SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
Commission file number 0-26596
Computational Systems, Incorporated
(Exact Name of Registrant as Specified in its Charter)
Tennessee 62-1198047
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
835 Innovation Drive
Knoxville, Tennessee 37932
(Address of Principal Executive Office) (Zip Code)
Registrant's Telephone Number, Including Area Code: (423) 675-2110
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form l0-K
or any amendment to this Form 10-K. [ X ]
As of March 6, 1997 there were 5,002,845 shares of common stock,
of the Registrant outstanding. The aggregate market value of such shares,
other than shares held by persons who may be deemed affiliates of the
Registrant, was $67,138,730.
DOCUMENTS INCORPORATED BY REFERENCE
1. Specified portions of Computational Systems, Incorporated's Proxy
Statement relating to the 1997 Annual Meeting of Shareholders are
incorporated by reference into Part III.
Page of
Exhit Index located on page
PART I
Item 1. Business
Computational Systems, Incorporated ("CSI" or the "Company") was
incorporated under the laws of the State of Tennessee in February 1984,
under the name Canada Systems, Incorporated. In May 1984, the
Company changed its name to Computational Systems, Incorporated. The
Company's principal offices are located at 835 Innovation Drive, Knoxville,
Tennessee 37932 and its telephone number is (423) 675-2110. At
December 31, 1996, the Company employed 430 persons, of whom 416
were full-time and 14 were part-time employees.
The Company primarily designs, produces and markets an integrated
family of advanced predictive maintenance products and services for use in
large scale, continuous run manufacturing facilities. The Company's
Reliability-Based Maintenance products and services help customers detect
potentially disruptive conditions in the operation of their machinery before
damage or complete mechanical failure occurs, thereby allowing
maintenance to be scheduled at the most appropriate time. The Company
believes that its products and services enable its customers to effectively
increase plant capacity by reducing unplanned downtime; reduce overall
maintenance costs by minimizing parts and labor committed to repairing
capital equipment; and improve their product quality by ensuring greater
consistency in the operation of manufacturing equipment.
The Company's products allow its customers to accomplish a wide range
of predictive maintenance tasks including detecting and diagnosing
abnormal machinery vibration, abnormal oil condition (degradation and
contamination), abnormal temperatures and misalignment and imbalance
conditions. The Company manufactures hand-held and fixed
instrumentation to take measurements which detect these conditions.
Substantially all of the Company's products are supported by the
Company's proprietary, PC-based MasterTrend software platform that
automates data collection, supports local and remote transfer of the data,
and analyzes the data to detect existing and emerging problems.
MasterTrend software formats the data into reports that allows the
customer to confirm the problem diagnosis, observe trends and search for
underlying causes of mechanical problems. MasterTrend software
compares data from periods of normal operation to failure modes and
learns to detect developing problems on an ongoing basis. CSI also offers
complementary services including: reliability services (turnkey contract
maintenance services tailored to a specific customer's needs); training
services; tribology services (advanced fluid analysis); and consulting and
engineering services.
The Company targets manufacturers worldwide that have continuous run
operations involving large capital investments. These target customers
typically have well-funded maintenance budgets and experience substantial
losses from unplanned downtime of production facilities. These customers
include petrochemical and chemical manufacturers, primary metals
producers, power generation companies, motor vehicle and equipment
manufacturers, and food and paper producers. The Company's customers
include a substantial number of the largest industrial U.S. companies,
including Exxon, DuPont, Alcoa, Weirton Steel, Duke Power, Tennessee
Valley Authority, General Motors, Ford, Chrysler, General Electric,
Westinghouse, Miller Brewing Company, Coca-Cola, M&M Mars and
Kimberly Clark. No individual customer accounted for more than 3% of the
Company's revenues in 1995 or 1996.
To accomplish its goal of providing the tools, technology and training to
change the way the Company's target customers perform maintenance, the
Company has developed successive generations of vibration analysis
products as well as other products which employ different technologies,
most of which use the Company's common software platform, to provide
Reliability-Based Maintenance capabilities to its target customers.
Products and Services
The Company manufactures products for use in connection with, and
offers contract services which provide vibration analysis, oil analysis,
infrared thermography, alignment, balancing and motor current analysis.
The Company also provides consulting services that assist customers in
developing and implementing predictive maintenance programs.
Products
The Company manufactures instrumentation for use in detecting and
diagnosing abnormal machinery vibration, abnormal oil condition
(degradation and contamination), abnormal temperatures and electrical
defects, as well as misalignment and imbalance conditions. These
products assist plant personnel by providing efficient data collection,
analysis and reporting to determine probable future machine failures and
their causes.
Vibration Analysis. The Company's vibration analysis products
provide a substantial part of its revenues and represent the initial products
developed by the Company. By routinely monitoring machinery vibration,
conditions which may lead to machine failure can be detected early. When
rotating equipment components begin to fail (such as a worn bearing), they
will generally produce vibration frequencies that are specific to the failure
condition and location. With an understanding of the general machine
design and its normal vibration frequencies, many of these fault vibration
frequencies can be detected. The Company's vibration analysis products
combine ease of use with state of the art technology to simplify and
automate the process of collecting and analyzing data for machinery
condition monitoring. The Company manufactures portable vibration
analysis systems that allow an operator to make spot measurements at key
measurements points along a pre-designed "route" around a factory. In
addition, the Company manufactures vibration analysis systems which
provide continuous monitoring of critical pieces of equipment. When used
with the Company's MasterTrend predictive maintenance software, data is
easily stored and recalled for display and analysis.
Operation of the Company's portable vibration analysis products is
relatively easy, requiring little training for fast, accurate and reliable data
collection. Data from a typical measurement point may be acquired in five
to ten seconds for display and analysis. A data collection route may involve
hundreds of such measurements. The Company's vibration analysis
products utilize digital signal processing. A large, backlit, wide angle LCD
display provides a complete description of the current machine and
measurement point. In addition to data collection capability, the Company's
vibration analysis products provide the ability to analyze data collected in
the field and, in conjunction with the Company's MasterTrend software,
provide a more powerful analytical tool to determine the root cause of
machine failure. The Company has also developed certain additional
optional down-loadable programs to provide additional proactive
maintenance capabilities such as balancing, alignment and resonance
testing. Prices for the Company's vibration analysis products range from
$3,000 for the Company's model 1900 portable vibration analyzer to
$31,000 for the Company's advanced model 2120 vibration analyzer in a
package with the Company's MasterTrend software.
The Company also makes vibration analysis systems which are
designed for continuous monitoring of especially critical machinery. The
Company has designed both dedicated and movable systems, for the
customer with very advanced needs, which use continuous monitoring to
warn of developing problems or perform continuous monitoring on a short-term
basis to determine the root cause of problems. Prices for the
Company's continuous monitoring products range from approximately
$20,000 for the Company's movable products to as much as $300,000 for a
dedicated monitoring system incorporating the Company's model 3130
analyzer.
Oil Analysis (Tribology). Wear-related fatigue in machines can be
significantly reduced through proper oil sampling, diagnostics and
procurement practices. The Company's tribology products are designed to
enhance the traditional function of oil analysis (i.e. problem detection), with
solutions which help the customer identify and correct the root causes of
mechanical wear associated with different aspects of lubrication. The
Company provides a combination of products which allow its customers to
operate an on-site mini-lab customized to the customer's needs and
applications. The lab allows the customer to quickly monitor oil condition,
oil contamination, machine wear debris, particle counts and viscosity and
utilizes the Company's OilTrend software to manage and analyze the data
collected. The Company offers a tribology total solution in which the
Company's tribology consultants are available for on-site advisory service.
The total solution provides specific strategies and recommendations for
achieving long range maintenance goals such as effective lubricant
selection, system contamination control and extended lubricant use. The
Company also operates an advanced fluid analysis laboratory to which its
customers send fluid samples for highly detailed analysis. The lab analysis
provides information which allows the Company's customers to improve
plant lubricant procurement methods, contamination control methods and
filtration practices.
Infrared Thermography. The Company's infrared thermography
products are designed to pinpoint problems related to faulty electrical
connections and friction induced heating and insulation deficiencies by
measuring the temperature patterns presented by the equipment. Data
collection is accomplished with a penbased analyzer as well as a
lightweight, high resolution infrared camera which incorporates thermal
imaging capability. The camera allows the customer to read the
temperature of a very small object or machine component from a distance.
CSI's patented infrared thermography data acquisition system provides a
route-based approach that makes infrared surveys more efficient and
effective. The Company's Infranalysis data
storage/display/analysis/reporting software enables customers to detect
and solve maintenance problems initially indicated through temperature
variation.
