SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10KSB
|X| Annual Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997
|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 (no fee required)
For the transition period from _________ to __________.
Commission File Number: 0-12575
ARIZONA INSTRUMENT CORPORATION
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(Name of small business issuer as specified in its charter)
Delaware 86-0410138
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
4114 East Wood Street, Phoenix, AZ 85040
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (602) 470-1414
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes |X| No |_|
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference In Part III of this Form 10-IKSB or any
amendment to this Form 10-KSB. |_|
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As of March 23, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $7,771,285. The aggregate market value is
computed with reference to the average bid and asked prices. Shares of Common
Stock held by each officer and director and by such person who owns 10% or more
of the outstanding Common Stock have been excluded in that such persons may be
deemed to be affiliates. This determination of affiliate status is not
necessarily conclusive.
Issuers revenues for its most recent fiscal year were $15,232,319
As of March 20, 1998, 6,717,086 shares of Common Stock ($.01 par value) were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III: Portions of the Proxy Statement for the 1998 Annual
Shareholders' Meeting (to be filed).
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Unless the context indicates otherwise, the term "Company" or "AZI" refers to
Arizona Instrument Corporation and its wholly-owned subsidiaries.
Except for the historical information contained herein, the discussion in this
Form 10-KSB contains certain forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, and the Company intends
that such forward-looking statements be subject to the safe harbors created
thereby. The forward-looking statements include statements regarding
management's anticipation of the Company's future market position, development
of additional products, product introduction and delivery dates, reliability of
products, adequate sources of supplies, acquisition of related product lines or
companies, positive responses to new developments, and availability and terms of
credit. The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties, and on
assumptions that involve judgments with respect to, among other things, future
economic, competitive and market conditions, research and development results,
product introduction and delivery schedules, raw materials, market conditions,
stability of the regulatory environment, future business decisions and the
outcome of negotiations with its lender, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking statements, many of which are beyond the control of the Company,
are reasonable, any of the assumptions could prove inaccurate and, therefore,
there can be no assurance that the results contemplated in forward-looking
information will be realized. Important factors which may cause actual results
to differ materially from those contemplated or implied by such forward-looking
statements are discussed in more detail in this form 10-KSB and the Company's
1997 Annual Report to Shareholders. In light of the significant uncertainties
inherent in the forward-looking information included herein, the inclusion of
such information should not be regarded as a representation by the Company or
any other person that the objectives or plans of the Company will be achieved.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
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Arizona Instrument Corporation designs and manufactures precision
instruments used in quality control, industrial control and environmental
monitoring applications. The operations of AZI's wholly-owned subsidiary,
Horizon Engineering and Testing, Inc. ("Horizon"), which had specialized in
testing and engineering services for the underground storage tank ("UST")
market, were discontinued during 1997.
AZI completed its initial public stock offering on September 22, 1983
as Computrac Instruments, Inc. Later that year, the Company changed its name to
Quintel Corporation. In March 1987, to reflect new product offerings, the
Company was renamed Arizona Instrument Corporation.
AZI's initial product was the Computrac moisture analyzer for use in
process control industries, but the Company has successfully expanded into other
product areas. In December 1986, AZI acquired Jerome Instrument Corporation
("Jerome"), a manufacturer of mercury and hydrogen sulfide gas analyzers. In
January 1988, AZI completed the acquisition of certain assets from Genelco, Inc.
("Genelco") including the Soil Sentry line of UST leak detection systems. In
June 1994, the Company introduced the ENCOMPASS(TM) product, its next generation
of fuel management and leak detection compliance systems. In September 1992, the
Company
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acquired Horizon, a company that specialized in testing and engineering services
for USTs; however, the Company discontinued Horizon's operations during 1997.
Sales of the Company's Encompass and Soil Sentry products, as well as
similar products of the Company's competitors, have been slower than predicted
by industry analysts. Many UST operators have chosen the less expensive but
temporary, regulatory option of annual tank testing, combined with monthly
inventory reconciliation, thus delaying their move to more expensive permanent
monitoring. By December 1998, the law will require virtually all UST operators
to move from the temporary, annual testing option to a monthly inventory
reconciliation service or permanent leak monitoring.
ENCOMPASS(TM) and Soil Sentry Product Line
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Products - ENCOMPASS and the Soil Sentry line of UST monitoring systems
include various products that allow UST operators with diverse site needs to
automate fuel management and comply with federal and local leak detection
regulations.
In June 1994, the Company introduced the ENCOMPASS product, a personal
computer-based fuel inventory reporting and environmental compliance system that
utilizes on-site personal computers to manage fuel inventory and meet EPA leak
detection requirements. The ENCOMPASS system is compatible with other business
software and runs in the computer's background without interrupting other site
activities. In the event of an alarm condition, the system automatically
notifies the operator. The ENCOMPASS system runs in a Windows-based environment.
In 1996, the Company expanded the ENCOMPASS system to include line leak
detection and continuous statistical tank testing products. The addition of
statistical inventory reconciliation ("SIR"), as well as additional interfaces
to hardware produced by third parties is scheduled for 1998.
The Soil Sentry Twelve-X, improved in 1993, combines aspirated and
dynamic vapor monitoring technologies to monitor both tanks and piping at sites
which have existing hydrocarbon contamination. It uses a unique aspirated vapor
technology to measure for the presence of leak-indicating hydrocarbon vapors in
the soil surrounding underground and aboveground tanks. Sampling points placed
at strategic locations throughout a site are connected with transport tubing to
a Twelve-X console. A pump inside the system console automatically draws air
samples from each sampling point, one at a time, back to the console for
analysis by the sensor. The microprocessor establishes a baseline contamination
level, then employs a series of statistical tests and mathematical modeling to
differentiate between new leaks, spills and existing background contamination to
eliminate false alarms. If thresholds are exceeded, an alarm is sounded. Because
the monitoring wells are located throughout the site, the user is able to
pinpoint the problem area quickly, greatly reducing costs to repair tanks and/or
piping and remediate the site.
Primary features of all ENCOMPASS and Soil Sentry products include the
ability to remotely access and control the system through a modem using a
personal computer.
Market and Applications - In 1984, Congress amended the Resource
Conservation and Recovery Act, requiring the implementation of strict
registration and monitoring regulations for all underground storage tanks in the
United States. For the purpose of these regulations, the EPA has defined any
storage tank system with
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more than 10 percent of its total volume underground as a UST. Estimates of the
total number of USTs affected by the federal regulations vary, ranging from 1.8
to 2.1 million, with an average of 3.3 USTs per site.
The markets and applications for UST leak detection include: major oil
company service stations; major oil company production and storage facilities;
independent retail service stations; convenience stores that sell gasoline;
shipping and trucking firms; manufacturing and distribution firms with fleets;
airports; government and military sites equipped with underground storage tanks
and pipelines, and facilities with back-up power systems. All of these markets
contain applications appropriate for ENCOMPASS and Soil Sentry systems. In
addition, non-regulated fuel systems such as aboveground storage tanks can also
be monitored with the ENCOMPASS and Soil Sentry products.
Horizon
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Services - Horizon was acquired in 1992 to facilitate the penetration
of the UST market by the Company's Soil Sentry products. Horizon provided tank
testing services using a tracer testing system for USTs, which was licensed to
Horizon by Tracer Research Corp. ("Tracer") of Tucson, Arizona.
In 1996, Horizon began offering a complete set of products and services
which were required by its tank testing customers choosing to convert to a
permanent method of leak detection. Offering ENCOMPASS as the leak detection
compliance method, Horizon also provided installation management of the system,
cathodic protection, interior tank lining, spill/overfill protection as well as
other services and products required to upgrade the site to meet federal and
local leak detection requirements.
Markets - Horizon had been engaged since 1990 in the business of
testing USTs for leakage using EPA-recognized testing methods. Due to its
declining market share in tank testing, and its inability to generate profits
from tank upgrades, Horizon was discontinued in 1997.
Jerome Product Line
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Products - The first Jerome product was developed in 1976 as a portable
mercury detector for mining applications. The initial "mercury in soil" detector
spawned a line of hand-held, battery powered, field portable instruments capable
of detecting mercury vapor and hydrogen sulfide in minute quantities.
The Jerome 431-X mercury vapor analyzer ("Jerome Mercury Analyzer")
quickly and accurately quantifies low levels of mercury in ambient air for
on-site environmental testing, clean-up and analysis. Using the Company's
gold-film sensing technology, the unit can be carried to sources of mercury, and
displays results in seconds with the push of a button. After spill clean-up, the
analyzer can be used to verify that no hazardous residue remains.
The Jerome 631-X hydrogen sulfide analyzer ("Jerome H2S Analyzer")
detects and measures low levels of ambient hydrogen sulfide ("H2S"). Using the
Company's gold-film sensing technology, the hand-held instrument quickly
quantifies H2S levels down to parts-per-billion, allowing corrective action to
reduce complaints which arise at noxious-odor levels. The simple-to-operate,
push button unit is easily carried to sources of H2S where it monitors gas
levels to meet air quality standards.
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The Company is working on developing new proprietary gold film sensors
for future generations of the Company's Jerome line of toxic gas monitors.
Markets and Applications - Mercury - The market for Jerome Mercury
Analyzer comprises customers in three major groups:
Industrial Hygiene - These applications involve workplace screening to
ensure employees are not subjected to unacceptable mercury risk. The United
States Occupational Safety and Health Administration requires industries such as
battery and caustic soda manufacturers, thermometer and fluorescent light
manufacturers, hospitals and laboratories to monitor for mercury.
Industrial Process Quality Control - These customers test for mercury
in products where even trace amounts can have toxic effects, such as the
confined environments of submarines, engine rooms or spacecraft. Suppliers to
the National Aeronautics and Space Administration and the United States Navy are
required under procurement contracts to certify that certain equipment
components are mercury free.
Mercury Dental Amalgam Screening - Mercury and silver dental amalgams
have become the subject of intense scrutiny and controversy. The Jerome Mercury
Analyzer has been used in research on this topic, and the Company believes that
it is recognized in the dental and medical professions as the only portable
instrument that provides accurate mercury vapor readings at the required levels.
Markets and Applications - Hydrogen Sulfide - The Jerome H2S Analyzer
allows industries to monitor H2S in low parts per billion levels for odor and
corrosion control.
Odor Control - Jerome H2S Analyzers effectively quantify the noxious
odor of H2S given off from industrial processes in order to manage customer
complaints or potential litigation. The most common market is the wastewater
treatment industry.
Corrosion Control - Searching for and quantifying the presence of H2S
near costly industrial equipment is critical since H2S and its byproducts are
highly corrosive. Industries utilizing the Jerome H2S Analyzer for corrosion
control include wastewater treatment, oil and gas refining, and pulp and paper
processing.
Computrac Product Line
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Products - AZI was founded on the Computrac line of moisture analyzers.
The Computrac moisture analyzers simplify and automate a tedious industrial
quality control procedure. Typically, a sample material is weighed, then dried
in an oven for several hours to drive off moisture. The sample is weighed again
and the initial moisture content of the sample is computed based on the loss of
water weight. Computrac instruments house a heating chamber to dry the sample, a
precision balance to measure sample weight change and a microprocessor that uses
an algorithm to quickly extrapolate moisture content based on the rate of weight
loss. This technology is named the loss on drying or LOD technique.
