPENDITURES: The Company expended $2,074,000 for capital additions
during fiscal 1995, compared with $2,365,000 and $1,862,000 in fiscal 1994 and
fiscal 1993, respectively. Approximately $850,000 of fiscal 1995 capital
additions were for computer hardware, and approximately $470,000 was for
leasehold improvements and furniture and fixtures for the Company's additional
facility leased in fiscal 1995. Budgeted capital additions for fiscal 1996 total
approximately $1,100,000.

SHARE REPURCHASE PROGRAM: Since fiscal 1990, the Company's Board of Directors
has approved resolutions authorizing the Company to repurchase up to 3,800,000
of its common shares outstanding. The Company repurchased 111,500 shares at a
total cost of $921,969 during fiscal 1995. There were 300,000 shares authorized
for repurchase as of July 31, 1995.

LINE OF CREDIT: The Company maintains an unsecured $6,000,000 bank line of
credit for working capital and other corporate purposes. During fiscal 1995,
borrowings under the line of credit reached a high of $5,200,000.

REPORT OF MANAGEMENT
Varitronic Systems, Inc.

The management of Varitronic Systems, Inc. is responsible for the integrity of
the information contained in the annual report including the consolidated
financial statements. These statements have been prepared in conformity with
generally accepted accounting principles appropriate to the circumstances of the
Company and include amounts based on estimates and judgments of management.

The Company maintains internal accounting controls designed to provide
reasonable assurance that the financial records are accurate, that the assets of
the Company are safeguarded, and that the financial statements present fairly
the consolidated financial position and consolidated results of operations and
cash flows of the Company. The Company's independent accountants, Coopers &
Lybrand L.L.P., have considered the Company's internal control structure to the
extent they deemed necessary in expressing an opinion on the consolidated
financial statements.

The Audit Committee of the Board of Directors, which consists of three
outside directors, reviews the scope of the audit and the findings of the
Company's independent accountants. The Audit Committee meets periodically with
the independent accountants to review accounting, auditing and financial
reporting matters.

Coopers & Lybrand L.L.P. has audited the consolidated financial statements
prepared by management. The report of our independent accountants appears
herein.

/s/ Scott F. Drill
Scott F. Drill
Chairman, President and Chief Executive Officer

/s/ Norbert F. Nicpon
Norbert F. Nicpon
Vice President of Finance and Chief Financial Officer

SELECTED FINANCIAL DATA
Varitronic Systems, Inc.
1995 1994 1993 1992 1991
Year Ended July 31,

INCOME STATEMENT
Net sales ............................ $49,525 $44,819 $45,423 $36,094 $39,165
Income from operations ............... 931 2,580 3,612 1,691 4,446
Net income ........................... 543 1,690 2,621 1,452 2,913
Weighted average common shares ....... 2,321 2,615 2,781 3,356 3,651

BALANCE SHEET
Working capital ...................... $17,366 $14,466 $16,455 $16,593 $20,297
Property and equipment, net .......... 4,514 4,264 3,109 2,777 1,672
Total assets ......................... 27,565 25,940 24,037 22,351 25,355
Long-term debt ....................... 3,300 -- -- -- --
Stockholders' equity ................. 18,580 18,731 19,563 19,469 22,494

PER COMMON SHARE
Net income ........................... $ .23 $ .65 $ .94 $ .43 $ .80
Book value ........................... 7.98 7.78 7.37 6.47 6.11
Dividends declared ................... -- -- -- -- --

SIGNIFICANT RATIOS/OTHER
Return on net sales .................. 1.1% 3.8% 5.8% 4.0% 7.4%
Return on average assets ............. 2.0% 6.8% 11.3% 6.1% 12.2%
Return on average stockholders' equity 2.9% 8.8% 13.4% 6.9% 13.9%
Current ratio ........................ 4.1 3.0 4.7 6.8 8.1
Number of employees .................. 280 245 231 209 217

(Amounts in thousands, except per common share and ratio amounts,
and number of employees)

CONSOLIDATED STATEMENTS OF OPERATIONS
Varitronic Systems, Inc.
1995 1994 1993

Year Ended July 31,
Net sales ................................ $ 49,525,329 $ 44,818,582 $ 45,423,143
Cost of sales ............................ 33,456,920 27,357,819 27,549,116
Gross margin ................... 16,068,409 17,460,763 17,874,027

