VERSUS TECHNOLOGY INC, ARS, 1997-04-01

VERSUS TECHNOLOGY INC
ARS, 1997-04-01
COMMUNICATIONS EQUIPMENT, NEC

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<PAGE> 1

C O N T E N T S

Message from the President and CEO . . . . . . . . . . . 1

Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . .3

Consolidated Financial Statements. . . . . . . . . . . .7

Notes to Consolidated Financial Statements. . . . . . . . . .12

Independent Auditors' Report . . . . . . . . . . . . .22

Market for Common Equity and Related Stockholder Matters. . . . . .23

Directors, Officers and General Information . . . . . . . . .24

B U S I N E S S O F V E R S U S T E C H N O L O G Y, I N C.

Versus Technology, Inc. develops and markets products using infrared technology
for the health care industry and other markets located throughout North
America. These products permit the instantaneous identification and tracking
of the location of people and equipment, can be used to control access and
permit instantaneous two-way communication.

Olmsted Engineering Company, a wholly-owned subsidiary, writes and maintains
complex programs for the CAD/CAM industry. It sells its own software under the
ACU.CARV(R) name, resells third party software, and provides systems support
services throughout North America.

<PAGE> 2

Dear Shareholders:

Fiscal year 1996 was a year of exciting change for your Company. We
successfully acquired Olmsted Engineering Co. ("Olmsted"), a business that will
have a positive impact on our future sales and profitability; we raised the
required capital to mount a full-scale product launch of our flagship product
(infrared tracking); and we signed an exclusive marketing agreement with
Marquette Electronics, Inc. ("Marquette").

Olmsted is a successful operating company, and our acquisition provides us with
increased annual sales and very high margin. Along with these sales, we gained
an experienced engineering development team and expanded product line. By
doing so, we reduced Versus' reliance on a single product group and achieved a
head start on our 1997 sales goals.

Olmsted is a mature entity which has designed and sold manufacturing software
solutions (ACU.CARV(R)) and support services throughout North America for the
past 20 years. It provides positive cash flow and a high gross profit due to
low reproduction costs of software. In addition, the entire infrared product
line was based on developments taken from the Olmsted source code library. We
now have control over the entire source code library. The scope of this
library will provide the basis for future product enhancements and
significantly reduce development time for new products. Additionally, the
engineering team that developed, tested, and built the initial infrared system
remains intact within the new organization.

Olmsted was acquired with minimal cash through an exchange of approximately 6.4
million shares of Versus common stock.

On August 26, 1996, we completed a private placement of 11,335,000 shares of
common stock, netting proceeds of approximately $5,201,000. While securing
these funds, we caught the eye of Merrill Lynch Special Value Fund, Inc., who,
through this investment, became one of the major shareholders of Versus.

The proceeds from the 1996 private placement allowed us to complete our
positioning for our 1997 launch of the infrared product line and will provide
working capital for further development of the infrared tracking system.

A major step forward in our infrared market launch was reached in the signing
of Marquette as an exclusive distributor with firm commitments over a
three-year period to maintain their exclusivity.

Marquette is a $500 million company focusing on medical applications with a
successful national sales force in place. Marquette is also a leading designer
and manufacturer of medical electronic equipment and clinical information
systems for the diagnosis and monitoring of patients requiring critical care.

Under the terms of the agreement, Marquette receives the exclusive rights to
distribute and supply our infrared tracking system for personnel and equipment
tracking to acute care hospitals located in the United States. The exclusivity
is limited to the "main headquarters building of any acute care hospital
located in the 50 states of the United States of America;" however, Marquette
maintains non-exclusive rights in other markets. In return, we receive from
Marquette minimum annual purchase commitments over a three-year period. This
agreement gives us a solid relationship with a market leader in the health care
field. We are also working together on a broad range of new product
developments.

In late December of 1996, we moved to our new facility in Traverse City,
Michigan, which was specially designed to support our software products.

<PAGE> 3

Throughout fiscal year 1996, we had a firm commitment to continued development,
enhancement, and sale of our primary product, the infrared tracking system. By
the end of fiscal year 1996, we made sales of this product to such prestigious
health organizations as Baylor University Medical Center in Dallas, Texas, and
the VA Medical Center in Ann Arbor, Michigan.

Effective January 31, 1997, Versus signed an agreement with Precision Tracking
F.M., Inc., of Dallas, Texas, ("PTFM") to become a licensee of PTFM's patents
and intellectual properties related to infrared tracking technology. Subject
to certain existing PTFM license and supply agreements, Versus will become the
sole and exclusive PTFM licensee for a period of ten years, after which our
rights will become nonexclusive.

Under this agreement, PTFM desires to withdraw from its infrared technology
based products, and will work over the next twelve months to help assure a
complete technology transfer to Versus, coupled with a smooth transition to
Versus of infrared product manufacturing capabilities, ongoing distribution and
customer support activities previously provided by PTFM to its customers. PTFM
has previously been a supplier of infrared components of ours. In the future,
we will control component production and distribution.

We are very pleased with this agreement. Versus' infrared patents, especially
when combined with the PTFM patents, give us a significant base of proprietary
intellectual property from which to work. The agreement should also make a
solid contribution toward our goal of expanding the Versus product distribution
network, especially into markets outside the medical field. And, with the new
product enhancements we are working on, Versus' infrared tracking products will
continue to be the finest available, offering features and options other
products do not have.

In addition to the medical market for our infrared tracking products, we have
begun work on the next market launch into the governmental market. Trials are
under consideration at both a U.S. post office for payroll tracking and a
prison for corrections officer protection. This market is of a similar size to
the medical market but smaller than the professional market (professional
buildings and offices), which is intended to be launched in the next 18-24
months.

We have assembled a team with first-rate employees who are committed to the
success of your Company. These employees are owners of Versus and have a
personal interest in its growth and prosperity.

We are geared up and ready to go with a major launch of the infrared product
for fiscal year 1997. Our financing has been secured, the acquisition of
Olmsted Engineering Co. is complete, our team is in place and functioning well,
our move to our new headquarters is finished, and we are eager to position the
Company to achieve greater value for our shareholders.

Management appreciates the continued support of our shareholders as we look
forward to 1997.

Sincerely,

VERSUS TECHNOLOGY, INC.

/s/Gary T. Gaisser

Gary T. Gaisser
President and CEO

<PAGE> 4

MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following discussion and analysis focuses on the significant factors which
affected the Company's consolidated financial statements during fiscal year
1996, with comparisons to fiscal 1995 where appropriate. It also discusses the
Company's liquidity and capital resources. The discussion should be read in
conjunction with the consolidated financial statements and related notes.