Computrac instruments are rugged enough to be used on the factory floor
for quick batch analysis and accurate enough for precise laboratory testing.
They do not require a trained technician for operation. Thus, they can save
customers both time and money.
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In 1994, the Company completed development of the Computrac MAX-2000
and MAX-1000 moisture analyzers. The MAX-2000 uses the latest digital technology
to detect moisture levels accurately down to .005% in as little as two minutes.
The MAX-2000 is programmable from an easy-to-use front panel menu system,
allowing the user to store test parameters for 30 different sample materials. It
features a real-time front panel display of moisture values, the elapsing test
time and drying-curve graph, a statistical software package, and the ability to
send test results to a PC or printer.
In December 1995, the Company announced that it completed proof of
concept of its new line of Computrac moisture analyzers with Alpha and Beta
production units completed in 1996. The new product, targeted at the worldwide
titration market, requires no toxic reagents, is simple to use and maintain, and
offers excellent correlation and repeatability. The new Computrac product was
released for sale to customers during 1997 and additional product enhancements
are under development.
The MAX-500 was introduced in 1996 as a lower priced, reduced feature
version of the MAX-1000 and MAX-2000. The MAX-500 is for customers who do not
need all the features or the resolution of the other Computrac moisture
analyzers.
Markets and Applications - The markets for Computrac instruments tend
to be niche applications in various industries. Three primary industries have
yielded the Company's historical sales: Foods - measuring the moisture content
of cookie dough, cigarette tobacco, pasta and numerous other raw and finished
food products; Chemicals - measuring moisture and total solids content of such
chemical products as adhesives, coatings, and paints; and Plastics - measuring
the water content of resins used in molding or extrusion. Other applications
include pharmaceutical production and forestry management.
Product Reliability and Quality Control
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The Company believes its products are highly reliable. The Company's
products have built-in self-test features which are designed to insure that the
instrument is functioning properly and will provide an accurate result. If any
of the self-tests indicate abnormal conditions, the operator is alerted by a
light, and a coded display indicates the type of malfunction. The Company's
products have one-, two- and five-year parts and labor warranties. For the year
ended December 31, 1997, warranty expense approximated 2% of net sales.
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In February 1996, the Company announced that it achieved ISO 9001
Quality System Certification. This certification is registered through SGS
International Certification Services, Inc., an ANSI-RAB accredited registrar.
The ISO 9001 certification defines models for quality assurance in every phase
of business operations including design, development, quality control, customer
service, production, installation and service. Certification to the worldwide
ISO 9001 standard documents that the Company has in place policies, practices
and procedures to provide services using quality management systems in
compliance with International Organization of Standardization (ISO) model.
Manufacturing and Sources of Supply
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The majority of the Company's manufacturing costs are for purchased
components. Certain of the components are then provided to outside companies for
subassembly, with final assembly and testing performed by the Company. Although
two vendors currently supply in excess of 45% of the raw materials used in
Jerome's instrumentation, secondary vendors are available. The raw materials and
component parts are supplied by the two vendors pursuant to specifications by
the Company. The Company has prequalified certain other vendors and believes
that, if necessary, the raw materials and components could be supplied by such
other vendors without disruption of the manufacturing process or other adverse
effect on the Company.
Marketing and Sales; Backlog
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The Company's marketing and sales strategy is to identify major markets
its products can serve, evaluate the sales potential of each market segment, and
conduct specialized promotional campaigns, market by market, to elicit sales
inquiries from prospective customers. The majority of the Company's promotion
budget is spent on trade advertising, public relations and exhibiting at
industry trade shows.
Inquiries are processed through an in-house inquiry handling system.
Sales representatives are trained to follow up on inquiries and qualify the
applicability of the Company's products to the prospect's need.
Historically, due to the relatively short time period between receipt
of customer orders and shipment of products, the Company's backlog has been
quite low. Since 1988, the dollar amount of unfilled orders at the beginning of
any quarter has not exceeded 15% of sales for that quarter.
The Company markets its instruments for export through its own sales
force, as well as through foreign distributors in Canada, Europe, the Middle
East, the Far East, and Latin America.
Industries Served - Customers
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The specific industries served domestically by each product are
detailed in the specific Markets and Applications sections presented earlier.
One customer represented approximately 29% of net sales in 1997. The
Company is actively seeking to diversify sales of this product to other
customers and anticipates that additional customers will be added in the next 12
months.
Most export sales are to foreign distributors. The Company is unable to
determine which industries are served by the export sales, but believes them to
be similar in pattern to domestic sales. Export sales were
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approximately 14% of total sales in 1997, with no sales to any country exceeding
10% of net sales. (See Note I to the Consolidated Financial Statements)
The Company's business with United States government agencies is
effected through two contracts with the General Services Administration. Both
Jerome and Soil Sentry products are available for purchase by federal agencies
through these contracts. None of the contracts provide for renegotiation of
profits, except upon renewal of such contract or termination at the election of
the government. The contracts will expire in January 1999. The Company's
products and services are not subject to government approval. The Company is not
aware of any pending government regulations which would materially affect its
business.
Competition
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ENCOMPASS and Soil Sentry - There are a number of suppliers of
permanent storage tank monitoring systems which compete with the ENCOMPASS and
Soil Sentry product line. These companies are nationwide in scope and many
operate in foreign markets. Channels of distribution for the competition include
direct account sales, distributors, and manufacturers' representatives. The
ENCOMPASS and Soil Sentry products overlap the products of these competitors,
except that AZI believes that it is the only provider of an aspirated vapor
monitoring system.
Computrac - A number of companies have products which compete with
Computrac moisture analyzers. For applications where very low moisture levels
are measured, titrators provide the greatest competition. Many of these
companies operate both domestically and internationally.
Jerome - There is no significant competition for Jerome in applications
where low levels of hydrogen sulfide gas or mercury vapor need to be measured
with a hand-held ambient air analyzer. When a less sensitive instrument is
needed, the level of competition increases.
Research and Development
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The Company believes that the development of new products, enhancements
for existing products, and the development of new applications for its existing
products are critical to its success. Research and development expenses
increased 37% in 1997 compared to 1996. Expenditures for research and
development for the years ended December 31, 1997, 1996 and 1995 were $984,628,
$720,133, and $605,628, respectively. This represented 6.5% of sales in 1997,
6.8% of sales in 1996, and 5.7% of sales in 1995. The Company's research and
development expenditures for 1997 were channeled into the development of new
products in all three product lines. The Company also intends to develop
additional instrumentation products and services through OEM relationships and
the acquisition of related product lines or instrument companies.
Patents, Licenses and Trademarks
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The Company owns two patents directed to aspects of its Computrac
product, one patent directed to aspects of its Soil Sentry product, one patent
directed to its ENCOMPASS product and one domestic and five foreign patents
directed to aspects of its Jerome product. Two additional domestic Jerome
patents, one domestic ENCOMPASS patent and one Computrac patent are currently
pending. The Company does not
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believe that patents are a significant long-term competitive factor in these
businesses and intends to rely more on its on-going research and development,
engineering and customer service to maintain a long-term competitive advantage
in the market place. The Company has not granted licenses under any of its
patents and such patents have not been challenged or upheld in court. There can
be no assurance that the validity of the patents will be upheld if challenged.
The Company has trademarked its ENCOMPASS(TM) product.
Employees
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As of December 31, 1997, the Company had a total of 86 full time
employees and 2 part-time employees. The Company provides ongoing training to
its technical and sales personnel. None of the Company's employees are
represented by a union. Management believes that relations between the Company
and its employees are excellent.
ITEM 2. DESCRIPTION OF PROPERTY
The Company currently leases approximately 35,000 square feet in
Phoenix, Arizona. All administration, sales, customer service, engineering and
manufacturing for the Company are in the Phoenix facility. The lease on this
building expires in August 2003. The Company believes that its facilities are
modern, well-maintained and adequate for current needs.
ITEM 3. LEGAL PROCEEDINGS
On March 7, 1997, the Company was served with a summons and first
amended complaint which was filed in the United States District Court for the
District of Idaho on February 28, 1997 by United Co-op, Inc. and Idaho Petroleum
Clean Water Trust Fund. The complaint alleges breach of contractual promises and
breach of warranties in a commercial transaction for tank and line tightness
services. The Company does not believe that the resolution of this claim will
have a material adverse effect.
From time to time, the Company is involved in routine litigation that
is incidental to its business. The Company is not currently involved in any
other legal proceedings, the result of which the Company believes would have a
material adverse effect upon the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of security holders in
the fourth quarter of 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information regarding executive officers of
the Company.
George G. Hays, age 42, is the President, Chief Executive Officer and
Chairman of the Board of Directors. Mr. Hays joined the Company in 1997 as Vice
President of Finance, Chief Financial Officer, and Vice President of
Manufacturing. In November 1997, Mr. Hays was elected President and Chief
Executive
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Officer for the Company. In January 1998, Mr. Hays was elected Chairman of the
Board of Directors. Prior to his position with the Company, Mr. Hays was
president and founder of Hays Financial Group, Inc., an investment banking firm,
since 1986.
Walfred R. Raisanen, age 62, is the Vice President of Engineering of
the Company and a member of the Board of Directors. He served as Chairman of the
Board of Directors since the Company's inception in January 1981 until early
1998. Prior to his position with the Company, he was President and a Director of
Motorola Process Control, Inc., a predecessor to the Company.
Susan Berry, age 49, was named Secretary in early 1989. She has served
as Human Resources Manager for the Company since 1985. Prior to her position
with the Company, Ms. Berry was in corporate administration for Inter-Tel, Inc.
Allen Porter, age 40, was named Vice President of Marketing in 1996.
Mr. Porter has been with the Company since 1985, working in sales, sales
management and product management. Prior to his position with the Company, he
was program director for an Arizona-based behavioral health agency.
Linda Shepherd, age 46, was named Controller and Chief Accounting
Officer in mid-1997. Ms. Shepherd has been an accountant for the Company since
1984. Prior to her position with the Company, she served as an accountant for a
local trucking firm for nine years.
Executive officers are elected annually and serve at the discretion of
the Board of Directors.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on the Nasdaq Small Cap Market. As of
March 20, 1998, there were approximately 400 shareholders of record of the
Company's common stock, its only class of common equity. The high and low prices
set forth below are derived from the Nasdaq Monthly Statistical Report prepared
by the National Association of Securities Dealers, Inc., represent quotations by
dealers, may not reflect applicable markups, markdowns or commissions, and do
not necessarily represent actual transactions.
Bid
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1997 HIGH LOW
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First Quarter 2.56 2.44
Second Quarter 1.81 1.75
Third Quarter 1.65 1.50
Fourth Quarter 0.96 0.84
1996 HIGH LOW
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First Quarter 2.71 2.51
Second Quarter 3.42 3.11
Third Quarter 2.84 2.64
Fourth Quarter 2.63 2.38
The Company has never paid a cash dividend and currently intends to
retain all earnings for use in its business. The declaration and payment of
dividends in the future will be determined by the Board of Directors in light of
conditions then existing, including the Company's earnings, financial condition,
capital requirements and other factors. Dividends are also restricted by the
Company's lines of credit agreements with Silicon Valley Bank. See "Management's
Discussion and Analysis or Plan of Operation."