Alignment and Balancing Technologies. CSI's UltraSpec alignment
and balancing systems help eliminate two of the most common and costly
machine problems - misalignment and imbalance - by improving technique,
data management and job documentation. UltraSpec and its PC-based
data management program, UltraMgr, provide a complete
alignment/balancing solution with built-in error resistance, auto
documentation, alignment and balancing optimization, data management
and several system configuration options. The Company's laser alignment
systems offer numerous methods of data collection including a partial
sweep method which allows users to collect data without having to fully
rotate the shaft.
MasterTrend Software. The Company's proprietary MasterTrend
software is the PC-based common software platform linking all of the
Company's products and services. MasterTrend software (available in
Windows, DOS, and network versions) is the central point of control for
Reliability-Based Maintenance technologies. MasterTrend is designed to
be straightforward to use, while offering the diagnostic depth needed to
solve complex machinery problems. The database administration features
of MasterTrend include database setup and management functions. In
addition, MasterTrend automates many of the routine tasks associated with
data collection by creating and managing routes. The communications and
data transfer features of MasterTrend software include an analyzer
communications program which supports local and remote transfer of data.
At the conclusion of field data, the collected data is transferred to the
computer through the analyzer communications program and is then stored
in the database and can be examined and analyzed later using
MasterTrend's diagnostic and display options. With the data collected and
stored, MasterTrend's automated problem detection features use alarm
algorithms to detect not only existing problems but problems just beginning
to emerge. The advanced diagnostics and reporting features of the
MasterTrend software allow the customer to confirm the diagnosis of the
problem or search further for root causes. MasterTrend displays allow a
customer to see how machine conditions change over time, while spectral
and wave form displays assist in the in-depth analysis of developing
machinery problems. Finally, the archival features of the MasterTrend
program allow the customer to document and archive a complete history of
its Reliability-Based Maintenance program and create understandable
reports for management.
Services
During 1996, the Company created a new subsidiary, CSI Services, Inc.
(CSI Services), consisting of two divisions; Paragon Services (Paragon),
formerly known as the Company's technical service division, and
Maintenance & Diagnostics (M&D), a company acquired in the fourth
quarter of 1996. Paragon provides both contract services, utilizing all of the
various Reliability-Based Maintenance technologies on a turnkey basis, as
well as training for personnel in organizations that have invested in these
technologies. M&D is the premier research, service and training center for
the electric power industry.
CSI Reliability Services. Paragon provides contract services tailored
to a customer's needs and budget. The division's reliability services
program allows a customer to implement any one of the individual
maintenance technologies described above or allows the customer to
implement a turnkey, multi-technology contract. In addition to long-term
contracts, Paragon provides short-term troubleshooting services. Paragon
believes that offering its services on a contract basis allows it to serve a
broader segment of the industrial market and introduce its products to
potential customers on a cost effective basis.
Training Services. Each year, Paragon offers more than 250 technical
courses in its state-of-the-art training facilities in Knoxville, Houston, San
Diego, Detroit and Leuven, Belgium, as well as at customer sites. The
Company offers courses in vibration analysis, tribology, infrared
thermography, alignment/balancing, electric motor analysis, multichannel
analysis and industry specific topics. During 1996, approximately 2,700
people attended the Company's technical courses at the Company's
training facilities and at various customer sites.
Tribology Services. In addition to the Company's oil analysis products
Paragon offers services designed to provide synergy to the on-site tribology
program. As described above, in the tribology total solution, Paragon
consultants are available for on-site advisory services. In addition, an
advanced fluid analysis lab at the facility in Knoxville, provides sophisticated
oil analysis for industrial machinery. Results from the advanced fluid
analysis lab are available to the customer via electronic data transfer.
Management Level Consulting Services. CSI Services' consulting
services are designed to provide customers with the expertise to insure the
long-term success of the customer's maintenance program. CSI Services'
consultants conduct in-plant evaluations of the client's facilities and develop
specific strategies for implementing or expanding the Reliability-Based
Maintenance program for that client. The service also includes
management training, identification of optimal maintenance strategies and
benchmarking services (identification of present output levels of facilities).
Engineering Services. CSI provides high level engineering services
for technically challenging machinery and process related problems. The
services include general design engineering service, modal and structural
analysis services, and finite element modeling services, as well as trouble
shooting of plant equipment.
Engineering and New Product Development
Engineering and Product Development. The Company's engineering
and product development teams have been integral to the Company's
successful development of its products. The Company's engineering
function is headed by Dr. Kenneth R. Piety and is staffed with approximately
75 employees. Development of each of the Company's products is
organized around a product development team consisting of as few as
three or as many as nine members. The teams are headed by product
"champions" who not only lead the product's development but also retain
responsibility for the success of the product through testing, marketing and
developmental improvements. The objectives of the engineering and
product development teams are to continue to develop successful
maintenance products. The engineering area seeks to develop a family of
products utilizing each of the Company's principal technologies and to
integrate those products with the Company's existing product and service
lines. The Company tests each of its new products through in-house, pre-release
testing (alpha testing) and through testing of installed products at
actual facilities of customers (beta testing) prior to general release of the
product.
Products Under Development. The Company is developing the
following products which use additional technologies to those described
above, although there can be no assurance of their successful completion
or commercial viability:
Motor Analysis. The Company is developing an electric motor
analyzer that utilizes smart sensor technology to provide
information about run time, starts, operating temperature, load
electrical condition and vibration spectra.
Ultrasonic Analysis. The Company is developing a data
collection and reporting system for the detection of faults by
ultrasonic analysis. Faults which can be detected by ultrasonic
analysis include pressure leaks, malfunctioning steam traps and
corona discharge (the electrical arcing of two machine
components at high voltage).
In addition, the Company continually seeks to improve its existing
products. The Company has designed recent generations of its products to
be downloadable so that new software, which provides increased
functionality, can be installed in the Company's products easily and on a
cost effective basis. In addition, the Company continually strives to improve
its MasterTrend software to further enhance the automation of the data
collection and analysis process and the integration of various technologies.
Manufacturing and Quality Assurance
The Company manufactures substantially all of its own products, utilizing
components specified in its engineering design. The Company believes
that by manufacturing its products in-house it is able to assure the final
quality of its products as well as implement design improvements on a rapid
basis. Because most of the Company's products are manufactured and
shipped within 4 to 6 weeks of order, CSI's senior management meets at
the beginning of each month to determine production authorization and to
forecast inventory needs for the next several months. The Company
believes that this method of production management enables it to control
both material and labor costs as effectively as possible. Because of the
design of certain of the Company's products, the Company does not rely on
sole sources for some of its components. One of the Company's goals is to
reduce its reliance on sole source suppliers as its products mature.
Customer Concentration and Backlog
No customer of CSI accounted for more than 3% of the Company's
revenues in 1995 or 1996. Approximately 77% of the Company's sales are
made in the United States and 23% are international. The Company's
backlog was $5.1 million at December 31, 1994, $5.1 million at December
31, 1995 and $12.9 million at December 31, 1996. The Company
generally does not have a large backlog since it produces and ships
products within 4 to 6 weeks of receiving an order. Backlog also includes
future services to be provided pursuant to service contracts.
Patent and Proprietary Rights
Patents. Protection of the proprietary aspects of the Company's
products is an important factor in the success of the Company. The
Company's engineering staff actively works towards developing processes,
technology and products to achieve the Company's commercial aims. It is
the policy of the Company to protect its intellectual property rights by
obtaining patents from the United States Patent and Trademark Office. To
date, the Company has obtained fourteen patents and has seventeen
patent applications pending. To maintain its competitive position, the
Company expects to rely upon trade secrets, technological improvements,
and other unpatented proprietary know-how, incorporated, for example, in
manuals, formulae, specifications, test data and procedures, flow charts,
apparatus plans, drawings and designs. With respect to the use and
disclosure of the Company's proprietary technology, the Company has
confidentiality agreements with its employees and the members of its Board
of Directors. In addition, the Company has confidentiality and "work-for-hire"
agreements with consultants that assist in the engineering and
development of a product for the Company. There can be no assurance
that others have not or will not independently develop or otherwise gain
access to technology or information which is substantially similar to
technology which is patented by the Company or technology which is
unpatented yet relied upon by the Company.
Patent Litigation. Messrs. Canada and Piety were employed by
Technology for Energy Corporation ("TEC"), prior to Mr. Canada's founding
of CSI in 1984. In 1989, TEC filed suit against the Company for, among
other things, infringement of a patent on a vibration monitoring device
alleged to be used in some of the Company's products (the "TEC Patent").
In 1992, the Company was adjudged liable for approximately $1.5 million in
damages for infringement of the TEC Patent and was permanently enjoined
from using the TEC Patent without TEC's permission. Following an
unsuccessful appeal, the Company satisfied the judgement.