The following table sets forth selected financial data for the Company for the
past two fiscal years:

(in thousands except per share amounts)
<TABLE>
<CAPTION>
Years Ended October 31, 1996 1995
- -----------------------------------------------------------------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales $ 348 $ 989
Net loss (2,006) (2,497)
Net loss per common share (.09) (.46)

Weighted average number of common
shares outstanding 21,860 5,450

BALANCE SHEET DATA:
Working capital $ 4,076 $ 1,157
Total assets 8,787 2,435
Total liabilities 1,266 1,361
Shareholders' equity 7,521 1,074
</TABLE>

OPERATING RESULTS

During fiscal 1996, the Company experienced a net loss of $2,006,000 compared
to a net loss of $2,497,000 for 1995. As discussed in more detail below, the
1996 loss is primarily attributable to low sales levels, combined with
relatively high operating expenses, experienced as the Company transitioned to
its new product line, IR Tracking systems. Net loss per share decreased from
$.46 in 1995 to $.09 in 1996. As indicated by the increased weighted average
number of shares disclosed above, these per share numbers were significantly
impacted by the significant number of additional shares issued during 1996 and
1995. Outstanding shares at October 31, 1996 totaled 36,543,573. This higher
level of outstanding shares will affect future per share calculations.
On August 26, 1996, the Company acquired Olmsted Engineering Co. ("Olmsted") in
exchange for 6,379,889 shares of the Company's common stock, valued for
accounting purposes at $.50 per share, and cash of $65,000, resulting in a
total purchase price of $3,255,000. For accounting

<PAGE> 5

purposes, the price of the acquisition was
determined based upon a contemporaneous sale of restricted common stock at $.50
per share. Olmsted's operating results have been included in the consolidated
results of operations since the date of acquisition and, as such, did not have
a significant impact on results for the year. Olmsted has served as the
Company's research and development consultant since 1994. The Company and its
Board of Directors believe the acquisition was critical to the continued
development and success of the IR Tracking system due to the long-term business
relationships that have been developed by Olmsted over the years, the solid
name recognition of Olmsted in the industry and the knowledge Olmsted gained as
a consultant to the Company when developing the IR Tracking system.

Net sales for fiscal 1996 were $348,000 or 65% below net sales of $989,000
reported for fiscal 1995. This decrease of $641,000 resulted primarily from
the sale of the DCX product line in fiscal 1995 and to the discontinuance of
sales of certain cellular products during fiscal 1996. Net sales related to
cellular products and services were approximately $157,000 in fiscal 1996, down
approximately $598,000 or 79% from $755,000 reported in fiscal 1995. Net sales
attributable to the DCX product line in 1995, prior to its sale, amounted to
approximately $586,000. The remaining 1996 security segment sales, amounting
to $89,000, were IR Tracking system sales. Fiscal year 1996 net sales also
include approximately $102,000 from sales of software and related services by
Olmsted, which was acquired by the Company in August 1996. This net sales
amount represented Olmsted's net sales from the acquisition date through
year-end. Had all Olmsted net sales for the 12 months ended October 31, 1996,
except intercompany sales to Versus, been included in 1996 net sales, total
Olmsted net sales would have been approximately $522,000.

The Company has continued development of its infrared products during fiscal
1996, focusing primarily upon infrared tracking systems which the Company
intends initially to market to the health care markets. The Company began
marketing infrared personnel/equipment tracking systems to health care
providers nationally in November 1996 under its marketing arrangement with
Marquette Electronics, Inc., as discussed below.

Cost of sales as a percentage of net sales for fiscal 1996 increased to 65%
from 51% in fiscal 1995. This increase is primarily due to temporary changes
in product mix concentrations in fiscal 1996. Cost of sales of infrared
product lines, as a percentage of net sales, are expected to be significantly
lower than total cost of sales as a percentage of net sales as reported for
fiscal 1996. Similarly, cost of sales of software and related services of
Olmsted are expected to be significantly less as a percentage of sales.

Selling, general and administrative expenses were reduced in fiscal 1996 by
approximately $420,000 or 22% from fiscal 1995. The decrease was primarily due
to the Company's continued downsizing of its sales, marketing and other
administrative functions during 1996 while it was preparing for market
introduction of its infrared tracking systems in November of 1996. Research
and development expenditures similarly were reduced by approximately $525,000
or 55% from fiscal 1995. That reduction was primarily the result of the
Company's completion of research and development associated with its existing
infrared tracking system product lines. Litigation defense costs, settlements
and judgments were reduced in fiscal 1996 by approximately $701,000 from fiscal
1995, largely as a result of the settlement of pending
litigation in August 1995. Substantially all costs associated with that
pending litigation were expensed by the Company in fiscal 1995.

<PAGE> 6

Interest income increased to $73,000 in fiscal 1996 from $17,000 in fiscal
1995, primarily due to the deposit of proceeds from the Company's private
placement of its common stock into interest bearing accounts in late fiscal
1996. Interest expense increased to $49,000 in fiscal 1996 from $19,000 in
fiscal 1995. This increase is primarily attributable to notes payable executed
by the Company in August 1995, which mature in January 1997. The reduction of
$815,000 of other income in fiscal 1996 from fiscal 1995 is due primarily to
the recognition in fiscal 1995 of the last installment of deferred gain
associated with the sale of a Company subsidiary in 1992, amounting to
$365,000, and the gain associated with the sale of the DCX product line in the
amount of $424,000.

For federal income tax purposes, the Company is in a net operating loss
carryforward position. As disclosed in more detail in Note 6 to the
consolidated financial statements, realization of gross deferred income tax
assets at October 31, 1996 is dependent upon generating sufficient taxable
income prior to expiration of the loss carryforwards and such loss
carryforwards are subject to certain tax law limitations. By recording a 100%
valuation allowance against its gross deferred income tax assets, the Company
has not reflected the net operating loss carryforward amounts or other deferred
income tax assets in its consolidated financial statements at October 31, 1996.
In addition, no income tax benefit was recorded relating to the 1996 operating
loss.

The Company is now positioned to begin aggressively marketing infrared tracking
systems to health care providers, beginning in early fiscal 1997, both through
its direct marketing efforts and its Exclusive Marketing Agreement with
Marquette Electronics, Inc. This Agreement gives Marquette exclusive marketing
rights to sell the IR Tracking system to any acute-care hospital in the United
States. It also obligates Marquette to purchase a certain number of systems
over a three-year period (10 systems through June 29, 1997, 100 systems from
June 30, 1997 through June 29, 1998 and 200 systems from June 30, 1998 through
June 29, 1999) to primarily track the location of heart monitor equipment, and
can be modified or terminated by either party prior to the beginning of the
second and third contract years. This Agreement is expected to result in
significantly more sales during fiscal 1997 and will be a key determining
factor for the initial success of the IR Tracking system. There can be no
assurance the agreement will not be terminated by Marquette, however,
management currently has no reason to believe that the agreement will be
modified or terminated to the detriment of the Company.

Longer term, the Company also intends to market its infrared tracking products
directly to financial institutions, governmental entities, professional
services providers, correctional facilities and manufacturing markets.
Additionally, the Company intends to continue marketing software and related
services through Olmsted. Lastly, the Company has retained two relatively
small product groups from the cellular era in the area of backup and mobile
security. However, these cellular products are not expected to constitute a
significant part of the Company's revenues in the future relative to infrared
sales.