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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Except for the historical information contained herein, the discussion in this
Form 10-KSB contains certain forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, and the Company intends
that such forward-looking statements be subject to the safe harbors created
thereby. The forward-looking statements include statements regarding
management's anticipation of the Company's future market position, development
of additional products, product introduction and delivery dates, reliability of
products, adequate sources of supplies, acquisition of related product lines or
companies positive responses to new developments, and availability and terms of
credit. The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties, and on
assumptions that involve judgments with respect to, among other things, future
economic, competitive and market conditions, research and development results,
product introduction and delivery schedules, raw materials, market conditions,
stability of the regulatory environment, and future business decisions, all of
which are difficult or impossible to predict accurately and many of which are
beyond the control of the Company. Although the Company believes that the
assumptions underlying the forward-looking statements, many of which are beyond
the control of the Company, are reasonable, any of the assumptions could prove
inaccurate and, therefore, there can be no assurance that the results
contemplated in forward-looking information will be realized. Important factors
which may cause actual results to differ materially from those contemplated or
implied by such forward-looking statements are discussed in more detail in this
form 10-KSB and the Company's 1997 Annual Report to Shareholders. In light of
the significant uncertainties inherent in the forward-looking information
included herein, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives or plans
of the Company will be achieved.
Results of Operations
The following table sets forth items in the Company's Consolidated Statements of
Operations as a percent of total net sales for the years ended December 31 1997,
1996 and 1995. See ITEM 7 FINANCIAL STATEMENTS.
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<TABLE>
<CAPTION>
Percentage of Net Sales
-------------------------- Percentage change
Year Ended December 31, -------------------
-------------------------- 1997 vs 1996 vs
1997 1996 1995 1996 1995
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
NET SALES 100% 100.0% 100.0% 42.8% 0.7%
COST OF GOODS SOLD 51.8% 41.4% 40.6% 78.8% 2.6%
------- ------- ------- ------- -------
Gross margin 48.2% 58.6% 59.4% 17.5% -0.7%
------- ------- ------- ------- -------
EXPENSES
Marketing 25.5% 26.1% 24.9% 39.4% 5.4%
General & administrative 17.9% 15.8% 12.4% 61.6% 28.5%
Research & development 6.5% 6.8% 5.7% 36.7% 18.9%
Amortization & depreciation 4.0% 5.4% 4.7% 5.5% 14.5%
------- ------- ------- ------- -------
Total Expenses 53.8% 54.0% 47.7% 42.2% 13.9%
------- ------- ------- ------- -------
OPERATING INCOME (LOSS) -5.5% 4.6% 11.7% -271.0% -60.2%
------- ------- ------- ------- -------
OTHER REVENUE (EXPENSE)
Interest income 0.1% 0.2% 0.2% -33.3% 0.4%
Interest expense -0.9% -1.9% -3.7% -31.2% -48.6%
Settlement of litigation 0.0% 9.4% 0.0% -100.0%
Other 0.0% 0.6% 0.9% -103.2% -34.9%
------- ------- ------- ------- -------
Total other income (expense) -0.8% 8.3% -2.6% -114.2% -425.2%
INCOME (LOSS) BEFORE INCOME TAXES -6.4% 12.9% 9.1% -170.4% 42.1%
------- ------- ------- ------- -------
INCOME TAXES (BENEFIT) -2.4% -4.1% 0.1% -17.0% -4109.1%
------- ------- ------- ------- -------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS -4.0% 17.0% 9.0% -133.1% 89.8%
GAIN (LOSS) FROM DISCONTINUED OPERATIONS -4.2% -0.6% -4.0% -788.7% 90.2%
------- ------- ------- ------- -------
NET INCOME -8.1% 16.4% 5.0% -171.0% 227.7%
======= ======= ======= ======= =======
</TABLE>
1997 vs. 1996
- -------------
Net sales increased by $4,568,830 or 42.8% to $15,232,319 in 1997 from
$10,663,489 in 1996. Sales increased primarily due to increased sales of
Encompass installations, Encompass systems, and Computrac instruments. Net sales
of Jerome instruments declined slightly, while sales generated from customer
service activities were essentially flat.
Cost of goods sold increased by $3,474,626 or 78.8% to $7,885,507 in
1997 from $4,410,881 in 1996. Cost of goods sold was 51.8% of sales in 1997
compared to 41.4% of sales in 1996. Gross margin decreased primarily due to the
substantially larger portion of sales represented by low margin Encompass
installations, and to a lesser extent, a price reductions in the Computrac
product line and increases in material costs.
Operating expenses in 1997 increased by $2,428,791 or 42.2% to
$8,188,933 from $5,760,142 in 1996. The percentage increase in operating
expenses for 1997 over 1996 was in line with sales growth. Operating expenses
were 53.8% of sales in 1997, as compared to 54.0% of sales in 1996. Marketing
expenses increased by $1,096,572 or 39.4% to $3,881,984 from $2,785,412 in 1996.
Marketing expenses increased primarily due
14
<PAGE>
to increased activities necessary to support the growth in sales, and were 25.5%
of sales in 1997 as compared to 26.1% of sales in 1996. General and
administrative expenses increased by $1,036,512 or 61.6% to $2,720,249 from
$1,683,737 in 1996. General and administrative expenses were 17.9% of sales in
1997 as compared to 15.8% of sales in 1996. General and administrative expenses
increased in 1997 due to the costs associated with efforts taken to improve
profitability including severance packages to terminated employees, the write
off of bad debt, increased reserves for bad debt and other contingencies, the
shutting down of the Company's office in Singapore, and increased personnel
expenses. Research and development expenses increased by $264,495 or 36.7% in
1997 to $984,628 from $720,133 in 1996. The increase in research and development
expenses was primarily the result of a planned increase in research and
development personnel to support the new product activities for all the
Company's various product lines. Research and development expenses were 6.5% of
sales in 1997 as compared to 6.8% of sales in 1996. Amortization and
depreciation expenses increased by $31,212 or 5.5% to $602,072 from $570,860 in
1996, due to the purchase of additional capital equipment, including
demonstration units of the Company's own instruments as well as computer
equipment.
Other revenue (expense) in 1997 decreased by $1,007,722 or 114.2.% to
an expense of $125,600 as compared to income of $882,122 in 1996. The decrease
in other revenue was due primarily to other revenue of $997,096 recognized in
1996 related to the settlement of litigation, which did not recur in 1997.
Interest expense in 1997 decreased by $62,713 or 31.2% to $138,314 from $201,027
in 1996,due to a decrease in average borrowings.
As a result income from continuing operations before taxes decreased by
$2,342,309 or 170.4% to a loss of $967,721 from income before taxes of
$1,374,589 for 1996.
Income taxes from continuing operations for 1997 were a benefit of
$366,000 which approximated the statutory rate. For 1996, the Company realized
an income tax benefit from continuing operations of $441,000 as a result of
reducing the Company's deferred tax valuation allowance and recognizing a
deferred tax asset.
As a result, income from continuing operations for 1997 was a loss of
$601,721, a decrease of $2,417,310 or 133.1% from the income from continuing
operations of $1,815,589 generated for 1996.
Loss from discontinued operations for 1997 was $636,799 as the Company
discontinued its tank testing business which was performed through its Horizon
Engineering and Testing, Inc. subsidiary. The loss from discontinued operations
in 1996 was $71,652. The increased loss in 1997 of $565,147 as compared to 1996
was due primarily to expenses associated in shutting down the tank testing
business and the write off of intangible assets associated with the purchase of
Horizon in 1992.
As a result, net income decreased by $2,982,457 or 171.0% to a net loss
of $1,238,520 in 1997 from net income of $1,743,937 in 1996.
1996 vs. 1995
- -------------
Net sales increased by $70,931 or 0.7% to $10,663,489 in 1996 from
$10,592,558 in 1995. Sales increased for Encompass and Jerome products which
offset a decrease in sales of Computrac products. Sales generated from customer
service activities were essentially flat.
15
<PAGE>
Cost of goods sold increased by $113,155 or 2.6% to $4,410,881 in 1996
from $4,297,726 in 1995. Cost of goods sold was 41.4% of sales in 1996 compared
to 40.6% of sales in 1995. Gross margin decreased slightly due to the a lower
mix of sales of Computrac products.
Operating expenses in 1996 increased by $704,109 or 13.9% to $5,760,142
from $5,056,033 in 1995. Operating expenses were 54.0% of sales in 1996, as
compared to 47.7% of sales in 1995. Marketing expenses increased by $143,791 or
5.4% to $2,785,412 for 1996 as compared to $2,641,621 in 1995. Marketing
expenses increased primarily due to increased personnel expenses. Marketing
expenses were 26.1% of sales in 1996 as compared to 24.9% of sales in 1995.
General and administrative expenses increased by $373,449 or 28.5% to $1,683,737
from $1,310,288 in 1995. General and administrative expenses were 15.8% of sales
in 1996 as compared to 12.4% of sales in 1995. General and administrative
expenses increased in 1996 due to the increased personnel expenses. Research and
development expenses increased by $114,505 or 18.9% in 1996 to $720,133 from
$605,628 in 1995. The increase in research and development expenses was
primarily the result of a planned increase in research and development
activities to support new product development including the development of the
Computrac 3000 moisture analyzer. Research and development expenses were 6.8% of
sales in 1996 as compared to 5.7% of sales in 1995. Amortization and
depreciation expenses increased by $72,365 or 14.5% to $570,860 from $498,495 in
1995, due to the purchase of additional capital equipment.
Other revenue (expense) in 1996 increased by $1,153,383 to income of $882,122
from an expense of $271,261 in 1995. The increase in other revenue was due
primarily to other revenue of $997,096 recognized in 1996 related to the
settlement of litigation, which did not occur in 1995. Interest expense in 1996
decreased by $190,455 or 48.6% to $201,027 from $391,482 in 1995,due to a
decrease in average borrowings.
As a result income from continuing operations before taxes increased by
$407,051 or 42.1% to $1,374,589 compared to $967,538 for 1995.
Income taxes from continuing operations for 1996 were a benefit of
$441,000 which resulted from the reduction in the Company's deferred tax
valuation allowance and the recognition of a deferred tax asset. Income taxes
for 1995 were $11,000 which differed from the amount computed at the statutory
rate due to a change in valuation allowance.
As a result, income from continuing operations for 1996 was $1,815,589
an increase of $859,051 or 89.8% from the income from continuing operations of
$956,538 generated in 1995.
Loss from discontinued operations for 1996 was $71,652, an improvement
of $352,748 from the loss from discontinued operations of $424,400 incurred by
the Company in 1995. In 1997, the Company discontinued its tank testing business
which was performed through its Horizon Engineering and Testing, Inc.
subsidiary.
As a result, net income increased by $1,211,799 or 227.7% to $1,743,937
in 1995 from net income of $532,138 in 1995.
Liquidity and Capital Resources
- -------------------------------
16
<PAGE>
Working capital decreased 35.2% to $2,556,983 at December 31, 1997
compared to $3,947,282 at December 31 1996. The current ratio decreased to 1.6
at December 31, 1997 from 2.8 at December 31, 1996. The decrease in working
capital and the current ratio was primarily due to the Company's net loss.