Operating expenses:
Marketing and sales ................. 6,974,971 6,724,866 6,889,721
General and administrative .......... 5,634,215 5,908,771 5,982,307
Product development ................. 2,528,200 2,247,355 1,390,447
Total operating expenses ....... 15,137,386 14,880,992 14,262,475
Income from operations ......... 931,023 2,579,771 3,611,552

Gain on sale of investment ............... -- -- 391,898
Interest expense, net .................... (313,078) (89,991) (57,539)
Income before income taxes ..... 617,945 2,489,780 3,945,911

Provision for income taxes ............... 75,000 800,000 1,325,000
Net income ..................... $ 542,945 $ 1,689,780 $ 2,620,911

Net income per common share .............. $ .23 $ .65 $ .94
Weighted average common shares outstanding 2,321,000 2,615,000 2,781,000

The accompanying notes are an integral part of the consolidated financial
statements.

CONSOLIDATED BALANCE SHEETS
Varitronic Systems, Inc.
1995 1994

July 31,
ASSETS
Current assets:
Cash ............................................................ $ 1,347,139 $ 209,844
Accounts receivable, net ........................................ 9,058,870 8,902,523
Inventories ..................................................... 11,327,130 11,736,803
Deferred income taxes ........................................... 830,000 520,000
Other current assets ............................................ 487,892 306,322
Total current assets ........................................ 23,051,031 21,675,492
Property and equipment, net .......................................... 4,513,837 4,264,098
Total assets ................................................ $27,564,868 $25,939,590

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................ $ 3,918,169 $ 2,992,734
Accrued liabilities ............................................. 1,066,511 1,216,335
Current maturities on long-term debt ............................ 700,000 --
Borrowings under line of credit ................................. -- 3,000,000
Total current liabilities ................................... 5,684,680 7,209,069
Long-term debt, less current maturities .............................. 3,300,000 --
Commitments
Stockholders' equity:
Common stock, $.01 par value, 10,000,000 shares
authorized; 2,328,153 and 2,408,123 shares
issued and outstanding .......................................... 23,281 24,081
Additional paid-in capital ...................................... 228,376 --
Retained earnings ............................................... 18,328,531 18,706,440
Total stockholders' equity .................................. 18,580,188 18,730,521
Total liabilities and stockholders' equity .................. $27,564,868 $25,939,590

The accompanying notes are an integral part of the consolidated financial
statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS
Varitronic Systems, Inc.

1995 1994 1993
Year Ended July 31,
OPERATING ACTIVITIES

Net income .............................................. $ 542,945 $ 1,689,780 $ 2,620,911
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization ...................... 1,824,371 1,209,180 1,583,297
Provision for uncollectible accounts receivable .... 73,866 340,553 7,550
Provision for inventory valuation allowance ........ 1,270,000 175,000 325,000
Deferred income taxes .............................. (310,000) (110,000) 70,000
Other .............................................. 12,000 25,000 110,625
Changes in operating assets and liabilities:
Accounts receivable ............................ (230,213) (110,838) (2,705,427)
Inventories .................................... (860,327) (1,210,584) (938,321)
Other current assets ........................... (181,570) 43,621 273,254
Accounts payable ............................... 925,435 1,105,556 (331,559)
Accrued liabilities ............................ (149,824) 130,019 422,633
Net cash provided by operating activities ...... 2,916,683 3,287,287 1,437,963

INVESTING ACTIVITIES
Additions to property and equipment ..................... (2,074,110) (2,364,765) (1,862,228)
Other ................................................... -- -- 142,733
Net cash used by investing activities .......... (2,074,110) (2,364,765) (1,719,495)

FINANCING ACTIVITIES
Repayments under line of credit ......................... (8,600,000) (4,000,000) (4,500,000)
Borrowings under line of credit ......................... 5,600,000 5,500,000 6,000,000
Proceeds from long-term debt ............................ 4,000,000 -- --
Repurchases of common stock ............................. (921,969) (2,710,688) (3,039,639)
Proceeds from sale of common stock under incentive
stock option plan and employee stock purchase plan ...... 216,691 163,282 410,357
Net cash provided (used) by financing activities 294,722 (1,047,406) (1,129,282)
Net increase (decrease) in cash ......................... 1,137,295 (124,884) (1,410,814)
Cash at beginning of year .......................... 209,844 334,728 1,745,542
Cash at end of year ................................ $ 1,347,139 $ 209,844 $ 334,728

SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid during the year for interest .................. $ 323,000 $ 81,000 $ 66,000
Cash paid during the year for income taxes .............. $ 836,000 $ 441,000 $ 1,141,000

The accompanying notes are an integral part of the consolidated financial
statements.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Varitronic Systems, Inc.
Additional
Common Stock Paid-In Retained
Shares Amount Capital Earnings

BALANCE, JULY 31, 1992........................... 3,011,227 $ 30,112 -- $ 19,438,406
Stock options exercised.......................... 55,400 554 $ 334,296
Common stock issued through
employee stock purchase plan..................... 15,441 155 75,352
Income tax benefit from exercise of stock options 103,000
Repurchases of common stock...................... (427,300) (4,273) (497,721) (2,537,645)
Net income....................................... 2,620,911

BALANCE, JULY 31, 1993........................... 2,654,768 26,548 14,927 19,521,672
Stock options exercised.......................... 9,267 92 60,070
Common stock issued through
employee stock purchase plan..................... 21,088 211 102,909
Income tax benefit from exercise of stock options 25,000
Repurchases of common stock...................... (277,000) (2,770) (202,906) (2,505,012)
Net income....................................... 1,698,780

BALANCE, JULY 31, 1994........................... 2,408,123 24,081 -- 18,706,440
Repurchases of common stock...................... (111,500) (1,115) (920,854)
Stock options exercised to purchase 20,166
shares of common stock, less 6,038, shares
exchanged as payment and subsequently retired.... 14,128 141 83,425
Common stock issued through
employee stock purchase plan..................... 17,402 174 132,951
Income tax benefit from exercise of stock options 12,000
Net income....................................... 542,945

BALANCE, JULY 31, 1995........................... 2,328,153 $ 23,281 $ 228,376 $ 18,328,531

The accompanying notes are an integral part of the consolidated financial
statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Varitronic Systems, Inc.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS DESCRIPTION: Varitronic Systems, Inc. (the Company) develops,
manufactures and markets labeling and presentation products which enhance the
quality, professionalism and effectiveness of a wide range of communications.
The Company sells its products to independent domestic dealers and domestic
private label and international distributors.

PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.

INVENTORIES: Inventories are stated at the lower of standard cost (which
approximates first-in, first-out cost) or market.

PROPERTY AND EQUIPMENT: Depreciation and amortization of property and equipment
is recorded using the straight-line method over the shorter of the estimated
useful asset lives of generally five years, or lease terms for leasehold
improvements. The cost of specialized tooling is capitalized and depreciated
using the straight-line method over the estimated life of the related product
which is generally two to four years.

INCOME TAXES: Deferred income taxes are recorded to reflect the tax consequences
in future years of differences between the financial reporting and income tax
bases of assets and liabilities using enacted tax laws and statutory rates.
Income tax expense is the sum of the tax currently payable and the change in
deferred taxes during the period.

ADVERTISING EXPENSE: The costs of advertising are expensed as incurred.
Advertising expense of $1,142,000, $1,050,000, and $1,170,000 was incurred for
the years ended July 31, 1995, 1994, and 1993, respectively.

FOREIGN EXCHANGE CONTRACTS: The Company enters into foreign exchange contracts
to hedge inventory purchase commitments which are denominated in Japanese yen.
These contracts are accounted for as hedging transactions. Gains or losses on
the contracts are deferred and are recognized in cost of sales when the
inventory purchased with the contract yen is sold. As of July 31, 1995, the
Company had outstanding foreign currency contracts with a face amount of
$4,357,000, and a fair value of $4,233,000, based on the closing currency rate
at July 31, 1995.

REVENUE RECOGNITION: The Company recognizes revenue upon shipment of product.

NET INCOME PER COMMON SHARE: Net income per common share is based on the
weighted average number of common shares outstanding during each period. Common
stock equivalents did not have a dilutive effect on net income per common share
during each of the past three fiscal years.

USE OF ESTIMATES: The preparation of the Company's financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that effect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities, and the
reported amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates.

2. OTHER FINANCIAL STATEMENT DATA
The following provides additional disclosures for selected information from the
consolidated balance sheets and consolidated statements of operations.