LIQUIDITY AND CAPITAL RESOURCES

During fiscal 1996, the Company relied primarily on cash proceeds generated
from private placements of its common stock in September 1995 and again in
August 1996. Those two private placement offerings generated net proceeds to
the Company of approximately $2.7 million and $5.2 million, respectively. The
cash balances at October 31, 1996 resulted from the proceeds of the most recent
private placement offering. The Company believes the combination of these cash

<PAGE> 7

balances, the cash expected to be generated during fiscal 1997 from the market
introduction of its infrared tracking systems, and continued sales of software
and related services, should be sufficient to meet projected cash needs over
the next 12 months.

SIGNIFICANT LIQUIDITY FACTORS:

<TABLE>
<CAPTION>
October 31, 1996 1995
- ----------------------------
<S> <C> <C>
Current ratio 4.2:1 2.1:1
Quick ratio 4.0:1 2.0:1
</TABLE>

NEW ACCOUNTING STANDARDS

In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. The new
statement requires the Company to review long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. If it is determined that an impairment
loss has occurred based on expected future cash flows, the loss should be
recognized in the statement of operations and certain disclosures regarding the
impairment should be made in the financial statements. SFAS No. 121 is
required to be adopted by the Company beginning November 1, 1996. The Company
does not expect the adoption of SFAS No. 121 to have a material impact on the
Company's financial position or results of operations.

In October 1995, SFAS No. 123, Accounting for Stock-Based Compensation, was
issued. SFAS No. 123 allows companies to continue to account for their stock
option plans in accordance with APB Opinion 25 but encourages the adoption of a
new accounting method to record compensation expense based on the estimated
fair value of employee stock options. Companies electing not to follow the new
fair value based method are required to provide expanded footnote disclosures,
including pro forma net income and earnings per share, determined as if the
company had applied the new method. The Company is required to adopt SFAS No.
123 prospectively beginning November 1, 1996. Management intends to continue
to account for its stock option plans in accordance with APB Opinion 25 and
provide supplemental disclosures as required by SFAS No. 123, beginning in
1997.

<PAGE> 8

VERSUS TECHNOLOGY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
October 31, 1996 and 1995

<TABLE>
<CAPTION>
1996 1995
ASSETS
- ------------------------------------------------------------------------------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 4,931,000 $ 1,998,000
Accounts receivable (net of allowance for doubtful
accounts of $53,000 and $25,000) 154,000 88,000
Notes receivable, net (Note 4) 32,000 -
Inventories - purchased parts and assemblies 145,000 11,000
Prepaid expenses and other assets 80,000 82,000
----------------------------
TOTAL CURRENT ASSETS 5,342,000 2,179,000
----------------------------
NOTES RECEIVABLE, net (Note 4) 19,000 -
----------------------------
PROPERTY AND EQUIPMENT
Machinery, equipment and vehicles 293,000 114,000
Furniture and fixtures 47,000 25,000
Leasehold improvements 85,000 -
----------------------------
425,000 139,000
Less accumulated depreciation 155,000 136,000
----------------------------
NET PROPERTY AND EQUIPMENT 270,000 3,000
----------------------------
SOFTWARE DEVELOPMENT COSTS, net of accumulated
amortization of $12,000 588,000 -
GOODWILL, net of accumulated amortization of $26,000 2,313,000 -
PATENTS AND OTHER INTANGIBLE ASSETS, net of
accumulated amortization of $170,000 and $112,000
(Note 5) 255,000 253,000
----------------------------
$ 8,787,000 $ 2,435,000
============================
</TABLE>

<PAGE> 9

1996 1995
LIABILITIES AND SHAREHOLDERS' EQUITY
- -------------------------------------------------------------------------------------
<S> <C> <C>
CURRENT LIABILITIES
Accounts payable (Note 5) $ 748,000 $ 508,000
Accrued expenses 135,000 395,000
Deferred revenue - customer advance payments 16,000 9,000
Note payable, current portion (Note 5) 367,000 110,000
--------------------------------
TOTAL CURRENT LIABILITIES 1,266,000 1,022,000
NOTE PAYABLE, less current portion (Note 5) - 339,000
--------------------------------
TOTAL LIABILITIES 1,266,000 1,361,000
--------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 7, 9 and 10)
SHAREHOLDERS' EQUITY (Notes 2, 3, 5 and 8)
Common stock, $.01 par value; 50,000,000 and
25,000,000 shares authorized; 36,543,573 and
18,910,697 shares issued and outstanding 366,000 190,000
Additional paid-in capital 31,910,000 23,410,000
Accumulated deficit (24,532,000) (22,526,000)
Unearned compensation (Note 8) (223,000) -
---------------------------------
TOTAL SHAREHOLDERS' EQUITY 7,521,000 1,074,000
---------------------------------
$ 8,787,000 $ 2,435,000
=================================
</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE> 10

VERSUS TECHNOLOGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended October 31, 1996 and 1995

1996 1995
------------------------------------
<S> <C> <C>
NET SALES (Note 12) $ 348,000 $ 989,000
COST OF SALES 225,000 500,000
------------------------------------
GROSS PROFIT 123,000 489,000
------------------------------------
OPERATING EXPENSES
Research and development (Note 9) 432,000 957,000
Selling, general and administrative (Note 9) 1,526,000 1,946,000
Litigation defense costs, settlements and
judgments (Note 7) 195,000 896,000
------------------------------------
2,153,000 3,799,000
------------------------------------
LOSS FROM OPERATIONS (2,030,000) (3,310,000)
------------------------------------
OTHER INCOME (EXPENSE)
Interest income 73,000 17,000
Interest expense (Note 5) (49,000) (19,000)
Gain on sale of subsidiary and sale of product
line (Note 3) - 789,000
Other, net - 26,000
------------------------------------
24,000 813,000
------------------------------------
NET LOSS $ (2,006,000) $ (2,497,000)
------------------------------------
NET LOSS PER SHARE $ (.09) $ (.46)
====================================
</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE> 11

VERSUS TECHNOLOGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended October 31, 1996 and 1995

Common stock Additional Unearned
-------------------- paid-in Accumulated compensation
Shares Amount capital deficit (Note 8) Total
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, November 1, 1994 4,160,780 $ 42,000 $ 20,834,000 $ (20,029,000) $ - $ 847,000
Sale of common stock, net
of issuance costs (Note 8) 14,674,917 147,000 2,539,000 - - 2,686,000
Directors fees (Note 8) 75,000 1,000 37,000 - - 38,000
Net loss - - - (2,497,000) - (2,497,000)
-------------------------------------------------------------------------------------------------
BALANCE, October 31, 1995 18,910,697 190,000 23,410,000 (22,526,000) - 1,074,000
Sale of common stock, net
of issuance costs (Note 8) 11,335,000 113,000 5,088,000 - - 5,201,000
Sale of common stock to
shareholder (Note 8) 425,000 4,000 155,000 - - 159,000
Shares issued in
acquisition of Olmsted
Engineering Co., net of
dissenting shares (Note 3) 6,379,889 64,000 3,126,000 - - 3,190,000
Shares issued for
restricted stock bonus plan
(Note 8) 253,467 3,000 223,000 - (223,000) 3,000
Extinguishment of demand
note payable through
issuance of common stock
(Note 5) 174,408 1,000 86,000 - - 87,000
Repurchase and retirement of
shares (934,888) (9,000) (178,000) - - (187,000)
Net loss - - - (2,006,000) - (2,006,000)
-------------------------------------------------------------------------------------------------
BALANCE, October 31, 1996 36,543,573 $ 366,000 $ 31,910,000 $ (24,532,000) $ (223,000) $ 7,521,000
=================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE> 12