At December 31, 1997, accounts receivable were $3,990,192 an increase
of $1,072,716 from the accounts receivable of $2,917,476 as of December 31,
1996. Receivables increased to support the increased level of sales. The ratio
of net sales to ending accounts receivable for 1997 was 3.8 as compared to 3.7
for 1996. This ratio increased due to a greater amount of sales being shipped
during the last part of 1997 as compared to 1996. Inventory at December 31, 1997
was $2,556,992 an increase of $507,010 from the inventory of $2,049,982 as of
December 31, 1996. Inventory increased due to substantially higher levels of
component inventory, primarily for the Encompass product line, which more than
offset a reduction in finished goods inventory.
Cash and cash equivalents at December 31, 1997 were $143,173, a
decrease of $454,758 from cash of $597,931 at December 31, 1996. Cash used by
operating activities was $283,093 for 1997. Cash was used by operating
activities primarily to fund the net loss of $1,238,520, an increase in
inventory , receivables, and the increase in deferred tax asset, which were
partially offset by depreciation and amortization of $1,167,514, a decrease in
other assets, and increases in accounts payable and accrued expenses. Cash used
by investing activities was $565,405 in 1997, which was due to capital
expenditures. Cash provided by financing activities was $393,739, as the Company
borrowed $1,066,000 under its line of credit and repaid $794,031 in long term
debt and capital leases.
As of December 31, 1997, the Company was operating under a forbearance
agreement with Silicon Valley Bank (the "Bank"), as a result of the breach of
certain financial covenants by the Company during 1997. This forbearance
agreement expired in February 1998. At December 31, 1997, the Company had lines
of credit with the Bank aggregating $3,500,000 which were collateralized by
accounts receivable, inventory and property, plant and equipment. These lines of
credit expired on March 15, 1998. At December 31, 1997, the Company had
$1,066,000 outstanding under these lines of credit. Of these borrowings,
$996,000 was at the Bank's prime rate of interest plus 1.5% (10% at December 31,
1997), and $70,000 was at the international borrowing rate. As part of this
credit facility the Company was able to borrow at prime plus 1.0% (9.5% at
December 31, 1997) to support international receivables 90% guaranteed by the
Export-Import Bank of the United States. The Company is currently negotiating
with the Bank to renew the lines of credit and revise the financial covenants
previously breached by the Company. Although there can be no assurance that the
Bank will renew the lines of credit or revise the financial covenants, the
Company believes that the Bank will continue to make credit available to it. It
is likely that any continuing borrowing arrangement with the Bank will contain
certain covenants, including minimum net income ratios and financial covenants.
There can be no assurance that the Company will be able to meet any such
covenants under any future borrowing arrangement with the Bank. Failure by the
Company to renew the lines of credit or the default of the Company under the
terms of the renewed borrowing arrangement will likely result in the
acceleration of all amounts payable under the borrowing arrangement. The failure
to maintain adequate credit facilities would have a material adverse effect on
the Company.
On November 17, 1995, the Company entered into a Loan Agreement with
the Bank. Pursuant to the Loan Agreement, at December 31, 1997 the Bank held a
note in the principal amount of $231,757 at an interest rate of prime plus 2%
17
<PAGE>
(10.5% at December 31, 1997) and a warrant to purchase up to 62,500 shares of
the Company's Common Stock at an exercise price of $2,08 per share. The Company
is required to pay 28 monthly principal payments of $13,633 and one final
payment of $13,629 in addition to monthly interest payments from January 7, 1997
through May 7, 1999. The note is cross-collateralized with the Company's bank
lines of credit with accounts receivable, inventory, and property, plant and
equipment. The note contains certain covenants, including minimum net income
levels and certain financial ratios. On a quarterly basis, half of any excess
cash flow that the Company generates is required to be used to prepay any
remaining principal balance due on this note. Excess cash flow is defined as net
income plus non-cash expenses less capital expenditures, scheduled principal
payments and increases in net working capital. At December 31, 1997, the Company
was not in compliance with certain covenants of this agreement and was operating
under a forebearance agreement with the Bank. The forebearance agreement expired
in February 1998. In connection with the renewal of the lines of credit
discussed above, the Company is negotiating with the Bank to revise the
financial covenants previously breached by the Company. See the paragraph above
for a discussion of the likelihood and effects of obtaining a renewed borrowing
arrangement.
On April 14, 1995, the Company entered into a Subordinated Loan
Agreement with Classic Syndicate, Inc. ("Classic"). Pursuant to the Subordinated
Loan Agreement, Classic held a 10% Note in the principal amount of $375,000 with
a maturity date of April 30, 1997. This Loan was repaid in 1997.
The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process data fields containing a 2
digit year is commonly referred to as the Year 2000 problem. As the year 2000
approaches, such systems may be unable to accurately process certain date-based
information.
The Company has identified some applications that will require modification to
address the Year 2000 problem. Internal and external resources will be used to
make the required modifications and test these modifications. The Company plans
on completing the modifications and testing of these modifications by mid 1999.
The total cost to the Company of these Year 2000 problem related activities is
not anticipated to be material. These costs and the date on which the Company
plans to complete the modifications and testing to solve the Year 2000 problem
are based upon management's estimates. However, there can be no assurance that
these estimates will be achieved and the costs of solving the Year 2000 problem
could differ significantly from management's estimates.
18
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
INDEX
Page
Independent Auditors' Report ............................................ 20
Consolidated Balance Sheets ............................................. 21
Consolidated Statements of Operations ................................... 22
Consolidated Statements of Shareholders' Equity ......................... 23
Consolidated Statements of Cash Flows ................................... 24
Notes to Consolidated Financial Statements .............................. 26
19
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Arizona Instrument Corporation:
We have audited the accompanying consolidated balance sheets of Arizona
Instrument Corporation and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Arizona Instrument Corporation and
subsidiaries as of December 31, 1997 and 1996 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Phoenix, Arizona
March 15, 1998
20
<PAGE>
ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
----------------------------
1997 1996
----------------------------
ASSETS
-------------------------------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 143,173 $ 597,931
Receivables, less allowance for doubtful
accounts of $279,000 and $165,000 3,990,192 2,917,476
Inventories:
Components 1,974,553 1,369,007
Finished Goods 582,439 680,975
----------------------------
Total Inventories 2,556,992 2,049,982
Current portion of notes receivable related party 45,501
Prepaid expenses and other current assets 49,942 550,840
----------------------------
Total current assets 6,740,299 6,161,730
PROPERTY, PLANT AND EQUIPMENT, net 975,180 846,458
GOODWILL, net of accumulated amortization 1,680,261 2,209,650
of $2,650,655 and $2,121,266
COVENANT NOT TO COMPETE, net of accumulated -- 102,084
amortization of $350,000 and $247,917
DEFERRED INCOME TAXES 1,431,237 641,437
OTHER ASSETS 764,739 1,062,805
----------------------------
TOTAL ASSETS $ 11,591,716 $ 11,024,164
============================
LIABILITIES AND SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
CURRENT LIABILITIES
Lines of credit $ 1,066,000 $ --
Accounts payable 1,342,539 771,679
Current portion of long-term debt and
capital lease obligations 284,801 794,268
Other accrued expenses 1,489,976 648,501
----------------------------
Total current liabilities 4,183,316 2,214,448
LONG-TERM DEBT AND CAPITAL LEASE
OBLIGATIONS - less current portions 93,444 378,010
SHAREHOLDERS' EQUITY
Common stock, .01 par value per share:
Authorized, 10,000,000 shares;
Issued, 6,774,696 and 6,677,680 shares 67,747 66,777
Preferred stock, $.01 par value per share:
Authorized, 1,000,000 shares
Additional paid-in capital 9,826,963 9,706,163
Deficit (2,357,303) (1,118,783)
----------------------------
7,537,407 8,654,157
Less treasury stock, 86,165 shares at cost (222,451) (222,451)
----------------------------
Total shareholders' equity 7,314,956 8,431,706
============================
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 11,591,716 $ 11,024,164
============================
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
21
<PAGE>
ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
-----------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
NET SALES $ 15,232,319 $ 10,663,489 $ 10,592,558
COST OF GOODS SOLD 7,885,507 4,410,881 4,297,726
------------ ------------ ------------
Gross margin 7,346,812 6,252,608 6,294,832
------------ ------------ ------------
EXPENSES
Marketing 3,881,984 2,785,412 2,641,621
General & administrative 2,720,249 1,683,737 1,310,288
Research & development 984,628 720,133 605,628
Amortization & depreciation 602,072 570,860 498,495
------------ ------------ ------------
TOTAL EXPENSES 8,188,933 5,760,142 5,056,033
------------ ------------ ------------
OPERATING INCOME (LOSS) (842,121) 492,466 1,238,799
------------ ------------ ------------
OTHER REVENUE (EXPENSE)
Interest income 14,751 22,124 22,038
Interest expense (138,314) (201,027) (391,482)
Settlement of litigation (Note J) -- 997,096
Other (2,037) 63,929 98,183
------------ ------------ ------------
TOTAL OTHER INCOME (EXPENSE) (125,600) 882,122 (271,261)
------------ ------------ ------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES (967,721) 1,374,589 967,538
------------ ------------ ------------
INCOME TAXES (BENEFIT) (366,000) (441,000) 11,000
------------ ------------ ------------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS (601,721) 1,815,589 956,538
------------ ------------ ------------
LOSS FROM DISCONTINUED OPERATIONS, NET OF INCOME
TAX BENEFIT OF $388,000, $47,000, AND $0 (636,799) (71,652) (424,400)
------------ ------------ ------------
NET INCOME $ (1,238,520) $ 1,743,937 $ 532,138
============ ============ ============
NET INCOME (LOSS) PER SHARE - BASIC:
FROM CONTINUING OPERATIONS $ (0.09) $ 0.28 $ 0.15
============ ============ ============
FROM DISCONTINUED OPERATIONS $ (0.10) $ (0.01) $ (0.07)
============ ============ ============
NET INCOME (LOSS) $ (0.19) $ 0.27 $ 0.08
============ ============ ============
NET INCOME (LOSS) PER SHARE - DILUTED:
FROM CONTINUING OPERATIONS $ 0.09 $ 0.26 $ 0.14
============ ============ ============
FROM DISCONTINUED OPERATIONS $ 0.10 $ (0.01) $ (0.06)
============ ============ ============
NET INCOME (LOSS) $ 0.19 $ 0.25 $ 0.08
============ ============ ============
BASIC SHARES OUTSTANDING 6,647,689 6,507,112 6,186,966
EQUIVALENT SHARES - STOCK OPTIONS -- 444,699 397,894
------------ ------------ ------------
DILUTED SHARES OUTSTANDING 6,647,689 6,951,811 6,584,860
============ ============ ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
22
<PAGE>
ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Additional (Deficit)
Common Stock paid-in retained Treasury
Shares Amount capital earnings stock TOTAL
------------- ----------- -------------- ----------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE JANUARY 1,1995 6,195,484 $ 61,955 $ 9,294,400 $ (3,395,306) $ (222,451) $ 5,738,598
Issuance of stock pursuant to:
Stock purchase plan 46,476 465 37,806 38,271
Exercise of warrants 105,603 1,056 21,444 22,500
Exercise of stock options 5,000 50 7,300 7,350
Net Income 532,585 532,585
------------- ----------- -------------- ----------------- ------------ -------------
BALANCE DECEMBER 31, 1995 6,352,563 63,526 9,360,950 (2,862,721) (222,451) 6,339,304
Issuance of stock pursuant to:
Stock purchase plan 40,637 406 57,207 57,613
Exercise of warrants 22,714 227 27,773 28,000
Earnout agreement 208,424 2,084 200,501 202,585
Exercise of stock options 53,342 534 59,732 60,266
Net Income 1,743,938 1,743,938
------------- ----------- -------------- ----------------- ------------ -------------
BALANCE DECEMBER 31, 1996 6,677,680 66,777 9,706,163 (1,118,783) (222,451) 8,431,706
Issuance of stock pursuant to:
Stock purchase plan 43,756 437 72,367 72,804
Exercise of stock options 53,260 533 48,433 48,966
Net Income (1,238,520) (1,238,520)
------------- ----------- -------------- ----------------- ------------ -------------
BALANCE DECEMBER 31, 1997 6,774,696 $ 67,747 $ 9,826,963 $ (2,357,303) $ (222,451) $ 7,314,956
============= =========== ============== ================= ============ =============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
23
<PAGE>
ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $(1,238,520) $ 1,743,937 $ 532,138
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Depreciation and amortization 1,167,514 804,495 779,577
Gain on sale or abandonment of property,
plant and equipment 0 (34,570) (62,294)
Provision for losses on receivables 113,855 (25,289) 4,257
Provision for inventory obsolesence 35,035
Change in operating assets and liabilities:
(Increase) decrease in receivables (1,186,571) 479,650 486,164
(Increase) decrease in inventories (542,046) (256,212) 296,388
Decrease in other current assets 546,400 46,257 11,639
Increase in settlement receivable 0 (364,419)
Increase in deferred tax asset (789,800) (518,000)
(Increase) decrease in other assets 198,707 (330,412) 21,011
(Decrease) increase in accounts payable 570,860 (91,707) 47,025
(Decrease) increase in accrued expenses 841,474 (222,635) 125,836
------------ ------------ ------------
NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES (283,092) 1,231,095 2,241,741
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of property, plant
and equipment and other assets (565,405) (207,354) (106,523)
Proceeds from sale of property, plant
and equipment and other assets 0 77,897 80,553
------------ ------------ ------------
NET CASH USED BY
INVESTING ACTIVITIES (565,405) (129,457) (25,970)
------------ ------------ ------------
</TABLE>
(continued)
24
<PAGE>
ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES:
Borrowings of long-term debt $ - $ - $ 1,625,000
Payments of long-term debt and capital leases (794,031) (1,104,058) (2,441,192)
Net (payments) borrowings under bank
lines of credit 1,066,000 (250,000) (1,375,000)
Proceeds received on notes receivable 0 15,506 5,703
Stock issued for warrants and options 0 88,265 29,850
Sale of common stock, net proceeds 48,966
Issuance of common stock for earnout agreement 0 202,585
Issuance of common stock pursuant
to stock purchase plan 72,804 57,613 38,271
------------ ------------ ------------
NET CASH (USED) PROVIDED BY
FINANCING ACTIVITIES 393,739 (990,089) (2,117,368)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (454,758) 111,549 98,403
CASH AND CASH EQUIVALENTS,
beginning of year 597,931 486,382 387,979
------------ ------------ ------------
CASH AND CASH EQUIVALENTS
end of year 143,173 597,931 486,382
============ ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Transfer of inventories to property, plant and
equipment to be used as demonstration units 315,354 57,057 100,589
Property, plant and equipment acquired through
capital lease obligations 51,524
Interest paid 153,736 126,172 502,759
Income taxes paid 90,000 5,025 4,669
</TABLE>
25
<PAGE>
ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
-----------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
THREE YEARS ENDED DECEMBER 31, 1997
-----------------------------------
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidated financial statements include the accounts of Arizona
Instrument Corporation and its wholly-owned subsidiaries (collectively,
the "Company"). All material intercompany profits, transactions and
balances have been eliminated upon consolidation.
Description of business. Arizona Instrument Corporation designs,
manufactures and markets the Computrac line of automated microprocessor
controlled analytical instruments used to measure the moisture content
of various materials, the ENCOMPASS and Soil Sentry line of
computer-based fuel management and compliance leak detection
instruments for monitoring underground storage tanks (USTs) and the
Jerome line of toxic gas detection instruments primarily used to detect
mercury and hydrogen sulfide. The Company also provided tank testing
and related services for the underground storage tank market through
its subsidiary, Horizon Engineering and Testing, Inc. In 1997, the
Company discontinued the operations of Horizon Engineering and Testing,
Inc. See Note K. The Company sells in the United States and also in
international markets.
Sales of instruments are recognized once the shipment is made.
Inventories are stated at the lower of cost (first-in, first-out
method) or market.
Property, plant and equipment are recorded at cost. Depreciation is
provided by the straight-line method over the estimated useful lives of
the various classes of assets. Equipment and furniture/fixtures are
estimated to have 5 and 7 year lives, respectively. Leasehold
improvements are amortized over the shorter of the estimated useful
life or the period of the lease. Equipment under capital leases are
generally amortized over the estimated lives of the related equipment.
Goodwill is the cost of investments in purchased companies in excess of
the fair value of net assets of the businesses acquired. Goodwill is
amortized on a straight-line basis over 20 years for the Jerome
goodwill and over 10 years for the Horizon goodwill (See Note K). The
Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 121 during 1995. SFAS No. 121
establishes the accounting standard for the impairment of long-lived
assets, certain identifiable intangibles, and goodwill related to those
assets to be held and used for long-lived assets and certain
identifiable intangibles to be disposed of. The Company adopted SFAS
No. 121 effective January 1, 1996.
Covenant not to compete resulted as part of the Horizon acquisition in
1992 and had been amortized on a straight line basis. See Note K.
Debt issue costs are amortized using the interest method over the term
of the related debt.
26
<PAGE>
Stock-based compensation. In October 1995, the Financial Accounting
Standards Board issued SFAS No. 123 "Accounting for Stock Based
Compensation". The Company has determined that it will not change to
the fair value method and will continue to use Accounting Principles
Board Opinion No. 25 for measurement and recognition of employee stock
based compensation. SFAS No. 123 additional disclosures have been
included in the financial statements.
Income (Loss) per share is computed on the weighted average number of
common or common and common equivalent shares outstanding during each
year. Basic EPS is computed as net income (loss) divided by the
weighted average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution that could occur from
common shares issuable through stock options, warrants, and other
convertible securities and includes shares issuable upon exercise of
stock options when dilutive.
Statements of cash flows - For purposes of the consolidated statements
of cash flows, cash and cash equivalents represent cash in bank and
money market funds.
Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles necessarily
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 these estimates.
New accounting pronouncements - In February 1997, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share", effective
for both interim and annual periods ending after December 15, 1997.
This statement specifies the computation, presentation and disclosure
of earnings per share for entities with publicly held common stock or
potential common stock. Prior year disclosure of earnings per share
have been restated to comply with SFAS No. 128.
The Financial Accounting Standards Board recently issued SFAS No. 130
on "Reporting Comprehensive Income" and SFAS No. 131 on "Disclosures
about Segments of an Enterprise and Related Information." The
"Reporting Comprehensive Income" standard is effective for fiscal years
beginning after December 15, 1997. The standard changes the reporting
of certain items currently reported in the stockholders' equity section
of the balance sheet. The Company is currently evaluating what impact
this standard will have on the Company's financial statements. The
"Disclosures about Segments on an Enterprise and Related Information"
standard is effective for fiscal years beginning after December 15,
1997. This standard requires that public companies report certain
information about operating segments in their financial statements. It
also establishes related disclosures about products and services,
geographic areas, and major customers. The Company is currently
evaluating what impact this standard will have on its financial
statements and related disclosures.
B. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 31 consists of the following;
27
<PAGE>
1997 1996
----------------- ---------------
Leasehold Improvements $ 169,654 $ 157,604
Furniture, fixtures and equipment 4,452,959 3,936,984
Automobiles 99,358 99,359
----------------- ---------------
4,721,971 4,193,947
Less accumulated depreciation (3,746,791) (3,347,489)
----------------- ---------------
and amortization
$ 975,180 $ 846,458
================= ===============
C. BANK LINES OF CREDIT
At December 31, 1997, the Company had two lines of credit available
(one for domestic operations and one for international operations)
collateralized by accounts receivable, inventory, and property, plant
and equipment which provided for an aggregate maximum commitment of
$3,500,000 through March 15, 1998. At December 31, 1997, the Company
had $996,000 outstanding under its domestic line of credit at the
bank's prime rate of interest plus 1.5% (10% at December 31, 1997). The
Company also had $70,000 outstanding under the international line of
credit at December 31, 1997. Borrowings under this line of credit were
at the bank's prime rate of interest plus 1.0% (9.5% at December 31,
1997). The lines of credit contained certain covenants, including
minimum net income levels and certain financial ratios. The lines of
credit expired on March 15, 1998 and have not yet been renewed. The
Company was not in compliance with certain bank covenants at December
31, 1997, and was operating under a forbearance agreement which expired
in February 1998.
D. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt and capital lease obligations at December 31 consist of
the following:
1997 1996
--------------- ------------
Capital lease obligation $ 146,487 $ 398,557
Notes payable 0 375,000
Notes payable to the bank 231,758 398,721
--------------- ------------
Total Debt and Capital Leases 378,245 1,172,278
Less current position 284,801 794,268
--------------- ------------
Long-Term Portion of Debt and Capital Leases $ 93,444 $ 378,010
=============== ============
28
<PAGE>
On April 14, 1995, the Company entered into an agreement with Classic
Syndicate, Inc. ("Classic"). Pursuant to the Subordinated Loan
Agreement, Classic held a 10% Note in the principal amount of $375,000
The loan matured during 1997 and was repaid in full.
On November 17, 1995, the Company entered into an agreement with a bank
("Bank"). Pursuant to the Loan Agreement, the Bank holds a Note in the
principal amount of $231,758 at an interest rate of prime plus 2%
(10.5% at December 31, 1997) and a warrant to purchase up to 62,500
unregistered shares of the Company's Common Stock at an exercise price
of $2.08 per share. The Company is required to pay 28 monthly principal
payments of $13,633 and one final payment of $13,629 in addition to
monthly interest payments from January 7, 1997 through May 7, 1999. The
Note is cross-collateralized with the Company's bank lines of credit
with accounts receivable, inventory, and property, plant and equipment.
The Note contains certain covenants, including minimum net income
levels and certain financial ratios. On a quarterly basis, half of any
excess cash flow that the Company generates, is required to be used to
prepay any remaining principal balance due on this Note. Excess cash
flow is defined as net income plus non-cash expenses less capital
expenditures, scheduled principal payments and increases in net working
capital. At December 31, 1997, the Company was not in compliance with
certain covenants of this agreement and was operating under a
forbearance agreement with the Bank. The forebearance agreement expired
in February 1998.