July 31, 1995 1994

ACCOUNTS RECEIVABLE:
Trade receivables ............ $ 9,408,870 $ 9,352,523
Less allowances for doubtful
accounts and dealer
program credits .............. (350,000) (450,000)
$ 9,058,870 $ 8,902,523
Inventories:
Finished goods ............... $ 5,237,054 $ 4,935,609
Raw materials and
component parts .............. 7,785,076 7,476,194
13,022,130 12,411,803
Less valuation allowance ..... (1,695,000) (675,000)
$ 11,327,130 $ 11,736,803
PROPERTY AND EQUIPMENT,
AT COST:
Tooling and production
equipment .................... $ 5,123,822 $ 4,757,176
Office furniture and data
processing equipment ......... 4,141,811 2,767,282
Other equipment .............. 862,934 819,981
Leasehold improvements ....... 997,480 707,498
11,126,047 9,051,937
Less accumulated depreciation
and amortization ............. (6,612,210) (4,787,839)
$ 4,513,837 $ 4,264,098
Accrued liabilities:
Accrued compensation,
including termination benefits $ 533,365 $ 190,699
Accrued vacation ............. 307,634 269,525
Other ........................ 225,512 756,111
$ 1,066,511 $ 1,216,335

3. REVOLVING CREDIT AGREEMENT AND LONG-TERM DEBT
During fiscal 1995, the Company restructured its $10,000,000 unsecured bank line
of credit to a $6,000,000 unsecured line of credit and a $4,000,000 unsecured
term loan.

REVOLVING CREDIT AGREEMENT: The Company has available an unsecured bank line of
credit in the maximum amount of $6,000,000 through December 1996. Borrowings
bear interest at the bank's base rate, which was 8.75% at July 31, 1995. The
Company is obligated to pay an annual commitment fee of .125% on the total bank
line. Restrictive covenants under this agreement include, among others,
requirements to not exceed a debt to net worth ratio of 1:1, and to maintain a
minimum amount of tangible net worth. In addition, the Company cannot pay
dividends on its common stock, and has limits on the amount of purchases of
Company stock under the share repurchase program. The Company also has available
a letter of credit commitment of $5,000,000 under the line of credit agreement.
As of July 31, 1995, letters of credit outstanding were $2,776,000. Letters of
credit outstanding were $2,730,000 at July 31, 1994.

LONG-TERM DEBT: The term loan has varying quarterly principal installments
ranging from $150,000 during fiscal 1996 to $300,000 during fiscal 1999. Fixed
and variable interest rate options are available under the terms of this debt
agreement. The interest rate was 8.03% at July 31, 1995 and was fixed through
October 31, 1995.

Maturities on long-term debt are as follows:

Year Ending July 31,

1996.................................... $ 700,000
1997.................................... 1,000,000
1998.................................... 1,100,000
1999.................................... 1,200,000

4. EMPLOYEE BENEFIT PLANS
STOCK OPTIONS: In fiscal 1995, the Company adopted the 1994 Incentive Stock
Option Plan which replaced the Restated Incentive Stock Option Plan, and
reserved 100,000 shares of common stock for issuance under the new plan. Options
granted under the previous plan are exercisable through 1998. Options are
granted at prices equal to fair market value on the date of grant and become
exercisable on a cumulative basis over a three-year period from the date of
grant. As of July 31, 1995, 47,831 options were exercisable.

A summary of changes in outstanding stock options under the plans is as follows:

Options Price
Outstanding Per Share
Balance, July 31, 1992 104,000 $5.00 to $20.25

Canceled (10,000) 6.50 to 20.25
Granted 23,000 5.63 to 8.75
Exercised (55,400) 5.00 to 6.75
Balance, July 31, 1993 61,600 5.63 to 8.75

Canceled (4,000) 9.00
Granted 108,000 9.00 to 9.90
Exercised (9,267) 5.63 to 6.75
Balance, July 31, 1994 156,333 5.63 to 9.90

Canceled (14,000) 6.25 to 9.00
Granted 4,000 9.25
Exercised (20,166) 6.50 to 9.00
Balance, July 31, 1995 126,167 5.63 to 9.90

In fiscal 1995, the Company granted nonqualified options to an officer to
purchase 75,000 shares of common stock at an exercise price of $7.75 per share.
These options become exercisable equally over a three-year period from the date
of the grant. None of these options are currently exercisable.

401(k) PROFIT-SHARING: The Company sponsors the Incentive Plus Plan, a defined
contribution profit-sharing plan, which qualifies under Section 401(k) of the
Internal Revenue Code and covers employees who meet certain age and service
requirements. At the discretion of the Board of Directors, the Company may make
matching contributions up to an amount equal to 50 percent of the contributions
made by each employee, subject to a maximum matching contribution for each
employee of three percent of compensation. For the years ended July 31, 1994 and
1993, $188,000 and $155,000, respectively, was charged to earnings for
contributions to the plan. No matching contribution was made to the plan for the
year ended July 31, 1995.