VERSUS TECHNOLOGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended October 31, 1996 and 1995

1996 1995
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (2,006,000) $ (2,497,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 32,000 121,000
Amortization of intangibles 96,000 124,000
Loss on disposal of assets - 260,000
Gain on sale of subsidiary - (365,000)
Gain on sale of product line - (424,000)
Directors' compensation expense - 38,000
Changes in operating assets and liabilities, net of
effects of 1996 purchase of Olmsted Engineering Co.:
Accounts receivable, net 45,000 288,000
Inventories (132,000) 284,000
Prepaid expenses and other current assets 7,000 (32,000)
Accounts payable 194,000 (240,000)
Accrued expenses (293,000) 20,000
Deferred revenues - customer advance payments 7,000 (43,000)
-----------------------------------
Net cash used in operating activities (2,050,000) (2,466,000)
-----------------------------------
INVESTING ACTIVITIES
Principal received on note receivable 2,000 698,000
Additions to property and equipment (114,000) (19,000)
Additions to patents and other intangible assets (60,000) (11,000)
Proceeds on sale of assets held for sale - 1,293,000
Cash paid to dissenting shareholders in acquisition of
Olmsted Engineering Co., net of cash acquired (38,000) -
-----------------------------------
Net cash provided by (used in) investing activities (210,000) 1,961,000
-----------------------------------
FINANCING ACTIVITIES
Payments on obligation under capital lease - (9,000)
Payments on note payable (82,000) (238,000)
Repurchase of common stock (85,000) -
Sale of common stock 5,360,000 2,686,000
-----------------------------------
Net cash provided by financing activities 5,193,000 2,439,000
-----------------------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,933,000 1,934,000
CASH AND CASH EQUIVALENTS, at the beginning of the year 1,998,000 64,000
-----------------------------------
CASH AND CASH EQUIVALENTS, at the end of the year $ 4,931,000 $ 1,998,000
-----------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for interest $ 46,000 $ 21,000

</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE> 13

VERSUS TECHNOLOGY, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
October 31, 1996 and 1995

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Versus Technology, Inc. (Versus) and its wholly-owned subsidiary, Olmsted
Engineering Co. (Olmsted), collectively referred to as "the Company," operate
in two business segments: security; and systems design and engineering. All
Company operations are located in one facility in Traverse City, Michigan.

Versus develops and markets products using infrared technology for the health
care industry and other markets located throughout North America. These
products permit the instantaneous identification and tracking of the location
of people and equipment, can be used to control access and permit instantaneous
two-way communication. Versus also develops, markets and integrates cellular
products for the security industry.

As discussed more fully in Note 3, Versus acquired Olmsted in August 1996.
Olmsted writes and maintains complex software programs for the computer-aided
design and computer-aided manufacturing (CAD/CAM) industry. It sells its own
software under the ACU.CARV(R) name, resells third party software, and provides
systems support services throughout North America. It receives monthly
maintenance and enhancement fees from customers in order to receive technical
support and semi-annual releases. Olmsted also provides software programming
services to Versus.

During 1995, Versus significantly downsized its manufacturing operations, moved
its headquarters and principal operating facilities, ceased production and
distribution of a significant product line and focused development efforts on
infrared product technology. All related costs of this relocation, including
the write-down of nonessential property and equipment to net realizable value,
were recognized in fiscal year 1995.

The Company maintains its cash accounts in national banks and does not consider
there to be a credit risk arising from cash deposits in excess of federally
insured limits. The Company's customer base is diverse and the Company does
not believe it has a significant credit risk related to its accounts
receivable.

PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Versus and the
accounts of Olmsted since the date of acquisition. Upon consolidation, all
significant intercompany accounts and transactions are eliminated.

USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates.

REVENUE RECOGNITION
Revenue from product sales is recognized when the related goods are shipped and
all significant obligations of the Company have been satisfied. The Company
generally offers a 90 day warranty on its products. Costs incurred to service
products under warranty, which have not been significant, are charged to
operations when incurred.

Revenue from software product sales is recognized when the related goods are
shipped and the obligations of the Company have been satisfied. Revenue from
software maintenance and service contracts is recognized pro rata over the life
of the individual contracts. Revenue from programming services is recognized
as services are provided.

Revenue from advance payments received from customers is deferred until all
revenue recognition criteria are satisfied.

INVENTORIES

<PAGE> 14

Inventories are stated at the lower of cost (first-in, first-out method) or
market.

PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, less accumulated depreciation.
Depreciation is computed principally on the straight-line method for financial
reporting purposes and accelerated methods for income tax purposes over the
following estimated useful lives:

<TABLE>
<S> <C>
Machinery, equipment and vehicles 3 to 10 years
Furniture and fixtures 3 to 10 years
Leasehold improvements 5 years
</TABLE>

SOFTWARE DEVELOPMENT COSTS
Software development costs recorded at October 31, 1996, represent the
estimated fair value of Olmsted's ACU.CARV(R) and related software as of the
August 1996 acquisition date, less amortization through the fiscal year-end.
Amortization is computed on a straight-line basis over eight years. With
respect to future software development, costs incurred to ready software
products for sale from the time that technological feasibility has been
established, as evidenced by a detailed working program design, to the time
that the product is available for general release to customers will be
capitalized. Such capitalized costs will be amortized based on current and
future revenue for each product with an annual minimum equal to the
straight-line amortization over the remaining estimated economic lives of the
products. Costs incurred prior to establishing technological feasibility and
costs incurred subsequent to general product release to customers will be
expensed as incurred.

PATENTS AND OTHER INTANGIBLE ASSETS
Patents and trademarks are recorded at cost, less amortization computed on a
straight-line basis over seven years. Other intangible assets, comprised
primarily of supplier royalty agreements, are recorded at cost, less
amortization computed on a straight-line basis over ten years.

GOODWILL AND AMORTIZATION
Goodwill, representing the cost in excess of net assets acquired in the August
1996 acquisition of Olmsted, which was accounted for using the purchase method
of accounting, is being amortized on a straight-line basis over 15 years.
Management periodically reviews goodwill for impairment based upon the
projected undiscounted cash flows from operations to which the goodwill
relates. Identified impairments will be measured based on the projected
discounted cash flows related to those operations. Amortization of $26,000 has
been recorded for the year ended October 31, 1996.

ADVERTISING COSTS
All advertising costs, amounting to $33,000 and $26,000 for the years ended
October 31, 1996 and 1995, respectively, are expensed in the period in which
they are incurred.

INCOME TAXES
Deferred income taxes are recognized for the future tax consequences
attributable to "temporary" differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred income 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. The effect on
deferred income tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. To the
extent that available evidence about the future raises doubt about the
realization of a deferred income tax asset, a valuation allowance is
established.