Long-term debt and capital lease obligations at December 31, 1997 are
payable as follows:
1998 $ 284,801
1999 81,618
2000 11,826
-----------------
$ 378,245
=================
E. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standard ("SFAS") No. 107
"Disclosures About Fair Value of Financial Instruments" was adopted for
the year ending December 31, 1995. SFAS No. 107 requires disclosure of
the estimated fair value of certain financial instruments. The Company
has estimated the fair value of its financial instruments using
available market data. However, considerable judgement is required in
interpreting market data to develop estimates of fair value. The use of
different market assumptions or methodologies may have a material
effect on the estimates of fair values. The carrying values of cash,
receivables, lines of credit, accounts payable, accrued expenses, and
long term debt and capital lease obligations approximate fair values
due to the short-term maturities or market rates of interest.
F. SHAREHOLDERS' EQUITY
In March 1985, the Company adopted a Stock Option Plan ("SOP") under
which the Company could, for a period of ten years, grant options to
purchase up to 250,000 shares of the Company's Common Stock. SOP
options may be granted to employees, officers or directors of the
Company or any
29
<PAGE>
subsidiary. The exercise price of options must be at least the fair
market value of the Company's Common Stock on the date of grant and the
options must be exercised within 11 years from the date of grant.
In April 1991, the Company adopted the 1991 Stock Option Plan ("OP")
under which the Company may, for a period of ten years, grant incentive
stock options and nonstatutory stock options to purchase up to 450,000
shares of the Company's Common Stock. In May, 1996 the Board of
Directors amended this Plan to increase the shares reserved for
issuance by 300,000 shares. Additionally, each year, the number of
shares of stock that may be issued is increased automatically by 1% on
January 1 if certain conditions are met. Stock options may be granted
to employees, directors and other persons whose participation is deemed
to be in the Company's best interest, but only employees may be granted
incentive stock options. Incentive stock options granted under the plan
have a maximum term of ten years and nonstatutory options may have a
maximum term of twenty years. The exercise price for an incentive stock
option must be at least the fair market value of the Company's common
stock on the date of grant. The exercise price for a nonstatutory
option may be any amount above the par value of the Company's Common
Stock determined in good faith.
The following is a summary of stock option activity:
Weighted
Average
Exercise
Number Price
Of Shares Per Share
Outstanding January 1, 1995 377,884 $ 2.39
Granted 678,903 0.92
Canceled (332,884) 2.39
Exercised (5,000) 1.47
-----------
Outstanding December 31, 1995 718,903 1.00
Granted 145,000 2.57
Canceled (17,850) 0.92
Exercised (53,342) 0.96
-----------
Outstanding December 31, 1996 792,711 1.29
Granted 97,500 1.91
Canceled (182,240) 0.96
Exercised (53,260) 0.99
-----------
Outstanding December 31, 1997 654,711 $ 1.50
============ =============
30
<PAGE>
At December 31, 1997, 225,083 options were exercisable. At December 31,
1996, 141,544 options were exercisable.
In January 1985, the Company adopted an Employee Stock Purchase Plan
which provides for the sale of up to 200,000 shares of common stock to
qualifying employees of the Company. In May, 1996 the Board of
Directors amended this Plan to increase the shares reserved for
issuance by 200,000 shares.
The purchase price of the stock is 85% of the lesser of the fair market
value at the beginning or the end of the offering period, January and
July of each year. During the years ended December 31, 1997, 1996 and
1995 a total of 43,756, 40,637 and 46,476 shares of common stock have
been purchased at average prices of $1.66, $1.42 and $.82 per share,
respectively. As of December 31, 1997 a total of 137,507 shares were
available under this plan.
The estimated fair value of options granted during 1997 was $0.57 per
share, while the estimated fair value of options granted during 1996
was $1.15 per share. The Company applies Accounting Principles Board
Opinion No. 25 and related interpretations in accounting for its stock
option and purchase plans. Accordingly, no compensation cost has been
recognized for its fixed stock option plans. Had compensation cost for
the Company's stock option plans been determined based on the fair
value at the grant dates for awards under those plans consistent with
the method of FASB Statement 123, the Company's net income and earnings
per share for the years ended December 31 would have been reduced to
the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Net income (loss) to common shareholders
As reported ($1,238,520) $1,743,937 $532,138
Pro forma ($1,266,730) $1,671,943 $485,340
Net income (loss) per common and dilutive share
As reported ($0.19) $0.25 $0.08
Pro forma ($0.19) $0.24 $0.07
</TABLE>
The fair values of options granted under the Company's fixed stock
option plans were estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used: No dividend yield, expected volatility of 35%, risk
free interest rate of 6.4% and expected lives of 3 years from vest
date.
Stock Private Placement
-----------------------
At November 30, 1993 the Company completed a private placement of
2,090,000 shares of common stock raising gross proceeds of $2,612,550
and net proceeds after fees and expenses of $2,195,523. The proceeds
were used to reduce debt, to obtain certain European product
certifications, and for new product development. The Company also
utilized $159,999 of the net proceeds to redeem 73,845 shares of its
common stock held primarily by Mr. Quinn Johnson, a director and
executive officer of the Company. On November 30, 1993, the Company
issued a warrant to purchase up to 209,000 shares at an exercise price
of $1.25 per share to the placement agent in connection with the
private placement of the Company's stock.
31
<PAGE>
A shelf registration statement covering 3,781,000 shares of common
stock issued in the private placement described above in a 1992 private
placement and in connection with the Horizon acquisition was declared
effective by the Securities and Exchange Commission on February 11,
1994.
G. INCOME TAXES
The (benefit) provision for income taxes for the years ended December
31, consists of the following:
1997 1996 1995
-------------- ------------ ------------
Current $ 35,800 $ 30,000 $ 11,000
Deferred (789,800) (518,000)
$ (754,000) $ (488,000) $ 11,000
============== ============ ============
The provision for income taxes as shown in the accompanying
consolidated statements of operations differs from the amounts computed
by applying the federal statutory income tax rates to income before
income taxes. A reconciliation of the (benefit) provision for income
taxes and the amounts that would be computed using the statutory
federal income tax rates for the years ended December 31 is set forth
below:
1997 1996 1995
------------- ------------ ------------
Provision (benefit) computed at
Federal statutory rates $ (678,000) $ 427,000 $ 185,000
State taxes (120,000) (15,500) 9,000
Goodwill 63,000 63,500 63,000
Other (19,000) (19,000) 66,000
Change in valuation allowance - (944,000) (312,000)
------------- ------------ ------------
$ (754,000) $ (488,000) $ 11,000
============= ============ ============
Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes, and (b) operating loss and tax credit carryforwards The tax
effects of significant items comprising the Company's net deferred tax
asset as of December 31 are as follows:
32
<PAGE>
1997 1996
----------- -----------
Deferred tax assets:
Reserves not currently deductible $ 323,000 $ 216,000
Operating loss carryforwards 636,000 123,000
Tax credit carryforwards 380,000 380,000
Difference between book and tax basis
of property 94,000 4,000
----------- -----------
Total deferred tax assets 1,433,000 723,000
Deferred tax liabilities
Other intangibles 0 (43,000)
Other (1,763) (39,500)
----------- -----------
Total deferred tax liabilities (1,763) (82,500)
Valuation allowance -- --
=========== ===========
Net deferred tax asset $ 1,431,237 $ 640,500
=========== ===========
The Company has evaluated its past earnings history and trends, sales
backlog and budgets and determined that it is more likely than not that
its deferred tax assets will be realized.
At December 31, 1997, the Company had net operating loss carryforwards
of approximately $1,600,000 available to reduce federal taxable income.
These net operating losses begin to expire in 2005.
H. PROFIT SHARING PLAN
Full time employees with greater than six months of service are
eligible to participate in the Company's 401K profit sharing retirement
plan adopted in 1981 whereby, at the Board of Directors' discretion,
contributions are made on an annual basis. Contributions made in any of
the three years ended December 31, 1997 have not been material.
I. SALES
Export sales, primarily to Canada, Korea and Sweden were approximately
$2,118,975, $2,191,000 and $1,950,000 for the years ended December 31,
1997, 1996 and 1995, respectively.
The Company has a concentration of sales of a product to a customer
that makes up approximately 29% of net sales during 1997. The potential
for a negative financial impact could result from a partial or total
loss of the business relationship with this customer. Management
believes that the relationship between the Company and the customer was
good at December 31, 1997. Management is actively seeking to diversify
sales of this product to a number of other customers.
J. COMMITMENTS AND CONTINGENCIES
Leases
------
Certain office facilities and equipment are held under capital and
operating leases. These leases expire in periods through 2004 and
include renewal options. Capital leases included in Property and
33
<PAGE>
Equipment total $1,281,374 and $1,281,374 (less accumulated
amortization of $1,160,190 and $945,105) as of December 31, 1997 and
1996, respectively.
At December 31, 1997, future minimum lease payments under such leases
having non-cancelable terms in excess of one year are summarized as
follows:
Operating
Minimum Lease Payments Capital leases Leases
----------------- ---------------
1998 131,000 333,422
1999 13,500 338,991
2000 12,000 328,182
2001 0 317,604
2002 0 304,900
Thereafter 0 568,511
----------------- ---------------
Total minimum lease payments 156,500 2,191,610
===============
Less amount representing interest 10,012
-----------------
Net present value of future minimum
Lease payments 146,488
=================
Rent expense for operating leases was approximately $289,598, $325,000
and $360,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.
Genelco Earnout Agreement
-------------------------
In connection with the Company's purchase of Genelco, Inc. on January
30, 1988, the Company entered into a potential $700,000 earnout
agreement based on future sales. The agreement was modified on December
31, 1992 for a remaining earnout of $202,585 to be compensated with
208,421 shares of unregistered common stock in 1996. Through December
31, 1991, $155,669 has been earned under the prior earnout agreement.
Under the modified agreement, the expense was $33,765, $33,764 and
$33,764 for the years ended December 31, 1997, 1996 and 1995,
respectively. In March 1996 the Company issued 208,421 shares of
unregistered common stock under the modified agreement. The earnout
period under the modified agreement was completed on December 31, 1997.
Litigation
----------
In a prior year, litigation was commenced in Superior Court, Maricopa
County, Arizona with respect to certain matters arising in connection
with a technology development agreement and related agreements entered
into by the Company and a state organization in 1988 related to the
Company's Jerome product line and providing the Company with certain
rights thereunder. The Company believed, not withstanding such
agreements, the state organization exclusively licensed relevant
technology to another firm in February 1993. The Company filed suit in
February 1996 against this firm and, the state organization and certain
other defendants requesting a declaratory judgement, confirming the
34
<PAGE>
Company's right to the contested technology and seeking damages. The
firm also filed suit in January 1996 against the state organization,
AZI and certain executive officers of AZI seeking declaratory judgement
confirming the validity of its license agreement with the state
organization and seeking damages. The parties reached a settlement in
June, 1996 under which the Company would receive $1,000,000 and certain
free education rights, in addition to exclusive rights to the contested
technology. The Company has received full payment of this settlement as
of January 30, 1997.
From time to time, the Company may become a defendant as the result of
a claim filed by a customer alleging breach of contractual promises and
warranties in a commercial transaction. While the outcome of any such
claim cannot be determined at this time, management of the Company does
not believe that the ultimate disposition of these claims will have a
material effect on the financial position or results of operations or
cash flows of the Company.