In September 1994, CSI and TEC entered into an Asset Purchase
Agreement (the "Purchase Agreement") pursuant to which the Company
acquired certain assets of TEC. As a condition to the Purchase Agreement,
TEC and CSI entered into a Release of Claims Agreement (the "Release
Agreement"), pursuant to which each party released the other from, and
covenanted not to sue the other in connection with, any and all rights
arising from or relating to patents, copyrights, trade secrets, trademarks,
confidential information, and business contracts or relationships with third
parties. As a further condition to the Purchase Agreement, TEC and CSI
entered into a Patent Agreement (the "Patent Agreement"), pursuant to
which TEC granted CSI a paid-up, non-exclusive sub-license to make, use
and sell products and processes covered by the TEC Patent. The sub-license
granted in the Patent Agreement is applicable to all past and future
uses of the TEC Patent in any CSI product. Following execution of the
Patent Agreement, the injunction against use of the TEC Patent by CSI was
dissolved. In connection with the TEC acquisition, the Company agreed not
to compete with certain specified activities of TEC including its nuclear
reactor business, stress analysis business and aviation business, all for a
period of five years from the date of the TEC acquisition.
IRD Mechanalysis, Inc., (now called Entek/IRD International, Inc.) one of
the Company's principal competitors, holds a patent on a portable vibration
data collector (the "IRD Patent"). In 1993, CSI filed an action for a
declaratory judgement for non-infringement of the IRD Patent in which IRD
counterclaimed for damages for patent infringement. In October of 1993,
IRD and CSI entered into a Settlement Agreement (the "Settlement
Agreement") pursuant to which IRD granted CSI a non-exclusive license for
portable vibration data collectors incorporating the IRD Patent. In the
Settlement Agreement, CSI agreed to make certain payments to IRD, the
past payments for which have been accounted for in the Company's cost of
revenue and litigation expenses. In 1993, IRD acquired a license from TEC
to use the TEC Patent, subject to TEC's right to enforce the patent against
CSI as discussed above.
Trademarks/Service Marks. The Company has registered the trade or
service marks Reliability-Based Maintenance, InTouch, MotorCheck,
RollView, WavePak, Accutrend, MachineView, MachineGuard, Nspectr,
TrendSetter, OilView, OilTrend, UltraSpec, Infranalysis, Level of Awareness
Training and "Changing the Way the World Performs Maintenance"
(collectively, the "Marks") in the United States Patent and Trademark Office.
The Company regards its Marks as valuable assets and believes that they
have significant value in the marketing of its products. The Company
intends to protect its Marks vigorously against dilution and infringement.
Competition
The predictive maintenance industry is relatively new and the Company
faces competition within the industry from a limited number of competitors
in the products areas and from a larger number of competitors in the
services area. In the products area, the Company faces competition
primarily from Entek/IRD International, Inc. ("Entek/IRD"), Predict/DLI, SKF
Condition Monitoring, Inc. ("SKF") and Bentley-Nevada Corp. ("Bentley-Nevada").
The Company believes that it is a significant competitor in the
products area except that with respect to fixed-vibration monitoring
equipment, Bentley-Nevada is generally viewed to be the dominant
competitor. Among the Company's other competitors, Entek/IRD holds one
patent and a license on an additional patent covering two processes that
are used in several of the Company's leading products, for which the
Company has licensed the use of those processes. Entek/IRD has signed
a partnership agreement with Hartford Steam Boiler Company to mutually
market each other's products and services. The industry for providers of
predictive maintenance services is highly fragmented and consists in part of
a number of small, contract service providers who purchase the Company's
products or products made by one of the Company's product competitors.
The Company believes that providers of predictive maintenance
products and services compete based primarily on their ability to educate
companies about the benefits and cost effectiveness of predictive
maintenance programs, upon their ability to create, implement, and support
predictive maintenance programs, and, to a lesser degree, on price. The
Company believes that because the predictive maintenance industry and
the technologies used in performing predictive maintenance are relatively
new, the ability to educate a company about the benefits and cost
effectiveness of predictive maintenance, to assist the company in
developing an appropriate predictive maintenance program and to present
the company with a total package of predictive maintenance products and
services, tends to foster a better understanding of predictive maintenance
by the company and raises the potential that the company will implement a
predictive maintenance program. The Company believes that it is well
positioned to compete in the predictive maintenance industry because of its
ability to offer fully integrated, multiple technologies for predictive
maintenance products and services and by its ability to support those
products and services from within.
It is likely that the Company will face increased competition as the
predictive maintenance industry grows and that the full market potential for
products and services similar to those offered by the Company is
developed. An increase of competition within the industry could have a
material adverse effect upon the Company's business.
Regulation
The Company's operations are subject to federal, state and local laws
governing wages, working conditions, citizenship and health and sanitation
requirements and licensing. Additionally, the Company's international
revenues are subject to federal laws concerning exports. Generally, the
Company is not subject to significant export license requirements for its
products. The Company must, however, obtain an export license from the
United States Department of Commerce prior to any international shipment
of infrared thermography cameras as it is a "controlled product" pursuant to
regulations promulgated by the Bureau of Export Administration of the U.S.
Department of Commerce. However, infrared thermography cameras do
not represent a significant percentage of the Company's international
revenues.
Risk Factors
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company is including the following
cautionary statements identifying important factors that could cause the
Company's actual results to differ materially from those projected in forward
looking statements of the Company made by, or on behalf of, the Company.
Dependence on a Single Product Family and New Product Introductions.
A substantial portion of the Company's revenues are
derived from the sale of its vibration analysis products. There can be no
assurance that the Company's revenues from its vibration analysis products
will grow or remain at historical levels. In addition, the Company's growth
and future financial performance depend in part upon its ability to develop
and introduce new, cost effective products and enhance existing products
to meet technological advances and customer requirements. There can be
no assurance that any such product will be successfully developed and
introduced or achieve market acceptance. Failure by the Company to
anticipate or respond adequately to changes in technology and customer
requirements, or delays in product development or introduction, could have
a material adverse effect on the Company's business.
Challenges Developing Customer Relationships in an Emerging
Market. Because predictive maintenance is a relatively new concept and
involves relatively high capital investment on the part of the Company's
target customers, before the Company can convince its target customers to
buy its products and services, rather than similar products or services
provided by the Company's competitors, it must first convince those
customers that the technology utilized in predictive maintenance and
applied by the Company's products is sound and that the return on
investment of establishing a predictive maintenance program is adequate.
Inability to Obtain, or Loss of, Patents and Proprietary Rights. All of
the Company's current products and those under development utilize the
Company's proprietary technologies. In addition, certain products utilize
technologies licensed to the Company by third parties. There can be no
assurance that the means utilized by the Company to protect its products
and technologies will be adequate. The inability of the Company to
maintain the proprietary aspects of its significant products and core
technologies could have a material adverse effect on the Company's results
of operations. During the last several years, the Company was involved in
litigation which challenged the right of the Company to utilize certain
intellectual property in its products. As a result of this litigation, the
Company paid or incurred the commitment to pay to third parties (including
the cost of defending the litigation) an aggregate of approximately $7.2
million for satisfaction of claims related to patent infringement and to insure
that the Company would have the right to utilize this technology in the future
pursuant to non-exclusive licenses. The extent to which the research and
development efforts of the competitors of the Company have or will result in
patents and the extent to which the issuance of patents to others would
have a material adverse effect on the Company or would force the
Company to obtain licenses from such competitors are currently unknown.
There can be no assurance that third parties will not make claims regarding
the Company's ability to use intellectual property the Company develops, or
that third parties may not own or have the rights to technologies or
processes that the Company desires to incorporate in its products.
Competing Technologies or Technological Obsolescence. There
exists the risk that the Company's competitors may develop products which
are superior to the Company's. The Company's product backlog of firm
orders generally represents orders expected to be filled within the two
months following the date of the order. Because of the short time frame for
filling backlog orders, the introduction of products using competing
technologies could have an immediate impact on the Company.
Significant Expenditures for Research and Development. In the last
three fiscal years, the Company has spent an aggregate of approximately
$14.1 million on research and development. For the same period, the
Company's net income aggregated approximately $9.3 million. The
Company believes that it will be required to continue to make a significant
investment in research and development to refine its existing products and
continue to develop additional advanced predictive maintenance products.
These expenses are made significantly in advance of sales of these
products. The Company expenses the majority of its research and
development costs as they are incurred and there exists the risk that it will
be unable to recover expenses for the development of these products if the
products developed do not prove to be commercially successful. The
remaining research and development costs are capitalized from the time a
product's prototype has been established until the time the product is
available for general release. Capitalized costs are amortized over the
economic life of the product on a per unit basis. The Company expects that
research and development expenses will increase on an absolute basis but
will remain steady or decline as a percentage of revenues, depending on
the timing of expenditures for particular projects.