EARNINGS (LOSS) PER SHARE
Earnings (loss) per share is based on the weighted average number of shares of
common stock outstanding. The Company has not included the effects of options
and warrants in its calculation of weighted average shares outstanding due to
their anti-dilutive effect. The resulting weighted average shares outstanding
were 21,860,076 and 5,450,430 for 1996 and 1995, respectively.

CASH AND CASH EQUIVALENTS
The Company considers all investments with original maturities of three months
or less to be cash equivalents.
NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be

<PAGE> 15
Disposed Of. This new statement requires the Company to review long-lived
assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If it is determined that an impairment loss has occurred based on
expected future cash flows, the loss should be recognized in the statement of
operations and certain disclosures regarding the impairment should be made in
the financial statements. SFAS No. 121 is required to be adopted by the Company
beginning November 1, 1996. The Company does not expect the adoption of SFAS
No. 121 to have a material impact on the Company's financial position or results
of operations.

(2) OPERATIONS AND LIQUIDITY

Losses incurred during 1996 and accumulated losses to date have had a
significant adverse impact on the Company's financial position. During fiscal
1996, the Company relied primarily on cash proceeds generated from private
placements of its common stock in September 1995 and again in August 1996.
Those two private placement offerings generated net proceeds to the Company of
approximately $2.7 million and $5.2 million, respectively. The cash balances
at October 31, 1996 resulted from the proceeds of the most recent private
placement offering. The Company believes the combination of these cash
balances, the cash expected to be generated during fiscal 1997 from the market
introduction of its infrared tracking systems, and continued sales of software
and related services related to its recent acquisition of Olmsted, should be
sufficient to meet projected cash needs over the next 12 months.

(3) ACQUISITION AND DISPOSITION

ACQUISITION
On August 26, 1996, Versus issued 6,379,889 shares of its common stock, valued
for accounting purposes at $.50 per share, and paid $65,000 in cash, in
exchange for all of the outstanding common stock and preferred stock of Olmsted
Engineering Co. The purchase price amounted to $3,255,000. For accounting
purposes, the price of the acquisition was determined based upon a
contemporaneous sale of restricted common stock at $.50 per share. Olmsted,
which will continue to do business as a wholly-owned subsidiary under the name
"Olmsted Engineering Co.," is in the business of developing, marketing and
maintaining various software products used primarily in the mold, die and
pattern making industries. Prior to the acquisition, the President of Versus
owned a majority of all classes of stock of Olmsted. Olmsted has served as a
research and development consultant to Versus since 1994 and has leased office
space to Versus on a temporary basis since 1995.

The occurrence of the acquisition was conditioned upon Versus raising at least
$4.5 million, net of commissions, through a private placement of its common
stock, as discussed in Note 8. On August 26, 1996, the date of the
acquisition, Versus sold 11,335,000 shares of its common stock in a private
offering to accredited investors at a price of $.50 per share, with proceeds
totaling $5,201,000, net of issuance costs.

The acquisition has been accounted for using the purchase method of accounting,
and accordingly, the purchase price has been allocated to the assets purchased
and the liabilities assumed based upon the estimated fair values at the
acquisition date. The excess of the purchase price over the fair values of the
net assets acquired was $2,339,000 and has been recorded as goodwill, which is
being amortized on a straight-line basis over 15 years.

14
<PAGE> 16
\
The purchase price was allocated as follows:

<TABLE>

<S> <C>
Working capital $ 145,000
Property and equipment 171,000
Software development costs 600,000
Goodwill 2,339,000
------------
Total purchase price $ 3,255,000
============
</TABLE>

As of the acquisition date, Olmsted had net operating loss carryforwards for
federal income tax purposes amounting to approximately $1,800,000, subject to
certain tax law limitations, which expire through 2011, if not previously
utilized. As discussed in Note 6, the Company has recorded a 100% valuation
allowance relating to the tax effects of these net operating loss
carryforwards. The following unaudited pro forma information has been prepared
assuming the acquisition had taken place at the beginning of the respective
periods. The pro forma information includes adjustments for depreciation based
on the fair value of the property and equipment acquired, intercompany
transactions, the amortization of intangibles arising from the transaction and
the shares issued in the acquisition. The pro forma financial information is
not necessarily indicative of what the actual consolidated results of
operations might have been if the acquisition had been effected on the assumed
dates.

<TABLE>

Pro forma results for
Year ended October 31,
1996 1995
--------------------------------
<S> <C>
Net sales $ 768,000 $ 1,756,000
Net loss (2,168,000) (2,489,000)
Net loss per common
share (.08) (.22)
</TABLE>

Olmsted's operating results have been included in the consolidated statement of
operations since the date of acquisition.

SALE OF MAJORITY-OWNED SUBSIDIARY
During 1992, the Company completed the sale of all of its capital stock in a
wholly-owned subsidiary to a newly-formed organization headed by the management
of the former subsidiary. The purchase price was approximately $1,653,000 plus
repayment of certain indebtedness from the former subsidiary to the Company.

The Company realized a net gain from this transaction of approximately
$1,129,000. Due to the fact that the purchaser was a highly-leveraged group of
investors, the gain was deferred and was recognized ratably as cash was
collected. The Company recognized the balance of this deferred gain in the
amount of $365,000 during the year ended October 31, 1995.

(4) NOTES RECEIVABLE

The Company has notes receivable of $60,000 in connection with certain sales of
software which have been reduced by an allowance for doubtful accounts of
$9,000. The notes are due in various payment terms, carry interest at rates
ranging from 7.5% to 8.5% and mature at various dates through March 2000.

(5) NOTES PAYABLE

DEMAND NOTE
As part of the Olmsted acquisition, the Company assumed a liability for a 6%
demand note payable to a former Olmsted shareholder. Effective October 30,
1996, the note ($74,745) and accrued interest ($12,459) were settled, at no
gain or loss, by the issuance of 174,408 shares of the Company's common stock.

TERM NOTE
On August 1, 1995, the Company signed a note payable to one of its law firms
for $449,000 as partial payment of fees billed. The note bears interest at a
specified bank's prime rate, 8.25% at October 31, 1996, and requires monthly
installments of $10,000 each, including interest, commencing on December 1,
1995, with a balloon payment for the remaining balance due on January 1, 1997.
The note, amounting to $367,000 at October 31, 1996, is secured by the
Company's patents and intellectual property. Approximately $150,000 of
additional fees to the same law firm are included in accounts payable at
October 31, 1996 and 1995. Management intends to dispute the amount and terms
of payment of the remaining unpaid balances. Any adjustment of the unpaid
balance will be recognized in the period in which it is made.

(6) INCOME TAXES

15
<PAGE> 17

Deferred income taxes result from temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. The tax effects of temporary differences that give rise
to deferred tax assets at October 31, 1996 and 1995 are as follows:

1996 1995
------------------------------
<S> <C> <C>
Net operating loss
carryforwards $ 6,052,000 $ 6,040,000
Inventory reserves - 8,000
Receivables - allowance
for doubtful accounts 21,000 10,000
Accumulated depreciation 3,000 -
Intangible asset
amortization 2,000 24,000
Accruals and reserves 25,000 62,000
------------------------------
Gross deferred income
tax assets 6,103,000 6,144,000
Less valuation allowance (6,103,000) (6,144,000)
------------------------------
Net deferred income tax
assets recorded in the
consolidated financial
statements $ - $ -
==============================
</TABLE>

At October 31, 1996, the Company had available net operating loss carryforwards
for federal income tax reporting purposes of approximately $17,800,000 which
expire through 2011, if not previously utilized.