K. DISCONTINUED OPERATIONS
In August 1997, the Company adopted a plan to discontinue the
operations of Horizon Engineering and Testing, Inc. ("Horizon"). The
disposition of Horizon was substantially completed by December 31,
1997. Net assets of the discontinued operation at December 31, 1997 and
1996 were $0 and $541,146 respectively. Such assets were primarily
goodwill and other intangibles. The Company estimates that the final
disposal of Horizon will not have a material effect on the Company's
operations during 1998. The loss from discontinued operations for 1997
(before income tax benefit) includes a write-off of goodwill and other
intangibles of $444,705 and a loss from operations of $580,713.
L. RELATED PARTY TRANSACTIONS
During September 1993, the Company loaned $45,000 to one of its
officers. The loan was collateralized by a pledge of 15,000 shares of
common stock of the Company and the cash value of a life insurance
policy. During 1996, a $10,000 principal payment was made on this loan
leaving a remaining balance of $35,000. The note bears interest at 10%
per annum and the remaining balance was due December, 1997. During
April 1994, the Company loaned approximately $10,000 to another
officer. The note bears interest at 10% and was due December, 1997.
These loans have been repaid.
35
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable
PART III
ITEMS 9 THROUGH 12.
Within 120 days after the close of the fiscal year, the Company intends
to file with the Securities and Exchange Commission a definitive proxy statement
pursuant to Regulation 14A which will involve the election of directors. The
answers to Items 9 through 12 are incorporated by reference pursuant to General
Instruction E(3).
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
Financial Statements. The following is a list of the consolidated financial
statements of Arizona Instrument Corporation and its subsidiaries included in
Item 8 of Part II.
Independent auditors' report
Consolidated balance sheets - December 31, 1997 and 1996
Consolidated statements of operations - Years ended December 31, 1997, 1996 and
1995
Consolidated statements of shareholders' equity - Years ended December 31, 1997,
1996 and 1995
Consolidated statements of cash flows - Years ended December 31, 1997, 1996 and
1995
Notes to consolidated financial statements
(a) The following exhibits are incorporated by reference or are filed with this
Form 10-KSB, as indicated.
3.1 Composite of Certificate of Incorporation of Registrant, as amended
through July 5, 1994. Incorporated by reference from Registrant's Form
8-A filed on June 26, 1996 (the "June 1996 8-A").
36
<PAGE>
3.2 Bylaws of Registrant, as amended. Incorporated by reference from the
June 1996 8-A.
10.1* Registrant's 1985 Stock Option Plan. Incorporated by reference from
Registrant's Form 10-KSB for the year ended December 31, 1995 filed in
March 1996.
10.2* Registrant's 1985 Stock Purchase Plan. Incorporated by reference from
Registrant's Form S-8 filed on August 5, 1996.
10.3* Registrant's 1991 Stock Option Plan. Incorporated by reference from
Registrant's Form S-8 filed on June 28, 1996.
10.4 Amended and Restated Export-Import Guaranteed Business Loan Agreement
between Registrant and Silicon Valley Bank dated February 1993.
Incorporated by reference From Registrant's Form 10-KSB for the year
ended December 31, 1992, filed in March 1993 (the "1992 10-KSB").
10.5 Warrant Purchase Agreement between Registrant and Silicon Valley Bank
dated December 14, 1991. Incorporated by reference from the 1992
10-KSB.
10.6 Loan Modification Agreement between Registrant and Silicon Valley Bank
dated November 7, 1995. Incorporated by reference to Registrant's Form
10-KSB for the Year ended December 31, 1995 filed on March 29, 1996
(the "1995 10-KSB").
10.7 Promissory Note between Registrant and Silicon Valley Bank dated
November 7, 1995. Incorporated by reference to the 1995 10-KSB.
10.8 Loan Modification Agreement between Registrant and Silicon Valley Bank
dated March 24, 1997. Filed herewith.
10.9 Promissory Note between Registrant and Classic Syndicate, Inc. dated
April 15, 1996. Incorporated by reference to the 1995 10-KSB.
10.10 Warrant Agreement between Registrant and Cruttenden & Co., Inc. dated
November 30, 1993. Incorporated by reference from Registrant's Form
10-QSB for the quarter ended September 30, 1993 filed on November 30,
1993 (the "September 1993 10-QSB").
10.11 Lease Agreement between Registrant and Wood Street Limited Partnership
dated September 1, 1993. Incorporated by reference from the September
1993 10-QSB.
10.12* Employment Agreement between Registrant and Walfred R. Raisanen dated
November 5, 1992. Incorporated by reference to the 1992 10-KSB.
10.13* Employment Agreement between Registrant and George G. Hays dated April
1, 1997. Incorporated by reference from Registrant's Form 10-QSB for
the quarter
37
<PAGE>
Ended March 31, 1997 filed on May 15, 1997.
10.14* Employment Agreement between Registrant and George G. Hays dated
January 1, 1998. Filed herewith.
21.1 Subsidiaries of Registrant. Filed herewith.
23.1 Consent of Deloitte & Touche LLP. Filed herewith.
27. Financial Data Schedule. Filed herewith.
- ------------------
*Management contract of compensatory plan or arrangement required to be filed
pursuant to Item 13(a) of Form 10-KSB.
(b) The following Form 8-K was filed by Registrant during the last quarter of
the period Covered by this Form 10-KSB.
Form 8-K filed November 26, 1997 reporting under Item 5 that George G. Hays
had been appointed President and Chief Executive Officer of Registrant, and
John P. Hudnall had resigned from the Board of Directors and his employment
as President and Chief Executive Officer of Registrant had been terminated.
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934 the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ARIZONA INSTRUMENT CORPORATION
Date: March 31, 1998 By: /s/ George G. Hays
------------------ -----------------------------
George G. Hays,
President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Capacity Date
- ------------------------------------- ----------------------------------------- ---------------------
<S> <C> <C>
/s/ George G. Hays President and Chairman of the Board March 31, 1998
- ------------------------------------- (Principal Executive Officer) ---------------------
George G. Hays
/s/ Walfred R. Raisanen Director, Vice President of March 31, 1998
- ------------------------------------- Engineering ---------------------
Walfred R. Raisanen
/s/ S. Thomas Emerson Director March 31, 1998
- ------------------------------------- ---------------------
S. Thomas Emerson
/s/ Steven Zylstra Director March 31, 1998
- ------------------------------------- ---------------------
Steven Zylstra
/s/ Harold Schwartz Director March 31, 1998
- ------------------------------------- ---------------------
Harold Schwartz
</TABLE>
39
LOAN MODIFICATION AGREEMENT
This Loan Modification Agreement is entered into as of March 14, 1997, by
and between Arizona Instrument Corporation ("Borrower") whose address is 4114
East Wood Street, Phoenix, AZ 85050, and Silicon Valley Bank, a California
chartered bank ("Lender") whose address is 3003 Tasman Drive, Santa Clara, CA
95054.
1. DESCRIPTION OF EXISTING INDEBTEDNESS: Among other indebtedness which may be
owing by Borrower to Bank, Borrower is indebted to Bank pursuant to, among other
documents, an Amended and Restated Loan and Security Agreement (the "Domestic
Loan Agreement") and a Second Amended and Restated Loan and Security Agreement
(the "Export Loan Agreement"), both dated March 15, 1995, as such agreements may
be amended from time to time, (collectively, the "Loan Agreement"). The Domestic
Loan Agreement provided for, among other things, a Committed Line in the
original amount of One Million Five Hundred Thousand and 00/100 Dollars
($1,500,000.00) (the "Domestic Line"). The Export Loan Agreement provided for,
among other things, a Committed Line in the principal amount of One Million Two
Hundred Fifty Thousand and 00/100 Dollars ($1,250,000.00) (the "Export Line").
Borrower has also executed a Promissory Note, dated November 7, 1995, in the
original principal amount of One Million Two Hundred Fifty Thousand and 00/100
Dollars ($1,250,000.00) (the "Term Loan"). The Export Loan Agreement has been
modified pursuant to, among other documents, a Loan Modification Agreement dated
March 15, 1996, pursuant to which, among other things, the principal amount of
the Committed Line was decreased to One Million and 00/100 Dollars
($1,000,000.00). Defined terms used but not otherwise defined shall have the
same meaning as in the Loan Agreements.
Hereinafter, all indebtedness owing by Borrower to Lender shall be referred to
as the "Indebtedness".
2. DESCRIPTION OF COLLATERAL AND GUARANTIES. Repayment of the Indebtedness,
together with other promissory notes from Borrower to Lender, is secured by the
Collateral as defined in each of the Loan Agreements, a Collateral Assignment,
Patent Mortgage and Security Agreement dated February 12, 1993 and a
Reaffirmation of Collateral Assignment, Patent Mortgage and Security Agreement
dated March 15, 1995. Additionally, repayment of the Export Committed Line is
guaranteed by the Export-Import Bank of the United States (the "Guarantor")
pursuant to a Guarantee Agreement (the "Guaranty").
Hereinafter, the above-described security documents and guaranties, together
with all other documents securing repayment of the Indebtedness shall be
referred to as the "Security Documents". Hereinafter, the Security Documents,
together with all other documents evidencing or securing the Indebtedness shall
be referred to as the "Existing Loan Documents".
3. DESCRIPTION OF CHANGE IN TERMS.
A. Modification(s) to the Loan Agreement.
-------------------------------------
1. The term "Maturity Date" shall mean March 13, 1998.
2. Section 6.9 entitled "Debt-Net Worth Ratio" is hereby amended in
its entirety to read as follows:
Borrower shall maintain as of the last day of each quarter, a
ratio of Total Liabilities less Subordinated Debt to Tangible Net
Worth plus Subordinated Debt of not more than 1.00 to 1.00.
1
<PAGE>
B. Modification(s) to the Domestic Loan Agreement.
----------------------------------------------
1. Subparagraph (a) of Section 2.3 entitled "Interest Rate" is
hereby amended to read as follows:
Except as set forth in Section 2.3(b), any Advances shall bear
interest, on the average Daily Balance, at a rate equal to one
(1.000) percentage point over the Prime Rate.
C. Modification(s) to the Export Loan Agreement.
--------------------------------------------
1. Subparagraph (a) of Section 2.3 entitled "Interest Rate" is
hereby amended to read as follows:
Except as set forth in Section 2.3(b), any Advances shall bear
interest, on the average Daily Balance, at a rate equal to three
fourths of one (0.750) percentage point over the Prime Rate.
4. CONSISTENT CHANGES. The Existing Loan Documents are hereby amended wherever
necessary to reflect the changes described above.
5. PAYMENT OF LOAN FEES. Borrower shall pay to Lender a fee for the Domestic
Loan in the amount of Seven Thousand Five Hundred and 00/100 Dollars ($7,500.00)
(the "Domestic Loan Fee"), and a fee for the Export Loan in the amount of
Fifteen Thousand and 00/100 Dollars ($15,000.00) (the "Export Loan Fee")
(collectively, the "Loan Fees") plus all out-of-pocket expenses.
6. NO DEFENSES OF BORROWER. Borrower (and each guarantor and pledgor signing
below) agrees that it has no defenses against the obligations to pay any amounts
under the Indebtedness.