Fluctuations in Quarterly Results of Operations. The Company's
revenues are seasonal, and the Company's product backlog generally
represents only products expected to be shipped within the two months
following the order. Generally, the Company's revenues are higher every
subsequent quarter of the fiscal year, due to customers' tendencies to
purchase capital assets (such as the Company's products) towards the end
of their fiscal years. Customers' capital spending patterns can have a
significant effect on the Company's results of operations, especially during
the fourth quarter when the Company has traditionally experienced its
highest revenue levels, and the results of one quarter are not necessarily
indicative of results for the next quarter. Because of the increased number
of shares outstanding after the Company's initial offering in August 1995,
increases in net income will not increase comparative earnings per share
proportionately, and any decrease in net income will result in a larger than
proportional decrease in comparative earnings per share.
Dependence on Senior Management. The Company's success
depends upon the continued contributions of its senior management,
including Ronald G. Canada, Chairman and Chief Executive Officer of the
Company, and Dr. Kenneth R. Piety, Vice Chairman, Secretary and Vice President
of Engineering of the Company. The loss of the services of one or more of
the Company's senior management could have a material adverse effect
upon the Company's business and development.
Volatility of Market Price for Common Stock. From time to time,
there may be significant volatility in the market price for the Common Stock.
Quarterly operating results of the Company or of other similar companies,
changes in general conditions of the economy (including potential
downturns in the national economy or in the economies of other countries
where the Company makes international sales), the financial markets or the
industry in which the Company operates and natural disasters or other
developments affecting the Company or its competitors could cause the
market price of the Common Stock to fluctuate substantially. In addition, in
recent years the stock market has experienced extreme price and volume
fluctuations. This volatility has had a significant effect on the market
prices of securities issued by many companies for reasons unrelated to their
operating performance.
Item 2. Properties
The Company's operations are primarily conducted from its 129,000
square foot headquarters and manufacturing facility in Knoxville, which the
Company owns. The Company leases property on which its satellite offices
are located. These satellite offices are located in Houston, Texas, San
Diego, California, Detroit, Michigan, Philadelphia, Pennsylvania, Merrillville,
Indiana, Brussels, Belgium, Rambouillet, France and Deeside, United
Kingdom.
Item 3. Legal Proceedings
From time to time the Company is involved in routine litigation and
proceedings in the ordinary course of business. The Company has been
involved in material litigation concerning patent infringement in the past.
Currently, the Company does not have pending any litigation or proceeding
that the Company believes will have a material adverse effect upon the
Company or its financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
There have been no matters submitted to a vote of the security holders
during the fourth quarter of 1996.
PART II
Item 5. Market for the Registrant's Common Equity and Related
Shareholder Matters.
On August 29, 1995, the Company completed an initial public offering of
its common stock (the "Initial Public Offering"). The common stock of the
Company is traded on the Nasdaq Stock Market's National Market (the
"Nasdaq National Market") under the symbol "CSIN". As of March 6, 1997,
there were approximately 315 record holders of common stock and
approximately 1,900 beneficial owners holding shares in nominee or
"street" name.
The Company has never declared or paid a cash dividend on its common stock.
It is the current policy of the Company's Board of Directors to retain all
earnings to support operations and to finance expansion; therefore, the Company
does not anticipate declaring or paying cash dividends on the common stock in
the foreseeable future. Pursuant to the Company's loan agreements, the Company
is subject to certain financial covenants which may restrict the payment of cash
dividends on its outstanding common stock. Future declaration and payment of
dividends, if any, will be determined in light of the then current conditions,
including the Company's earnings, operations, capital requirements, financial
condition, restrictions in financing agreements, and other factors deemed
relevant by the Board of Directors.
The following table sets forth, for the periods indicated, the high and low
prices of the Company's Common Shares as reported by the Nasdaq
National Market:
Price Range
Common Stock High Low
------------ ---- ---
First Quarter 1996 $19.25 $14.00
Second Quarter 1996 24.38 17.50
Third Quarter 1996 22.25 15.75
Fourth Quarter 1996 19.63 14.75
<PAGE>
Item 6. Selected Financial Data.
For the Years Ended December 31,
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(in thousands, except per share amounts)
Statement of Income Data:
Revenue, net:
Products $36,275 $31,990 $25,063 $21,566 $19,738
Services 13,771 9,782 6,102 4,784 3,765
------- ------- ------- ------- -------
Total 50,046 41,772 31,165 26,350 23,503
Cost of revenues:
Products 9,339 9,219 6,343 5,368 5,188
Services 10,732 7,443 4,312 2,938 2,061
------- ------- ------- ------- -------
Total 20,071 16,662 10,655 8,306 7,249
Gross margin 29,975 25,110 20,510 18,044 16,254
Operating expenses:
Selling, general and administrative 18,246 15,909 13,348 11,382 9,759
Research and development expenses 5,076 4,563 4,493 4,123 3,436
Litigation costs ----- ----- ----- 1,617 831
------- ------- ------- ------- -------
Income from operations 6,653 4,638 2,669 922 2,228
Other income (expenses):
Interest expense (4) (373) (458) (485) (584)
Interest income 458 261 109 145 140
Other income(expense),net (23) 77 37 73 70
Minority share of income ----- ----- ----- (1) (8)
------- ------- ------- ------- -------
Income before taxes 7,084 4,603 2,357 654 1,846
Provision for income taxes 2,550 1,656 559 347 753
------- ------- ------- ------- -------
Net income $ 4,534 $ 2,947 $ 1,798 $ 307 $ 1,093
======= ======= ======= ======= =======
Net income per share $ 0.90 $ 0.72 $ 0.51 $ 0.08 $ 0.29
Pro forma earnings per share(1) $ 0.68
Weighted average number of
common and common equivalent
shares outstanding 5,066 4,117 3,503 3,794 3,795
As of December 31,
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
Balance Sheet Data:
Working capital $11,413 $16,432 $ 2,417 $ 3,231 $ 3,343
Total assets 45,273 32,151 19,725 15,361 15,145
Long-term debt, including
current maturities 13 32 3,600 5,326 3,769
Total shareholders' equity 31,686 24,527 6,870 4,822 5,498
Shareholders' equity per share 6.25 5.96 1.96 1.27 1.45
Return on shareholders' equity (2) 16.1% 18.8% 30.8% 5.9% 23.2%
Current ratio 1.88 3.31 1.27 1.55 1.82
(1) Pro forma earnings per share for the year ended December 31, 1995 is
provided to reflect what earnings per share would have been had the
Company had available and used proceeds from the August 1995 initial
public offering to pay off long-term debt and the revolving line of credit.
(2) Return on equity is calculated using the average of beginning and
ending balances of shareholders' equity for the applicable year.
Selected Quarterly Information
(in thousands except per share amounts)
<TABLE>
<CAPTION>
Net Operating Net Total Debt (Including Retained Earnings
Sales Income Income Assets current maturities) Earnings Per Share
----- ------ ------ ------ ------------------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
4th Quarter 1996 $16,871 $2,894 $1,897 $45,273 $13 $12,786 $0.37
3rd Quarter 1996 11,234 1,740 1,185 35,269 18 10,889 $0.24
2nd Quarter 1996 11,210 1,345 950 34,025 23 9,704 $0.19
1st Quarter 1996 10,731 674 502 32,448 26 8,754 $0.10
4th Quarter 1995 $12,312 $1,984 $1,431 $32,151 $32 $8,252 $0.29
3rd Quarter 1995 10,427 1,044 642 30,310 37 6,821 0.16
2nd Quarter 1995 9,679 1,056 593 19,738 3,526 6,179 0.17
1st Quarter 1995 9,354 554 281 19,997 3,555 5,593 0.08
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview
Since its formation in February 1984, the Company has experienced
substantial growth in the sales of its products and services. The
Company's net revenues have increased from $16.1 million in 1990 to
$50.0 million in 1996, an average annual increase of approximately 35%.
Increases in the revenues of the Company's vibration analysis products
account for a substantial part of the Company's net revenues and have
accounted for a large portion of the Company's growth over this period. In
the last four years, the Company has also developed an array of non-vibration
products utilizing a variety of technologies and concentrated on
the marketing of services incorporating all product lines and technologies.
These developments have lessened the Company's dependence on a
single product line and allowed the Company to provide a more complete
line of Reliability-Based Maintenance products and services. In October
1996, the Company completed the acquisition of Maintenance &
Diagnostics, LLC ("M&D"), an operator of research, service and training
centers for the electric power industry, which increased the Company's
services revenues derived from contract maintenance services.
Nevertheless, the Company believes that its continued success will be
dependent in large part on the continued viability of its vibration analysis
products.
The Company's revenues are classified as product revenues and service
revenues. Product revenues include the sale of the Company's integrated
instruments and software. Service revenues include revenues relating to
the Company's training programs, the performance of contract maintenance
services, engineering and consulting services and services performed at
the Company's oil testing laboratory. Revenues are generated from the
sale of products and services in both domestic and international markets.