The above net operating loss carryfoward amounts include amounts attributable
to Olmsted which were carried over to the consolidated group as part of the
August 1996 acquisition. State net operating loss carryforwards of Versus
attributable to a state in which the Company no longer operates are not
included in the October 31, 1996, net operating loss carryforward amounts. The
utilization of the total operating loss carryforwards of Versus and Olmsted are
subject to limitations under the Internal Revenue Code rules relating to change
of ownership.

Due to the recording of the valuation allowance for deferred income tax assets
at October 31, 1996, actual related tax benefits recognized in the future will
be reflected as either a reduction of future income tax expense or goodwill
related to the acquisition of Olmsted. Those tax benefits will be allocated as
follows:

<TABLE>
<S> <C>
Income tax benefit that would be
reported in the consolidated
statement of operations as a
reduction of income tax expense $ 5,491,000
Recognized as a reduction of goodwill 612,000
------------
$ 6,103,000
</TABLE>

Realization of the gross deferred income tax assets is dependent upon
generating sufficient taxable income prior to expiration of the loss
carryforwards and, as discussed above, the loss carryforwards are subject to
tax law limitations. In assessing the realizability of deferred income tax
assets, management follows the guidance contained within SFAS No. 109,
Accounting for Income Taxes, which requires that deferred income tax assets be
reduced by a valuation allowance if, based on the weight of available evidence,
it is "more likely than not" that some portion or all of the deferred income
tax assets will not be realized. Under the provisions of SFAS No. 109, forming
a conclusion that a valuation allowance is not needed is difficult when there
is negative evidence such as cumulative losses in recent years and tax law
limitations, as discussed above. While it believes the Company will be
profitable in the future, management has concluded that, following the guidance
of SFAS No. 109, it is "more likely than not" that these deferred income tax
assets will not be realized. The net reduction in the valuation allowance
during the year ended October 31, 1996, amounting to $41,000, is attributable
to additional losses incurred during the year and the carry over losses of
Olmsted relating to the August 1996 acquisition, reduced by the state net
operating carryforwards, as discussed above, and an adjustment for the
difference between the prior year estimated and actual net operating loss
carryforward amount.

For the years ended October 31, 1996 and 1995, income taxes differed from the
amounts computed by applying the federal statutory rate of 34% to losses before
income taxes as follows:

16
<PAGE> 18

1996 1995
<S> <C> <C>
Computed "expected"
tax benefit $ (682,000) $ (849,000)
Increase (decrease)
in tax resulting
from:
Adjustment to
valuation allowance
for deferred income
tax assets relating
to current year
losses 677,000 827,000
Nondeductible expenses 5,000 22,000
----------------------------
$ - $ -
============================
</TABLE>

(7) COMMITMENTS AND CONTINGENCIES

EMPLOYMENT CONTRACT
On July 1, 1996, the Company entered into an employment agreement with its
President, which expires on June 30, 2002. The agreement provides for payment
of specified compensation amounts and specified fringe benefits during the term
of the agreement.

LITIGATION
In January 1995, the Company settled litigation pending with a former employee
of the Company. As part of the settlement, the employee agreed to forego all
his prior stock options, and was issued 100,000 new stock options immediately
exercisable at $.50 per share, expiring five years from the date of issuance.
The additional costs of the settlement were recognized in the Company's 1995
financial statements.

A judgment in the amount of approximately $132,000 was entered against the
Company in 1995 in connection with a patent infringement suit. This judgment
was settled by transferring $121,000 in inventory to the Plaintiff. The
remainder of the judgment was settled by an approximate $11,000 payment in
1996. All amounts of the settlements were accrued in the 1995 financial
statements. During 1995, in connection with the patent infringement judgment,
the Company wrote down all inventory, intangible assets, and fixed assets
related to the product line named in the lawsuit to net realizable value.
A judgment was entered against the Company during 1995 in connection with
litigation relating to the exercise of certain warrants. The judgment of
approximately $195,000 was accrued in the Company's 1995 financial statements.
The judgment was upheld on appeal during 1996 and was paid by the Company plus
interest and costs which were not material.

A suit was filed in November 1996 against the Company alleging that the Company
allowed certain warrants to expire which the plaintiff held and that the
plaintiff was damaged by the warrants' expiration. The plaintiff also alleges
that the Company breached the warrant agreement pursuant to which the warrants
were issued to the plaintiff and claims that the sale by the Company of
restricted stock in late 1993 required a downward adjustment of the exercise
price of the warrants under the warrant agreement. The sole named plaintiff
alleges this action should be tried as a class action, and alleges he is an
appropriate representative of the class. The plaintiff further alleges his
claims are substantially identical to the claims made by the plaintiff in the
litigation discussed in the preceding paragraph, which involved only 300,000 of
the 2,233,800 Class A warrants at issue. Apparently, the plaintiff believes
the Company has a liability for each of the remaining warrants identical to the
per warrant liability the Company had for the 300,000 warrants discussed in the
preceding paragraph. Due to the recent filing of this suit, any loss potential
is not determinable at this time. However, the Company disputes the material
allegations of the complaint and intends to vigorously defend itself against
this matter.

A suit was filed in May 1996 against Olmsted and its Chairman (the current
President of the Company) alleging that in connection with a private offering
in 1994, Olmsted and its Chairman breached an oral promise allegedly made in
connection with the plaintiffs' purchase of common stock. The plaintiffs
alleged that Olmsted's Chairman promised that the holders of Olmsted preferred
stock would cancel all of their preferred stock in consideration of the
plaintiffs' contemplated investment in Olmsted, so that the plaintiffs would
own approximately 19% of Olmsted after their investment (and have options to
purchase an equal amount of shares). Olmsted and its Chairman denied that any
such representation was ever made. Subsequent to year-end, a settlement
agreement was entered into and the suit was dismissed. The settlement amount,
which was not material, was accrued in the 1996 consolidated financial
statements.
17

<PAGE> 19

Total legal fees and other associated costs incurred in connection with the
above settlements amounted to $195,000 and $896,000 during 1996 and 1995,
respectively.

(8) SHAREHOLDERS' EQUITY

STOCK OFFERINGS
On August 26, 1996, the Company completed a private placement
of 11,335,000 restricted shares of common stock concurrently with the Olmsted
acquisition discussed in Note 3. The purchase price was $.50 per share. The
Company received $5,667,500, less placement agent commissions of approximately
$397,000 and other professional fees of approximately $70,000. In addition,
the placement agent was granted five-year warrants to purchase 396,725
shares of the Company's common stock at a price of $.50 per share. The
proceeds will be used to fund the development and marketing of infrared
tracking products and to meet anticipated cash flow needs. These shares also
contain certain registration rights which generally include (1) that the
investors, as a class, will have the right to demand registration to be
implemented by notice to the Company by a 25% interest of the investors of
their desire to sell their shares; (2) the right will continue until public
sale under Rule 144(k) under the Securities Act of 1933, as amended, and is
available to all investors who are not affiliates of the Company (under current
rules three years from closing); and (3) during this period, investors will
have the right to participate in a public offering by the Company of its shares
of common stock, subject to underwriter's cut back.