STOCK PURCHASE PLAN: The Company's Employee Stock Purchase Plan allows
participating employees to contribute 3 to 10 percent of their base salary to
purchase up to 500 shares per year of common stock. The shares are generally
issued by the Company at a price equal to 15% less than the lower of the closing
market price on the first or last day of the plan year. During fiscal 1995, the
Company increased the number of shares reserved for future issuance under the
plan by 75,000 bringing the total reserved shares to 83,086 as of July 31, 1995.

5. OPERATING LEASES
The Company leases office and plant facilities, and automobiles under operating
leases. The facility leases expire in fiscal 1997 and fiscal 1998, have renewal
options of four to ten years and include an allocation of real estate taxes and
other operating expenses.

Estimated future minimum lease payments under noncancelable operating leases
as of July 31, 1995 are as follows:

Year Ending July 31,

1996.................................... $ 944,000
1997.................................... 782,000
1998.................................... 524,000
1999.................................... 16,000
$2,266,000

Rent expense of $898,000, $908,000 and $880,000 was incurred for the years ended
July 31, 1995, 1994 and 1993, respectively.

6. STOCKHOLDERS' EQUITY
COMMON STOCK REPURCHASE: As of July 31, 1995, there were 300,000 shares
remaining for repurchase under Board of Director authorizations.

PREFERRED STOCK: Authorized capital includes 1,000,000 shares of preferred stock
having a par value of $.01 per share with undesignated rights. None of these
preferred shares have been issued.

7. SIGNIFICANT CUSTOMERS AND EXPORT SALES
Sales to one major customer amounted to 20% and 13% of fiscal 1995 and fiscal
1994 net sales, respectively. In fiscal 1993, sales to another major customer
were 11% of net sales.

The Company has no significant foreign operations. Export sales, primarily to
Europe, comprised approximately 25%, 23% and 24% of consolidated fiscal 1995,
1994 and 1993 net sales, respectively.

8. INCOME TAXES
The components of the provision for income taxes are as follows:

Year Ended July 31, 1995 1994 1993

Currently payable:
Federal ... $ 365,000 $ 860,000 $ 1,180,000
State ..... 20,000 50,000 75,000
Deferred ....... (310,000) (110,000) 70,000
$ 75,000 $ 800,000 $ 1,325,000

The approximate tax effects of temporary differences are as follows:

July 31, 1995 1994

Inventories ............. $ 735,000 $ 333,000
Excess of tax over
book depreciation ....... (183,000) (83,000)
Accounts receivable ..... 164,000 161,000
Accrued vacation ........ 72,000 61,000
Other ................... 42,000 48,000
Total .............. $ 830,000 $ 520,000

The reconciliation of the federal statutory rate to the effective income tax
rate is as follows:

Year Ended July 31, 1995 1994 1993

Federal income tax at statutory rate ..... 34.0% 34.0% 34.0%
Benefit of foreign sales corporation ..... (15.7) (2.3) (1.2)
Research and experimentation
tax credit ............................... (9.3) (1.5) (.7)
State income taxes, net
of federal benefit ....................... -- .4 1.3
Other .................................... 3.1 1.5 .2
Effective tax rate .................. 12.1% 32.1% 33.6%

9. FOURTH QUARTER PLAN OF TERMINATION AND OTHER ADJUSTMENTS
The Company recorded a charge to earnings of $1,647,000 in the fourth quarter of
fiscal 1995. The Company terminated 42 full-time employees in August 1995
pursuant to a plan of termination in place as of July 31, 1995, and recorded a
related charge of $247,000 in general and administrative expenses. A charge of
$1,145,000 was recorded in cost of sales to increase inventory valuation
reserves, and $255,000 was recorded in marketing and sales expenses to reflect a
decrease in the value of certain assets which support a product introduced for
sale during fiscal 1995. In the fourth quarter, the Company reversed charges
accrued earlier in the 1995 fiscal year of $162,000 for the Company's
discretionary matching portion to its defined contribution 401(k) profit-sharing
plan.