During 1996, approximately 23% of the Company's revenues were
generated in international markets. No individual customer accounted for
more than 3% of revenues during 1996. The Company generally expects
that during the next several years service revenues will increase at a faster
rate than product revenues and that product revenues from the Company's
products other than vibration analysis products will increase at a faster rate
than the Company's vibration analysis products. At present, the principal
reasons for the difference in growth rates are due to the relatively small
Services revenue base, the fourth quarter acquisition of M&D Services and
product revenues from products other than vibration analysis.
Cost of revenues include direct expenses, such as labor and inventory,
as well as overhead allocated to direct expenses incurred in manufacturing
products sold by the Company and estimated costs attributable to
warranties. The direct costs associated with providing services performed
by the Company for its customers are also included in cost of revenues. In
addition, royalties paid on certain patents licensed to the Company are
reflected in this category. In general, as a percentage of revenue, the cost
of service revenues is greater than the cost of product revenues. Also, as a
percentage of revenue, the cost of revenues associated with the
Company's products other than vibration analysis products is higher than
the Company's cost of revenues associated with vibration analysis
products. The Company expects service revenues and revenue from
products other than vibration analysis products to grow at a faster rate than
revenue from vibration analysis products over the course of the next
several years.
Selling, general and administrative ("SG&A") expense includes costs
related to the Company's sales force which is comprised of both direct
employees of the Company and independent sales representatives.
Included are the direct labor costs for employee sales representatives as
well as commissions paid to both employee sales representatives and
independent sales representatives. Costs associated with marketing and
advertisements for the Company's products and services are included in
this category. Administrative expenses, including all corporate and
administrative functions that serve to support the existing product and
service businesses of the Company as well as provide the infrastructure for
future growth, are reflected in this category, as are certain management,
supervisory and staff salaries and employee benefits, data processing,
training, rent and office supply costs. In addition, the portion of
depreciation and amortization expense allocable to SG&A expense is included
in this category.
Research and development expenses include labor, overhead and
material costs associated with the development of new products and
services offered by the Company and are expensed as incurred. Costs
associated with new product development are capitalized beginning when a
product's prototype has been established and ending when the product is
available for general release. Capitalized costs are amortized over the
economic life of the product on a per unit basis. The Company expects that
research and development expenses will increase on an absolute basis but
will remain steady or decline as a percentage of revenues, depending on
the timing of expenditures for particular projects.
Interest expense includes costs and expenses associated with working
capital indebtedness as evidenced by outstanding balances on the
Company's principal credit facilities. Interest income includes imputed
interest on prepaid maintenance contracts.
Comparison of Fiscal Years Ended December 31, 1996 and December 31, 1995
Revenues, Net. Net revenues for 1996 increased 19.6% to $50.0
million from $41.8 million in 1995. Product revenues increased 13.4% to
$36.3 million in 1996 from $32.0 million in 1995 principally as a result of the
continued development of existing markets. Non-vibration product
revenues grew 52.8% to $10.3 million from $6.8 million in 1995. Service
revenues increased 40.8% to $13.8 million in 1996 from $9.8 million in
1995 as a result of the Company's acquisition of M&D, the opening of two
new training centers in Detroit and San Diego, and increased marketing of
its services.
Cost of revenues. Direct product and services costs increased 20.5%
to $20.1 million in 1996 from $16.7 million in 1995. Product costs
increased 1.3% to $9.3 million in 1996 from $9.2 million in 1995, and
service costs increased 44.2% to $10.7 million in 1996 from $7.4 million in
1995. Total cost of revenues as a percentage of net revenues increased
from 39.9% in 1995 to 40.1% in 1996, reflecting the expansion into non-vibration
product lines and the increase in service revenues.
Selling, General and Administrative. SG&A expense increased
14.7% to $18.2 million in 1996 from $15.9 million in 1995. The increase
resulted from the continued investment in market development and
increases in the Company's sales force which led to the increase in sales
for the current year. Commission expense increased 26.9% to $4.9 million
in 1996 from $3.9 million in 1995 as a result of increased sales. As a result
of strong revenues in 1996, however, SG&A expense as a percentage of
net revenues decreased to 36.5% in 1996 from 38.1% in 1995.
Research and Development. Research and development expense
increased by $513,000 or 11.3% to $5.1 million in 1996 from $4.6 million in
1995. As a percentage of net revenues, research and development
expense declined to 10.1% in 1996 from 10.9% in 1995, reflecting
increased revenues in 1996.
Income from Operations. Income from operations for 1996 increased
by $2.1 million to $6.7 million, or 13.3% of net revenues, from $4.6 million,
or 11.1% of net revenues, in 1995.
Interest Expense, Interest Income, and Other Income. Interest
expense decreased 98.9% in 1996 to $4,000 from $373,000 in 1995,
primarily as a result of lower average balances on the Company's
outstanding indebtedness. Interest income increased to $458,000 in 1996
from $261,000 in 1995 due to additional funds being available for
investment. Other income (expense) decreased by $100,000 to ($23,000)
in 1996 compared to $77,000 in 1995.
Income Taxes. The Company's effective tax rate remained 36.0% in
1996 as compared to 1995. The Company's effective tax rate is lower than
the statutory rate primarily because of research and development tax
credits which have been available to the Corporation and the utilization of a
foreign sales company.
Comparison of Fiscal Years Ended December 31, 1995 and December 31, 1994
Revenues, Net. Net revenues for 1995 increased 34.0% to $41.8
million from $31.2 million in 1994. Product revenues increased 27.6% to
$32.0 million in 1995 from $25.1 million in 1994 principally as a result of the
Company's expansion into non-vibration product lines. Non-vibration
product revenues grew 83.8% to $6.8 million from $3.7 million in 1994.
Service revenues increased 60.3% to $9.8 million in 1995 from $6.1 million
in 1994 as a result of the Company's increased marketing of its services.
Cost of revenues. Direct product and services costs increased 56.4%
to $16.7 million in 1995 from $10.7 million in 1994. Product costs
increased 45.4% to $9.2 million in 1995 from $6.3 million in 1994, and
service costs increased 72.6% to $7.4 million in 1995 from $4.3 million in
1994. Total cost of revenues as a percentage of net revenues increased
from 34.2% in 1994 to 39.9% in 1995 for several reasons. First, the
expansion into non-vibration product lines increased revenues, but involved
products with lower margins. Margins are lower on the Company's non-vibration
products for two principal reasons: (i) the lower volume of units for
these products translates into a higher per unit manufacturing cost and (ii)
the Company is able to maintain relatively high margins on its vibration
analysis products because of increased efficiencies and its competitive
position in that area. Consequently, overall product costs as a percentage
of net revenues will continue to rise in the short term as sales of
non-vibration products increase as a percentage of net revenues, but unit costs
will stabilize to the extent that volume increases and manufacturing
efficiencies are achieved. Second, the Company generated greater service
revenues which tend to carry a lower gross margin percentage than the
Company's product business. Costs associated with the Company's
service business are accounted for almost entirely in cost of revenues.
Further, the service business acquired from TEC in October, 1994 had a
gross margin of approximately 4.6%, which was significantly lower than the
gross margin on the Company's existing service business of approximately
24.4%. The Company expects, however, that it may increase margins on
the TEC service business through operational improvements. The service
costs also reflect net additions to the Company's staff to support increased
service demands.
Selling, General and Administrative. SG&A expense increased
19.2% to $15.9 million in 1995 from $13.3 million in 1994. The increase
resulted in part from the shift in the composition of the Company's sales
force from the predominant use of independent sales representatives
toward the use of more employee sales representatives. This increase was
partially offset by the lower commission rates that are paid to employee
sales representatives. However, commission expense increased 21.1% to
$3.9 million in 1995 from $3.2 million in 1994 as a result of increased sales.
SG&A expense also increased in 1995 primarily as a result of increased
market development expenditures. As a result of strong revenues in 1995,
however, SG&A expense as a percentage of net revenues decreased to
38.1% in 1995 from 42.8% in 1994.
Research and Development. Research and development expense
increased by $69,000 or 1.5% to $4.6 million in 1995 from $4.5 million in
1994. As a percentage of net revenues, research and development
expense declined to 10.9% in 1995 from 14.4% in 1994, reflecting
increased revenues in 1995.
Income from Operations. Income from operations for 1995 increased
by $2.0 million to $4.6 million, or 11.1% of net revenues, from $2.7 million,
or 8.6% of net revenues, in 1994.
Interest Expense, Interest Income, and Other Income. Interest
expense decreased 18.4% in 1995 to $373,000 from $458,000 in 1994,
primarily as a result of lower average balances on the Company's
outstanding indebtedness. Interest income increased to $261,000 in 1995
from $109,000 in 1994 due to additional funds being available for
investment. Other income increased by $40,000 to $77,000 in 1995
compared to $37,000 in 1994.