During 1996, the Company sold 425,000 shares of common stock to a present
shareholder for $.375 per share, which represented the fair value of the common
stock at that time.

On September 29, 1995, the Company completed a private placement of 14,674,917
restricted shares of common stock. The purchase price was $.20 per share. The
Company received $2,935,000, less placement agent commissions of approximately
$205,000 and other professional fees of $19,000. In addition, the placement
agent was granted five-year warrants to purchase 1,027,244 shares of the
Company's common stock at a price of $.20 per share. The proceeds were used to
repay bridge loan financing extended to the Company, fund completion of
development of infrared tracking products, and to meet anticipated cash flow
needs. These shares also are subject to certain registration rights which
generally are identical to those set forth in the August 26, 1996 registration
rights agreement discussed above, except that a majority in interests of shares
is required to demand registration under this agreement.

During 1995, the Company issued 75,000 shares of common stock to its directors
in lieu of cash for their annual director fees. The shares were issued at $.50
per share, and the related director fee expense was recognized in the
accompanying 1995 financial statements.

STOCK WARRANTS
At October 31, 1996, the Company has outstanding warrants in the following
amounts exercisable through the following dates:

1. Warrants to purchase 225,000 shares at an exercise price of $2.05,
expiring in September 1998, issued relative to a 1993 private placement;

2. Warrants to purchase 70,000 shares at an exercise price of $2.05,
expiring in September 1998, issued relative to a 1993 private placement;

3. Warrants to purchase 95,000 shares at an exercise price of $1.00,
expiring in September 1999, issued to lenders with respect to a bridge
loan extended to the Company in September of 1994;

4. Warrants to purchase 200,000 shares at an exercise price of $.50,
expiring in June 2000, issued to lenders with respect to a bridge loan
extended to the Company in July of 1995;

5. Warrants to purchase 1,027,244 shares at an exercise price of $.20,
expiring in September 2000, issued to the private placement agent in
September 1995; and

6. Warrants to purchase 396,725 shares at an exercise price of $.50,
expiring in August 2001, issued to the private placement agent in August
1996.

STOCK OPTIONS

18
<PAGE> 20
The Company's 1996 Employee Incentive Stock Option Plan grants key management
employees options to purchase shares of common stock. A total of 2,000,000
shares are available for grant under the plan. During 1996, 1,000,000 options
were granted to the Company's President at $.375 per share, which represented
the fair value of the common stock at the grant date. The options may be
exercised from six months to ten years after the date of the grant, based on a
vesting schedule. Under the vesting schedule, 250,000 options became
exercisable in December 1996 and an additional 250,000 are exercisable each
December for the next three years. No options were exercisable under the plan
at October 31, 1996.

The Company has issued additional stock options under a variety of agreements
over the past few years. Under two agreements, the Company has issued options
expiring in 2000 and 2001, respectively, to purchase a total of 200,000 shares
at $.50 per share to former employees. As part of the Olmsted acquisition,
options held by Olmsted shareholders to acquire additional Olmsted common
shares were converted to options to acquire 266,870 of the Company's shares at
an exercise price of $.637 per share. These options expired unexercised on
December 1, 1996. The Company also had options outstanding to a former
employee to purchase 3,334 shares at $.84 per share, and 1,000 shares at $1.56
per share, which options expired unexercised. All of the outstanding options
under these agreements are exercisable at October 31, 1996.

RESTRICTED STOCK BONUS PLAN
During 1996, the Company established the 1996 Incentive Restricted Stock Bonus
Plan and reserved 500,000 common shares for issuance under the plan.

Under the terms of the plan, any salaried employee of the Company or any
subsidiary, except the President and directors, are eligible to receive an
allocation of bonus shares. Allocations of bonus shares are recommended by the
President and approved and adjusted, if necessary, by the Board of Directors.
Within 15 days of the allocation, the employee shall, if he desires to accept
the allocation, pay to the Company an amount equal to the par value of the
allocated bonus shares.

Upon issuance of bonus shares to the employee, he or she will have all the
rights of a shareholder with respect to such shares, including the right to
vote them and to receive all dividends and other related distributions. Bonus
shares may not, however, be sold, exchanged, transferred, pledged, hypothecated
or otherwise disposed of within three years after the date of issuance unless
they are first offered by written notice back to the Company. If a recipient's
employment is terminated for any reason during the three-year period, the
termination will be deemed as an offer to the Company to repurchase the shares
at par value as follows: 100% if termination occurs within one year from date
of issuance; 75% if termination occurs within two years; and 50% if the
termination occurs within three years.

Effective October 30, 1996, 253,467 shares were granted and issued in
conjunction with the bonus plan. The market value of the shares awarded was
$226,000. The difference between the market value and the sales price ($.01
per share) of the shares, amounting to $223,000, was recorded as unearned
compensation and is presented as a separate component of shareholders' equity.
Beginning November 1, 1996, unearned compensation will be amortized to expense
over the three-year vesting period.

(9) RELATED PARTY TRANSACTIONS

The President and Chief Executive Officer of the Company was also the Chief
Executive Officer, a member of the Board of Directors and a stockholder of
Olmsted which was acquired by the Company effective August 26, 1996, as
discussed in Note 3.

Olmsted provided a number of resources to the Company for the period ended
August 26, 1996 and for the year ended October 31, 1995, including research and
development, pass-through billings, use of office space and development of a
business plan. Related party billings for the period ended August 26, 1996 and
the year ended October 31, 1995 were as follows:

1996 1995
-------------------------
<S> <C> <C>
Programming $ 548,000 $ 666,000
Engineering pass-through
</TABLE>

19
<PAGE> 21
<TABLE>
<S> <C> <C>
billings 167,000 143,000
Business plan and materials 21,000 39,000
Rent 19,000 -
------------------------
Total Olmsted billings $ 755,000 $ 848,000
========================
</TABLE>

The Company believes that services provided by Olmsted were negotiated at arm's
length at the fair value of goods and services received. The Company is
currently maintaining its headquarters and principal operating facilities at
the former business location of Olmsted.

The Company and Olmsted intend to move their principal operating
facilities in December 1996 to a building which is beneficially owned by the
Company's President. The Company and Olmsted have entered into separate
five-year lease agreements calling for aggregate annual rents of $111,000,
increasing 4% annually after the first year. The Company and Olmsted have made
combined non refundable contributions to leasehold improvements amounting to
$85,000, in accordance with terms of the lease agreements.

(10) EMPLOYEE BENEFIT PLAN

The Company maintains a 401(k) plan for all of its employees. Under the plan,
the Company contributes $.50 for each dollar contributed by an employee to a
retirement savings account in any year (which may not be less than 2% or more
than 17% of the employee's annual compensation). Company contributions are
limited to a maximum of 3% of the employee's direct compensation for that year.
Participants are fully vested in the 401(k) plan at all times for those
amounts attributable to their own contributions and vest over a six-year period
for Company contributions. The Company's contributions to the plan were $1,460
and $8,000 for the years ended October 31, 1996 and 1995, respectively.