7. CONTINUING VALIDITY. Borrower (and each guarantor and pledgor signing
below) understands and agrees that in modifying the existing Indebtedness,
Lender is relying upon Borrower's representations, warranties, and agreements,
as set forth in the Existing Loan Documents. Except as expressly modified
pursuant to this Loan Modification Agreement, the terms of the Existing Loan
Documents remain unchanged and in full force and effect. Lender's agreement to
modifications to the existing Indebtedness pursuant to this Loan Modification
Agreement in no way shall obligate Lender to make any future modifications to
the Indebtedness. Nothing in this Loan Modification Agreement shall constitute a
satisfaction of the Indebtedness. It is the intention of Lender and Borrower to
retain as liable parties all makers and endorsers of Existing Loan Documents,
unless the party is expressly released by Lender in writing. No maker, endorser,
or guarantor will be released by virtue of this Loan Modification Agreement. The
terms of this paragraph apply not only to this Loan Modification Agreement, but
also to all subsequent loan modification agreements.
8. CONDITIONS. The effectiveness of this Loan Modification Agreement is
conditioned upon Borrower's payment of the Loan Fees.
2
<PAGE>
This Loan Modification Agreement is executed as of the date first written
above.
BORROWER: LENDER:
ARIZONA INSTRUMENT CORPORATION SILICON VALLEY BANK
By: /s/ George G. Hays By: /s/ Kevin Conway
--------------------------- ----------------------------
Name: GEORGE G. HAYS Name: Kevin Conway
------------------------- --------------------------
Title: VICE PRESIDENT Title: Vice President
------------------------ -------------------------
3
EMPLOYMENT AGREEMENT
ARIZONA INSTRUMENT CORPORATION
AND
George G. Hays
THIS EMPLOYMENT AGREEMENT ("Agreement") effective as of January 1, 1998
is between Arizona Instrument Corporation ("AZI" or the "Company" or "Employer")
and George G. Hays ("Employee").
1. Employment Duties. Employer hereby employs Employee and Employee
hereby accepts employment on the terms and conditions set forth herein. Employee
shall serve in the position of President and Chief Executive Officer, with
responsibility for overseeing the operations of the Company, and will have such
other powers and duties consistent with such position as may from time to time
be prescribed by the Board of Directors.
2. Term. Employee's employment shall continue from the effective date
of this Agreement through March 31, 2000. This Agreement shall be automatically
renewed for a one-year period unless the Company has given Employee written
notice of nonrenewal by September 30, 1999.
3. Full-time Employment. Employee shall devote substantially all his
employment energies, interest, abilities and time to the performance of his
obligations hereunder.
4. Compensation. Employer shall pay to Employee the sum of $165,000.00
per year during the term hereof, to be paid in accordance with the Employer's
normal payroll practice, but in no event shall such salary be paid less
frequently than twice a month. Employee shall participate in an annual incentive
bonus plan administered by the Board of Directors equal to at least 30% of
annual salary. The Board of Directors will consider merit increases on a
periodic basis commensurate with the executive compensation practices of the
Company. Employer may deduct from the compensation to Employee social security
taxes and all federal, state and municipal taxes and charges as may now be in
effect or which may hereafter be enacted or required. Employer shall pay or
reimburse Employee for reasonable travel and other expenses incurred by Employee
in furtherance of or in connection with the performance of his duties hereunder,
consistent with Employer policies regarding such expenses.
5. Participation in Employee Benefits. Employee shall be entitled to
and shall receive all other benefits and conditions of employment available
generally to executives of AZI pursuant to Employer plans and programs,
including group health insurance benefits, life insurance benefits and the
opportunity to participate in any stock option, profit sharing or retirement
income plan; provided, however, that Employee may request leave of absence
without pay during the term hereof, and Employer agrees to grant such leave if
it determines that the leave would not be materially injurious to the operations
of Employer; and provided, further, that Employee shall be entitled to a
vacation of four weeks in each twelve-month period during the term of this
Agreement, during which time his compensation shall be paid in full. The manner
of
<PAGE>
implementation of such benefits with respect to such items as procedures and
amounts is discretionary with the Company.
6. Termination.
A) For Cause. The Company may terminate this Agreement for
cause upon written notice to the Employee stating the facts constituting such
cause, provided that Employee shall have 10 days following such notice to cure
any conduct or act, if curable, alleged to provide grounds for termination for
cause hereunder. In the event of termination for cause, the Company shall be
obligated to pay the Employee only the base salary due him through the date of
termination. Cause shall include material neglect of duties, willful failure to
abide by ethical and good faith instructions or policies from or set by the
Board of Directors, commission of a felony or serious misdemeanor offense or
pleading guilty or nolo contendere to same, the commission by Employee of an act
of dishonesty or moral turpitude involving the Company, Employee's material
breach of this Agreement, the filing of bankruptcy proceedings by or against
Employee, or breach by Employee of any other material obligation to the Company.
B) Without Cause. The Company may terminate this Agreement at
any time immediately, without cause, by giving written notice to Employee. Upon
termination under this Section 6(B), the Company shall be obligated to pay
Employee the base salary payable hereunder for the balance of the employment
term set forth in Section 2. The amount of base salary to be paid to Employee
after termination under this Section 6(B) may be reduced by any wages or
consulting fees earned by Employee from third parties from the date of
termination of this Agreement through the term of this Agreement. At the
Company's election, such payment can be made in a lump sum or pursuant to the
Company's normal payroll practices over the balance of the term. The Company
shall also maintain Employee's participation in the employee benefit programs
referred to in Section 5 hereof for the remainder of the employment term set
forth in Section 2 and to the extent contemplated in Section 5 hereof, except
that the Company shall have no obligation to Employee under any profit sharing
or retirement plan other than amounts due through the date of termination of
employment. If continued coverage or participation in any such benefit program
is prohibited by the terms thereof, the Company will provide a substantially
similar benefit during such period. The obligations provided in this Section
6(B) shall be the Company's sole obligations upon termination under this Section
6(B).
C) Disability. If during the term of this Agreement, Employee
fails to perform his duties hereunder because of illness or other incapacity for
a period of two consecutive months, or for 90 days during any 150-day period,
the Company shall have the right to terminate this Agreement without further
obligation hereunder except for any amounts payable pursuant to
disability plans generally applicable to executive employees.
D) Death. If Employee dies during the term of this Agreement,
this Agreement shall terminate immediately, and Employee's legal representatives
shall be entitled to receive the base salary due Employee through the last day
of the calendar month in which his death shall have occurred and any other death
benefits generally applicable to executive employees.
<PAGE>
E) Employee Termination. Employee may terminate this Agreement
at any time upon written notice to the Company.
7. Cooperation with Employer After Termination of Employment. Following
any termination of employment hereunder, Employee shall fully cooperate with
Employer in all matters relating to the winding up of his pending work on behalf
of Employer and the orderly transfer of any such pending work to other employees
of Employer as may be designated by Employer. Employer shall be entitled to such
full time or part time services of Employee as Employer may reasonably require
during all or any part of the 30-day period following any termination hereunder,
and shall compensate Employee for such services on a basis consistent with
Employee's compensation pursuant to Section 4 hereof.
8. Non-Competition. The parties acknowledge that the Employee will
acquire much knowledge and information concerning the business of the Company
and its affiliates as the result of his employment. The parties further
acknowledge that the scope of business in which the Company is engaged as of the
date of execution of this Agreement is world-wide and very competitive and one
in which few companies can successfully compete. Competition by Employee in that
business after this Agreement is terminated would severely injure the Company.
Accordingly, for a period of one year after this Agreement is terminated for any
reason (except termination by the Company without cause), Employee agrees not to
become an employee, consultant, advisor, principal, partner or substantial
shareholder of any firm or business that in any way competes with the Company or
its affiliates in any of their presently existing or then existing products and
markets.
9. Specific Performance. The parties agree that the provisions in
Sections 3 and 8 are of a special, unique and extraordinary character, which
gives them a peculiar value, the loss of which could not be reasonably or
adequately compensated in damages in any action at law, and that a breach by
Employee will cause Employer great and irreparable injury and damage. Employee
hereby expressly agrees that Employer shall be entitled to the remedies of
injunction, specific performance and other equitable relief to prevent a breach
by Employee. This provision shall not, however, be construed as a waiver of any
of the rights which Employer may have for damages.
10. Miscellaneous Provisions.
10.1 Decisions by Employer. For all purposes herein, Employee
may not make any decisions or take any action with respect to this Agreement as
an agent of Employer. Actions of Employer hereunder shall be taken by its Board
of Directors.
10.2 Governing Law. This Agreement is governed by Arizona law.
10.3 Entire Agreement. This Agreement supersedes all prior
agreements between the parties concerning the subject matter hereof and this
Agreement constitutes the entire agreement between the parties with respect
hereto. This Agreement may be modified only with a
<PAGE>
written instrument duly executed by each of the parties. No person has any
authority to make any representation or promise not set forth herein on behalf
of any of the parties and this Agreement has not been executed in reliance upon
any representation or promise except those contained
herein.
10.4 Notices. Any notice, request, demand or other
communication hereunder shall be in writing and shall be deemed given when
personally delivered to AZI or to Employee, as the case may be, or when
delivered by certified mail, return receipt requested.
To the Company: 4114 East Wood Street
Phoenix, AZ 85040
To the Employee: 4114 East Wood Street
Phoenix, AZ 85040
10.5 Waiver of Breach. The failure of either party to require
the performance of any term or condition of the Agreement, or the waiver by
either party of any breach of this Agreement shall not prevent a subsequent
enforcement of any such term or any other term nor be
deemed to be a waiver of any subsequent breach.
10.6 Severability. The provisions of this Agreement shall be
deemed severable. If any part of this Agreement shall be held unenforceable, the
remainder shall remain in full force and effect, and such unenforceable
provisions shall be reformed so as to give maximum legal effect to the intent of
the parties as expressed herein.
11. Any controversy or claim arising out of or relating to this
Agreement or the breach thereof shall be settled by binding arbitration
conducted in Phoenix, Arizona in accordance with the laws of the State of
Arizona conducted in accordance with the rules of the American Arbitration
Association. Judgement upon the award rendered by the arbitration may be entered
in any court having jurisdiction thereof.
/s/ Walfred R. Rausamen 1/14/98 /s/ George G. Hays 1/13/98
- --------------------------------- ----------------------------------
Employer Date Employee Date
Exhibit 21.1
Subsidiaries of Registrant
Quintel International, Inc., incorporated under the Companies Act of 1982 of
Barbados, W.I. Computrac International, Inc., an Arizona corporation Horizon
Engineering and Testing, Inc., an Arizona corporation
Each of the above companies is wholly owned by Registrant.
Exhibit 23.1
INDEPENDENT AUDITOR'S CONSENT
We consent to the incorporation by reference in Arizona Instrument Corporation's
Registration Statement No. 33-73614 on Form S-3 and Registration Statement Nos.
33-2712, 33-2713 and 2-99078 on Form S-8 of our report dated March 15, 1998,
appearing in this Annual Report on Form 10-KSB of Arizona Instrument Corporation
for the year ended December 31, 1997.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Phoenix, Arizona
March 30, 1998
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<NAME> ARIZONA INSTRUMENT CORPORATION
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