Income Taxes. The Company's effective tax rate was 36.0% in the
1995 period as compared to a rate in 1994 of 23.7%, principally due to the
decrease in certain research and development tax credits available to the
Company and the 1994 decrease in the Deferred Tax Valuation Allowance.
The Company's effective tax rate is lower than the statutory rate primarily
because of research and development tax credits which have been
available to the corporation and utilization of a foreign sales company.
Liquidity and Capital Resources
Since its inception, the Company has financed its operations through a
combination of cash flow from operations, bank borrowings and equity
capital. The Company's capital requirements have arisen primarily in
connection with purchases of fixed and intangible assets, including
acquisitions, and the Company has made significant expenditures each
year for research and development and market development.
Net cash provided by operating activities in 1996 increased to
$5,331,000 from $2,546,000 in 1995 primarily due to increases in net
income and an increase in current liabilities reflecting the higher level of
business activity. Cash used in investing activities increased from $1.6
million in 1995 to $10.1 million in 1996, reflecting additions to property,
plant and equipment and the acquisition of M&D. These investments were
financed from the Company's cash flow from operations and cash on hand
from the Company's 1995 initial public offering. At December 31, 1996, the
Company's cash on hand totaled $4.6 million.
The Company maintains two bank lines of credit that provide for
borrowings of up to $12.0 million based on a minimum current ratio of 1.25
or better and bearing interest at the lender's base rate or the adjusted
LIBOR rate plus the applicable LIBOR margin at the Company's discretion.
Although the Company has at present no acquisition agreements nor
arrangements, the Company may in the future make strategic acquisitions
of other providers of maintenance products or services using stock, cash,
debt or a combination thereof. Depending on the terms of the acquisition,
the Company may need to incur additional indebtedness or issue equity
securities to make any such acquisition.
The Company routinely engages in transactions in foreign countries.
Substantially all of the Company's transactions are denominated in U.S.
currency, thereby limiting the Company's exposure to fluctuations in foreign
currency exchange rates.
Inflation
The Company believes that the relatively moderate rate of inflation
experienced over the past several years has not had a material impact on
its sales or profitability.
Item 8. Financial Statements and Supplementary Data
INDEX
Consolidated Financial Statements:
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Operations for each of the Three Years
in the period ended December 31, 1996
Consolidated Statements of Cash Flows for each of the Three Years
in the period ended December 31, 1996
Consolidated Statements of Shareholders' Equity for each of the Three
Years in the period ended December 31, 1996
Notes to Consolidated Financial Statements
Independent Accountants' Report
Financial Statement Schedule:
Independent Accountants' Report
Supplemental Schedule II - Valuation and Qualifying Accounts
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,576,801 $ 8,824,332
Trade accounts receivable, less
allowance for doubtful accounts
of approximately $198,500 in 1996
and $132,000 in 1995 15,656,516 9,980,006
Refundable income taxes ------- 160,000
Inventories 3,190,964 3,623,124
Deferred income taxes 740,000 703,000
Prepaid expenses and other current assets 166,733 239,369
----------- -----------
Total current assets 24,331,014 23,529,831
Property, plant and equipment:
Land 729,204 729,204
Building and improvements 6,714,979 4,488,421
Equipment and furniture 10,625,614 6,763,103
Construction-in-Progress 1,293,587 87,325
----------- -----------
19,363,384 12,068,053
Less accumulated depreciation (5,879,464) (4,129,812)
----------- -----------
Property, plant and equipment, net 13,483,920 7,938,241
----------- -----------
Other assets:
Other assets 552,777 43,193
Goodwill 6,292,490 -------
Other intangible assets 612,646 639,508
----------- -----------
Total assets $45,272,847 $32,150,773
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,598,425 $ 1,160,502
Accrued liabilities 7,222,579 3,977,241
Income taxes payable 1,026,110 492,010
Deferred maintenance contract revenue 2,070,411 1,468,238
----------- -----------
Total current liabilities 12,917,525 7,097,991
Other liabilities ------- 13,172
Deferred maintenance contract revenue 668,862 512,159
----------- -----------
Total liabilities 13,586,387 7,623,322
----------- -----------
Commitments and contingencies (Notes 7, and 9)
Shareholders' equity:
Common stock, no par value, 50,000,000 shares
authorized, 4,991,618 and 4,743,209 shares
issued and outstanding in 1996 and 1995,
respectively 18,034,208 15,459,192
Additional paid-in capital 865,805 815,862
Retained earnings 12,786,447 8,252,397
----------- -----------
Total shareholders' equity 31,686,460 24,527,451
----------- -----------
Total liabilities and shareholders' equity $45,272,847 $32,150,773
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Revenues, net:
Product $36,275,150 $31,990,239 $25,063,227
Services 13,770,973 9,782,244 6,102,050
----------- ----------- -----------
50,046,123 41,772,483 31,165,277
Cost of revenues:
Product 9,339,308 9,219,753 6,343,261
Services 10,731,998 7,442,778 4,312,237
----------- ----------- -----------
20,071,306 16,662,531 10,655,498
----------- ----------- -----------
Gross margin 29,974,817 25,109,952 20,509,779
Costs and expenses:
Selling, general and administrative expenses 18,245,737 15,909,203 13,348,015
Research & development expenses 5,075,674 4,562,481 4,492,988
----------- ----------- -----------
Income from operations 6,653,406 4,638,268 2,668,776
Other income (expenses):
Interest expense (3,985) (373,451) (457,547)
Interest income 457,560 261,184 108,865
Other income(expense), net (22,525) 76,795 36,857
----------- ----------- -----------
Income before taxes 7,084,456 4,602,796 2,356,951
Provision for income taxes 2,550,406 1,655,495 558,684
----------- ----------- -----------
Income after taxes $ 4,534,050 $ 2,947,301 $ 1,798,267
=========== =========== ===========
Earnings per share $ 0.90 $ 0.72 $ 0.51
=========== =========== ===========
Weighted average shares and
equivalents outstanding 5,065,510 4,117,251 3,503,329
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $4,534,050 $2,947,301 $1,798,267
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 2,021,041 1,321,191 927,803
Deferred income taxes 2,000 129,000 (342,000)
Accrued interest on notes from shareholders ----- ----- (12,191)
Changes in operating assets and liabilities:
Accounts receivable (4,155,437) (3,358,396) (1,079,624)
Income taxes refundable or payable 771,183 220,010 612,000
Inventories 165,676 (136,895) (1,490,401)
Prepaid expenses and other current assets 105,868 77,648 (60,720)
Other assets 6,438 (7,604) 2,924
Accounts payable 1,134,454 (45,004) (290,370)
Accrued liabilities (13,455) 1,115,615 916,220
Deferred maintenance contract revenue 758,876 282,900 385,856
---------- ---------- ----------
Net cash provided by operating activities 5,330,694 2,545,766 1,367,764
---------- ---------- ----------
Cash flows from investing activities:
Purchase of property, plant and equipment (6,576,186) (1,872,030) (1,754,940)
Purchase of business (net of cash acquired) (2,910,586) ----- (1,100,000)
Capitalized acquisition consts (113,908) ----- -----
Investment in other assets (506,118) ----- -----
Net repayments from (advances to) shareholders ----- 245,756 (13,000)
---------- ---------- ----------
Net cash used in investing activities (10,106,798) (1,626,274) (2,867,940)
---------- ---------- ----------
Cash flows from financing activities:
Net borrowings under (repayments on) line of credit ----- (3,193,664) 2,783,644
Repayment of long-term debt (13,172) (3,568,420) (1,726,393)
Net proceeds from issuance of common stock 541,745 14,739,152 333,520
Purchases of common stock ----- (28,840) (84,240)
Checks outstanding in excess of bank balances ----- (43,388) 43,338
---------- ---------- ----------
Net cash provided by financing activities 528,573 7,904,840 1,349,869
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents (4,247,531) 8,824,332 (150,307)
Cash and cash equivalents, at beginning of year 8,824,332 ----- 150,307
---------- ---------- ----------
Cash and cash equivalents, at end of year $4,576,801 $8,824,332 $ -----
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Additional Total
Common Paid-In Retained Shareholders'
Stock Capital Earnings Equity
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Balance, January 1, 1994 $ 471,283 $ 842,244 $ 3,508,764 $ 4,822,291
Issuance of 71,185 shares under employee stock
purchase plan 213,555 ----- ----- 213,555
Issuance of 12,200 shares under stock option plans 29,965 ----- ----- 29,965
Issuance of 30,000 shares 90,000 ----- ----- 90,000
Purchase and retirement of 28,080 shares (78,555) (3,750) (1,935) (84,240)
Net income ----- ----- 1,798,267 1,798,267
----------- ----------- ----------- -----------
Balance, December 31, 1994 726,248 838,494 5,305,096 6,869,838
Issuance of 60,834 shares under employee stock
purchase plan 240,081 ----- ----- 240,081
Issuance of 87,300 shares under stock option
plans 369,660 ----- ----- 369,660
Issuance of 1,283,970 shares, net of $1,608,000
in expenses and underwriting discounts 14,129,411 ----- ----- 14,129,411
Purchase and retirement of 7,560 shares (6,208) (22,632) ----- (28,840)
Net income ----- ----- 2,947,301 2,947,301
----------- ----------- ----------- -----------
Balance, December 31, 1995 15,459,192 815,862 8,252,397 24,527,451
Issuance of 5,009 shares under employee stock
purchase plan 81,797 ----- ----- 81,797
Issuance of 137,250 shares under stock option
plans 459,948 ----- ----- 459,948
Issuance of 73,146 shares due to acquisition of
subsidiary 1,143,271 ----- ----- 1,143,271
Stock options issued in connection with acquisition
of subsidiary 750,000 ----- ----- 750,000
Employee stock options issued at less than stock
market price 140,000 ----- ----- 140,000
Income tax benefits related to exercised
stock options ----- 49,943 ----- 49,943
Net Income ----- ----- 4,534,050 4,534,050
----------- ----------- ----------- -----------
Balance, December 31, 1996 $18,034,208 $ 865,805 $12,786,447 $31,686,460
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL:
Computational Systems, Incorporated and Subsidiaries' (the Company)
principal business is to design, develop, manufacture, market and support
predictive and proactive maintenance technology products for large scale,
heavy industrial manufacturing facilities worldwide. The Company has
several wholly-owned subsidiaries which perform maintenance and
consulting services, research and development services for the
commercialization of various products, and sell the Company's products in
foreign countries.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of consolidation - The consolidated financial statements of
the Company include the accounts of Computational Systems, Incorporated
and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated.