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
Varitronic Systems, Inc.:

We have audited the accompanying consolidated balance sheets of Varitronic
Systems, Inc. as of July 31, 1995 and 1994, and the related consolidated
statements of operations, cash flows and stockholders' equity for each of the
three years in the period ended July 31, 1995. 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 consolidated financial position of Varitronic
Systems, Inc. as of July 31, 1995 and 1994, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
July 31, 1995, in conformity with generally accepted accounting principles.

COOPERS & LYBRAND L.L.P.

Minneapolis, Minnesota
September 1, 1995

QUARTERLY FINANCIAL DATA
(Unaudited) Quarter Ended Quarter Ended Quarter Ended Quarter Ended
October 31 January 31 April 30 July 31

1995
Net sales ................. $ 11,858 $ 12,128 $ 12,332 $ 13,207
Gross margin .............. 4,420 4,439 4,244 2,965(1)
Net income (loss) ......... 574 702 238 (971)
Net income (loss) per share .25 .30 .10 (.42)

1994
Net sales ................. $ 11,003 $ 11,242 $ 11,064 $ 11,510
Gross margin .............. 4,386 4,269 4,234 4,572
Net income ................ 523 277 265 625
Net income per share ...... .20 .10 .10 .25

(In thousands, except per share amounts)

(1) See Note 9 to financial statements for further disclosure regarding fourth
quarter financial results.

DIRECTORS AND EXECUTIVE OFFICERS

DIRECTORS

SCOTT F. DRILL
Chairman, President, Chief
Executive Officer and Treasurer
Varitronic Systems, Inc.

ANTON J. CHRISTIANSON
Chairman
Cherry Tree Investments, Inc.

RAYMOND F. GOOD
Independent Executive
Consultant

DONALD J. KRAMER
Private Consultant

REID V. MACDONALD
President and Chief
Executive Officer
Faribault Foods, Inc.

JOHN B. ZAEPFEL
Investor and Consultant

EXECUTIVE OFFICERS

SCOTT F. DRILL
Chairman, President, Chief
Executive Officer and Treasurer

TIMOTHY P. FITZGERALD
Vice President of Operations

DAVID C. GREY
Vice President of Business
Development

ROGER A. LARSON
Vice President of Domestic
Sales and Marketing

KEVIN B. MCGOURTY
Vice President of Product
Planning

LYNN R. MCKEE
Vice President of Human
Resources

DEBORAH L. MOORE
Vice President of Corporate
Development and Secretary

MONTE J. MOSIMAN
Vice President of International
and OEM Sales

NORBERT F. NICPON
Vice President of Finance and
Administration and
Chief Financial Officer

COMMON STOCK AND CORPORATE INFORMATION

STOCK LISTING
Varitronic Systems, Inc. common stock is traded on The Nasdaq Stock Market under
the symbol VRSY. As of October 3, 1995, there were 232 holders of record of the
Company's common stock and in excess of 1,500 beneficial owners.

The following table sets forth the high and low prices for trades of VRSY
common stock as reported by Nasdaq for the years ended July 31, 1995 and 1994:

1995 1994
High Low High Low

First Quarter ...... $ 9.00 $ 7.75 $ 14.00 $ 8.25
Second Quarter ..... 10.00 7.75 15.00 9.75
Third Quarter ...... 14.00 9.00 10.75 7.75
Fourth Quarter ..... 13.00 8.75 10.00 6.75

DIVIDEND POLICY
The Company has never paid cash dividends on its common stock. The Board of
Directors presently intends to retain all earnings for use in the Company's
business. Under the existing bank line of credit, the Company cannot pay cash
dividends on its common stock.

TRANSFER AGENT
AND REGISTRAR
Norwest Bank Minnesota, N.A.
Stock Transfer Department
P.O. Box 738
South St. Paul, MN
55075-0738
800/468-9716

LEGAL COUNSEL
Best & Flanagan
4000 First Bank Place
601 Second Avenue South
Minneapolis, MN 55402-4331

INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P.
650 Third Avenue South
Minneapolis, MN 55402-4333

ANNUAL MEETING
The annual meeting of shareholders will be held on Friday, December 1, 1995 at
9:30 a.m. local time at the Hotel Sofitel, located at 5601 West 78th Street,
Bloomington, Minnesota.

FORM 10-K
A copy of the Company's Form 10-K filed may be obtained without charge by
writing to:

Varitronic Systems, Inc.
Investor Relations
300 Interchange North
300 Highway 169 South
Minneapolis, MN 55426