(11) NONCASH INVESTING AND FINANCING ACTIVITIES

As discussed in Note 3, on August 26, 1996, Versus issued 6,379,889 shares of
its common stock, valued for accounting purposes at $.50 per share, and paid
$65,000 in cash in exchange for all of the outstanding common stock and
preferred stock of Olmsted. The purchase price amounted to $3,255,000.

As discussed in Note 5, effective October 30, 1996, the Company settled a note
payable of $74,745 and accrued interest of $12,459 by issuance of 174,408
shares of the Company's common stock.

During 1994, the Company classified certain of its assets and liabilities
related to a particular product line as assets held for sale. Those items were
sold for cash of $1,293,000 in November 1994. The components of those items
sold were as follows, as of November 1, 1994:

<TABLE>
<S> <C>
Inventory, property,
plant and equipment,
net $ 929,000
Accounts payable (57,000)
----------
Net assets held for sale $ 872,000
==========
</TABLE>

During 1995, approximately $449,000 of accounts payable were renegotiated to a
note payable as discussed in Note 5.

(12) BUSINESS SEGMENT INFORMATION AND MAJOR CUSTOMERS

The Company operates in two business segments: security; and systems design and
engineering. During fiscal 1995 and through August 1996, when Olmsted was
acquired, the Company operated only in the security segment. The security
segment includes the Company's infrared products marketed to the health care
industry and other markets and its cellular products for the security industry.
The systems design and engineering segment, operated under the Olmsted name,
develops, sells and maintains programs for use in operating complex machinery.

Net sales, operating income (loss), identifiable assets, capital expenditures
and depreciation and amortization pertaining to the business segments are
presented below.

<TABLE>
<S> <C>
NET SALES
Security $ 246,000
Systems design and engineering 102,000
-------------
$ 348,000
=============

</TABLE>
20
<PAGE> 22
<TABLE>
<S> <C>
OPERATING LOSS
Security $ (1,927,000)
Systems design and engineering (53,000)
---------------
Total operating loss (1,980,000)
General corporate expenses (50,000)
Interest income, net 24,000
---------------
Net loss $ (2,006,000)
===============
IDENTIFIABLE ASSETS
Security $ 542,000
Systems design and engineering 3,234,000
Corporate 5,011,000
---------------
$ 8,787,000
===============
CAPITAL EXPENDITURES
Security $ 111,000
Systems design and engineering 3,000
---------------
$ 114,000
===============
DEPRECIATION AND AMORTIZATION
Security $ 75,000
Systems design and engineering 53,000
---------------
$ 128,000
===============
</TABLE>

Net sales in excess of 10% of the Company's total net sales were attributable
to sales to three and four major customers for the years ended October 31, 1996
and 1995, respectively. These individual customers accounted for net sales of
approximately $56,000 (16%), $37,000 (11%) and $34,000 (10%) in fiscal year
1996 and $286,000 (29%), $144,000 (15%), $134,000 (14%) and $103,000 (11%) in
fiscal year 1995.

<PAGE> 23

INDEPENDENT AUDITORS' REPORT

BOARD OF DIRECTORS AND SHAREHOLDERS
Versus Technology, Inc. and Subsidiary

We have audited the consolidated balance sheet of Versus Technology, Inc. and
subsidiary as of October 31, 1996, and the related consolidated statements of
operations, shareholders' equity and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit. The financial statements of Versus
Technology, Inc. as of October 31, 1995, were audited by other auditors whose
re-issued report dated February 9, 1996, except Note 2 which is as of December
9, 1996, expressed an unqualified opinion on those statements.

We conducted our audit 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 audit provides a reasonable basis
for our opinion.

In our opinion, the 1996 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Versus
Technology, Inc. and subsidiary at October 31, 1996, and the results of their
operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.

Grand Rapids, Michigan
December 9, 1996

<PAGE> 24

MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Previously the Company's common stock was traded over the counter on NASDAQ
under the trading symbol "VSTI." Such securities are not currently listed, as
the Company for a period of time did not meet the balance sheet requirement of
NASD. At present, the Company does not meet the NASD's minimum per-share price
requirements for new listings and, therefore, has not been relisted. The
Company intends to apply for NASDAQ relisting of its common stock as soon as
all of the NASD requirements are again met. The common stock is traded over
the counter by several market makers through the NASDAQ Bulletin Board.

The price ranges presented below represent the high and low bid prices of the
Company's common stock during each quarter. Quotations reflect interdealer
prices without retail mark-up, mark-down or commission and may not represent
actual transactions.

Bid Information
Common Stock
----------------------
<S> <C> <C>
Fiscal quarter ended High Low
- -----------------------------------------------------
January 31, 1996 $ 17/32 $ 3/8
April 30, 1996 7/8 3/8
July 31, 1996 29/32 21/32
October 31, 1996 1-1/16 21/32
January 31, 1995 $ 7/8 $ 3/8
April 30, 1995 3/8 1/4
July 31, 1995 9/16 1/4
October 31, 1995 17/32 3/8
====================================================
</TABLE>

As of December 16, 1996, the Company had 1,835 shareholders of record of its
common stock and the average of the bid and asked prices was 13/16.

To date, the Company has not declared or paid any dividends with respect to its
common stock, and the current policy of the Board of Directors is to retain any
earnings to provide for the growth of the Company. Consequently, no cash
dividends are expected to be paid on the common stock in the foreseeable
future.

The Company's Class A warrants, as last extended by the Board of Directors,
expired on February 15, 1996.
<PAGE> 25

VERSUS TECHNOLOGY, INC.
AND SUBSIDIARY

BOARD OF DIRECTORS

GARY T. GAISSER
President and CEO
Versus Technology, Inc.

ELLIOTT G. EISENBERG1,2
Managing Director
Dabney/Resnick/Imperial, L.L.C.

JULIAN C. SCHROEDER1,2
President and
Director of Research
BDS Securities, L.L.C.

1Compensation Committee Member
2Audit Committee Member

OFFICERS

GARY T. GAISSER
President and CEO

HENRY J. TENARVITZ
Executive Vice President of Operations

DEBRA A. BOYER
Chief Financial Officer

ANDREA BEADLE
Secretary

STOCK TRADING

The Company's Common Stock is traded over the counter by several market makers
through the NASDAQ Bulletin Board.

TRANSFER AGENT AND REGISTRAR

American Stock Transfer
and Trust Company
New York, New York

INDEPENDENT AUDITORS

BDO Seidman, LLP
Grand Rapids, Michigan

ANNUAL REPORT / FORM 10-KSB

A copy of the Company's Annual Report (Form 10-KSB) as filed with the
Securities and Exchange Commission is available by submitting your written
request to:

Versus Technology, Inc.
Attn: Debra A. Boyer
Chief Financial Officer
2600 Miller Creek Road
Traverse City, Michigan 49684