Cash and cash equivalents - For purposes of the statement of cash
flows, the Company considers all highly liquid debt instruments with a
maturity of three months or less when purchased to be cash equivalents.
Substantially all cash and cash equivalents are maintained at a local bank
or in U.S. government agency debt securities. Such items are primarily
uncollateralized.
Inventories - Inventories are stated at the lower of cost or market, with
cost determined using standard costs (which approximate first-in, first-out
costs).
Property, plant and equipment - Property, plant and equipment are
stated at cost. Routine maintenance and repairs are expensed as incurred.
Expenditures which materially increase values, change capacities or extend
useful lives of the respective assets are capitalized. Upon sale or retirement
of property, plant and equipment, the cost and accumulated depreciation
are removed from the respective accounts and the resulting gain or loss, if
any, is included in the consolidated statements of operations.
Depreciation is computed on a straight-line basis over the estimated
useful lives of the assets, which range from 2 to 31.5 years.
Intangibles - Intangible assets consisting principally of goodwill and
acquired patents are being amortized on a straight-line basis over their useful
lives ranging from three to twenty years. Amortization of these intangibles
was $232,794 in 1996, $179,162 in 1995 and $49,551 in 1994. The carrying value
of intangible assets is periodically reviewed by the Company and impairments are
recognized when the expected future operating cash flows derived from such
intangible assets are inadequate to fully recover their carrying value.
Retirements of Common Shares - Retirement of Company shares is
accounted for by reversing the amounts recorded within the applicable
shareholders' equity accounts when such shares were originally issued,
with the excess cost of such shares being charged to retained earnings.
Revenue recognition - Product sales are recognized upon shipment of
products. Maintenance contract revenue is deferred when contracts are
entered into and recognized as revenue on the straight-line basis over the
life of the related contract. Costs associated with performing services under
these contracts are charged to expense when incurred. Other service
revenues and costs are recorded at the time such services are performed.
Estimated costs attributable to the Company's standard warranty program are
provided for at the time of sale.
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued):
Research and development - The majority of research and development
costs are expensed as incurred. Other research and development costs incurred
in developing a product during the period that begins when the product's
prototype has been established and ending when the product is available for
general release are capitalized and are amortized over the economic life of the
product. Such costs capitalized in 1996 amounted to $506,118. These costs will
be amortized on a per unit sold basis.
Income taxes - Income taxes are computed in accordance with
Statement of Financial Accounting Standard No. 109 Accounting for
Income Taxes. The statement applies an asset and liability approach that
requires the recognition of deferred tax assets and liabilities based on the
differences between the financial statements and the tax basis of the assets
and liabilities using enacted rates in effect for the year in which the
differences are expected to reverse.
Royalties - The Company pays certain royalties on certain products in
connection with the use of certain patents. Total royalties included in cost
of sales for 1996, 1995 and 1994 were approximately $968,000, $843,000 and
$574,000 respectively. These royalties will continue to be paid through the
year 2001.
Earnings per share - Earnings per common share have been computed
by dividing net income by the weighted average number of common and
common equivalent shares outstanding during each period. Common
equivalent shares relating to options issued during the 12 month period
preceding the initial public offering have been calculated using the treasury
stock method assuming that the options were outstanding during each
period presented and that the fair value of the Company's common stock
during each period was equal to the initial public offering price of $12.50
per share. Common equivalent shares relating to additional options have
been calculated using the treasury stock method for the portion of each
period for which the options were outstanding and using the average fair
value of the Company's common stock for each of the respective periods.
Pro forma earnings per share for the year ended December 31, 1995 is
$0.68. The pro forma earnings per share have been provided to reflect
what earnings per share would have been had the proceeds from the
Company's August 1995 initial public offering been used by the Company
on January 1, 1995 to pay off long-term debt and the revolving line of credit.
Stock split - On June 29, 1995, the Company's Board of Directors
approved a five-for-one common stock split, to be effected in the form of a
stock dividend, of the Company's common stock. All share, per share and
conversion amounts relating to common stock and stock options included in
the accompanying financial statements and notes reflect the stock split.
Preferred Stock - The Company has authorized 5,000,000 shares of
preferred stock. The rights, privileges and dividend rates of such stock are
to be determined by the Board of Directors at the time of issuance. No
preferred shares have been issued.
Management estimates - The preparation of financial statements in
conformity with Generally Accepted Accounting Principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Accounting for Stock Based Compensation - On January 1, 1996, the
Company adopted Statement of Financial Accounting Standard No. 123,
Accounting for Stock Based Compensation (SFAS 123). As permitted by
SFAS 123, the Company has chosen to continue to apply APB Opinion 25,
Accounting for Stock Issued to Employees (APB 25) and related
interpretations in accounting for its Plans. The pro forma disclosures of the
impact of SFAS 123 are described in Note 7 of the financial statements.
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued):
Impairment of long-lived assets - In March 1995, the FASB issued
Statement of Accounting Standards No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of, which
(i) requires that long-lived assets to be held and used be reviewed for
impairment whenever events or circumstances indicate that the carrying
value of an asset may not be recoverable, (ii) requires that long-lived assets
to be disposed of be reported at the lower of the carrying amount or the fair
value less costs to sell, and (iii) provides guidelines and procedures for
measuring impairment losses that are different from previously existing
guidelines and procedures. The Company adopted the provisions of
Statement 121 in 1996: the adoption did not have a material effect on the
Company's financial position, results of operations or cash flows.
3. INVENTORIES:
Inventories consist of the following as of December 31:
1996 1995
---- ----
Raw materials $1,406,893 $1,835,885
Work-in-process 649,589 736,109
Finished goods, net 1,134,482 1,051,130
---------- ----------
$3,190,964 $3,623,124
4. ACCRUED LIABILITIES:
Accrued liabilities consist of the following as of December 31:
1996 1995
---- ----
Accrued payroll $ 1,513,432 $ 882,192
Accrued vacation 799,300 624,596
Commissions payable 425,375 392,108
Accrued bonus 350,000 542,772
Promissory Note 2,385,250 -----
Other liabilities 1,749,222 1,535,573
---------- ----------
$7,222,579 $3,977,241
5. DEBT:
The Company previously had available a $4,000,000 Revolving Credit
Agreement (Agreement) expiring on December 31, 1996. Borrowings
under the Agreement bore interest at the bank's base rate. During 1995,
the Company used a portion of the proceeds from its initial public offering to
pay off the balances outstanding under its $4,000,000 Revolving Credit
Agreement and its term note.
On June 14, 1996 the Company entered into an Amended and Restated
Credit Agreement (Agreement) with
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
5. DEBT- (Continued):
two banks for a line of credit with available borrowings up to $12,000,000.
The Agreement expires on April 30, 1999. Borrowings under the
Agreement bear interest at either the bank's base rate or the adjusted
LIBOR rate plus the applicable LIBOR margin at the Company's discretion.
As of December 31, 1996, there was no outstanding balance under the new
Agreement. The Company's debt is secured by certain of the Company's
assets and the agreement contains certain financial and operational
covenants which, among other things, require the Company to maintain
minimum tangible net worth and working capital levels and meet certain
financial statement ratios.
The Company also maintains a capital lease which had a current
maturity of $13,146 on December 31, 1996. The Company records the
current portion of its debt in Accounts Payable. Any long-term portion debt
would be recorded in Other Liabilities.
6. INCOME TAXES:
The provision (benefit) for income taxes, all of which relates to
continuing operations, is comprised of the following:
1996 1995 1994
---- ---- ----
Current:
Federal $2,156,406 $1,214,495 $ 775,684
State 392,000 312,000 125,000
---------- ---------- ----------
2,548,406 1,526,495 900,684
Deferred:
Federal 2,000 115,000 (335,000)
State ------ 14,000 (7,000)
---------- ---------- ----------
2,000 129,000 (342,000)
---------- ---------- ----------
$2,550,406 $1,655,495 $ 558,684
========== ========== ==========
The components of deferred income tax assets and liabilities at
December 31, 1996 and 1995, are as follows:
<TABLE>
<CAPTION>
1996 1995
Current Noncurrent Current Noncurrent
-------- ---------- ------- ----------
<S> <C> <C> <C> <C>
Deferred income tax assets:
Allowance for doubtful accounts $ 68,000 $ ----- $50,000 $ -----
Demonstration equipment ----- ----- 77,000 -----
Inventories 17,000 ----- 38,000 -----
Warranty, bonus and other accruals 655,000 ----- 538,000 -----
Deferred revenue ----- 194,000 ----- 182,000
Intangibles ----- 42,000 ----- 23,000
-------- ----------- ------- ----------
740,000 236,000 703,000 205,000
Deferred income tax liabilities:
Property, plant and equipment ----- (271,000) ----- (201,000)
Intangibles
-------- ----------- ------- ----------
----- (271,000) ----- (201,000)
-------- ----------- ------- ----------
Net deferred tax asset (liability) $740,000 $ (35,000) $703,000 $4,000
======== =========== ======= ==========
</TABLE>
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
6. INCOME TAXES - (Continued)
Management believes that a valuation allowance is not considered
necessary at December 31, 1996 and 1995 based upon the historical levels
of taxable income and the projections for future taxable income over the
periods during which the temporary differences giving rise to deferred tax
assets are expected to be recovered or settled.
The provision for income taxes in 1996, 1995 and 1994, differs from the
"expected" income tax expense (computed by applying the U.S. corporate
income tax rate of 34%) as a result of the following:
1996 1995 1994
Tax at statutory rate $2,409,000 $1,565,000 $801,000
State income taxes, net of
federal income tax benefit 284,000 184,000 95,000
Research and development tax credits (123,000) (66,000) (184,000)
Change in valuation allowance ----- ----- (228,000)
Other provision for income taxes (19,594) (27,505) 74,684
---------- ---------- --------
$2,550,406 $1,655,495 $558,684
7. EMPLOYEE STOCK AND BENEFIT PLANS:
Stock Options
The Company maintains incentive stock option plans. Under the 1987
Plan, 500,000 shares of the Company's common stock were reserved for
options. Options were granted to key officers and employees at the
discretion of the Company's Board of Directors. On July 27, 1995, the
Company's shareholders approved the 1995 Plan for the award of up to
350,000 shares. No further options shall be granted under the 1987 Plan.
Prior to the Company's initial public offering in August, 1995, the fair value
of the Company's shares was determined by the Board of Directors, based
on an independent valuation. Subsequent to August, 1995 the fair value is
the quoted market price of the Company's shares. Options are generally
exercisable ratably over five years beginning one year after the date granted,
and expire in six to ten years.
The Company's Board of Directors has the ability to grant stock options
that are not covered under any of the stock option plans on a discretionary
basis.
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. EMPLOYEE STOCK AND BENEFIT PLANS - (Continued)
Information with respect to all outstanding options at December 31, is
summarized as follows:
<TABLE>
<CAPTION>
Weighted Weighted
Average Average Weighted
of Grant Stock Average
Number Exercise Date Fair Options Exercise
of Options Prices Value Exercisable Price
---------- -------- --------- ----------- --------
<S> <C> <C> <C> <C> <C>
Shares under option as of January 1, 1994 196,500 $ 2.80
Options granted
Exercise Price = Market Price of Stock 220,000 $ 3.07 $ 3.07
Options exercised (12,200) $ 2.36
Options canceled (19,500) $ 1.99
---------- --------
Shares under option as of December 31, 1994 384,800 $ 2.72 85,465 $ 2.97
Options granted
Exercise Price < Market Price of Stock 10,000 $ 4.00 $15.00
Exercise Price > Market Price of Stock 14,955 $ 4.40 $ 4.00
Exercise Price = Market Price of Stock 66,775 $10.85 $10.85
Options exercised (87,300) $ 3.08
Options canceled (16,500) $ 2.94
---------- --------
Shares under option as of December 31, 1995 372,730 $ 4.48 65,046 $ 4.51
Options granted
Exercise Price < Market Price of Stock 50,000 $15.23 $18.13
Exercise Price > Market Price of Stock 230,565 $16.19 $15.61
Exercise Price = Market Price of Stock 88,738 $17.39 $17.39
Options exercised (137,250) $ 3.39
Options canceled (53,095) $11.28
---------- --------
Shares under option as of December 31, 1996 551,688 $12.06 85,840 $11.60
========= ========
</TABLE>
1996 1995
------- -------
Shares available for future grant under the 1987 Plan ----- -----
Shares available for future grant under the 1995 Plan 111,608 298,500
The following table summarizes information about the Plans' stock
options at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------- ---------------------------
Number Weighted-Average Weighted Number Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices at 12/31/96 Contractual Life Exercise Price at 12/31/96 Exercise Price
- --------------- ---------------- ------------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$ 2.46 - $ 4.40 176,274 3.08 years $ 3.23 26,900 $ 3.26
$12.50 - $21.88 375,414 8.87 years $16.20 58,940 $15.40
</TABLE>
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. EMPLOYEE STOCK AND BENEFIT PLANS - (continued):
Had compensation cost for the Company's Plans been determined
based on the fair value at the grant dates for awards under the Plans
consistent with the method of SFAS 123, the Corporation's net income and
net income per share would have been reduced to the pro forma amounts
indicated below:
1996 1995
------------------------ -------------------------
As As
Reported Pro Forma Reported Pro Forma
---------- ---------- ---------- ----------
Net income $4,534,050 $4,032,845 $2,947,301 $2,901,866
Earnings per share $0.90 $0.82 $0.72 $0.71
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model using the following weighted
average assumptions: dividend growth rate of 0% for both 1996 and 1995,
expected volatility of 0.395 for 1996 and 1995, risk-free interest rates of
6.25% for options issued prior to August 28, 1995 and 6.46% for options
issued subsequently to August 28, 1995 and expected lives of six years for
options issued prior to August 28, 1995 and ten years for options issued
subsequently to August 28, 1995.
Stock Purchase Plan
In 1990, the Board of Directors established an employee stock purchase
plan where all employees could elect to purchase an amount of common
stock equal up to 10% of their individual compensation. Shares were
offered at fair value as determined annually on January 1st by
management, based on an independent valuation and the Board reserved
the right to determine those years in which shares would be made available
under the Plan. In 1995, 60,834 shares were issued to employees under
this plan at a price of $4.00 per share. On July 27,
1995, the Company's shareholders approved a new employee stock
purchase plan that mirrors the 1990 Plan except that up to 150,000 shares
can be issued at a price equal to the lesser of 95% of the market price on
the last day of the plan period or the average of the market prices on the
first and last day of the plan period. An aggregate of 10,307 shares were
issued to employees under the employee stock purchase plan in 1996.
401(k) Plan
The Company has a 401(k) plan which is available to all full-time
employees and those part-time employees who have completed 1,000
hours of employment during twelve consecutive months. The Company will
contribute one-half of the contributions made by each participant, up to a
maximum Company contribution of 3% of each participant's annual
earnings. The Company made contributions of $380,249, $265,397 and
$216,092 in 1996, 1995 and 1994, respectively.
8. RELATED PARTY NOTE RECEIVABLE:
A note receivable from the Company's largest shareholder and
Chairman was paid on June 29, 1995. The outstanding balance and
accrued interest at the time amounted to $262,772.
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. LEASES:
The Company has operating leases for certain training facilities and
office equipment. Rent expense under these operating leases was
$353,780 in 1996, $100,163 in 1995 and $86,561 in 1994. Minimum
commitments under operating leases are as follows:
Year Amount
1997 $207,008
1998 207,008
1999 204,281
2000 196,100
2001 94,552
--------
Total $908,949
10. PURCHASE OF BUSINESS:
On October 28, 1996, the Company acquired the assets and assumed
certain liabilities of Maintenance & Diagnostics, L.L.C. ("M&D"), and the
rights to use certain technology from a third party. The acquistion has been
accounted for under the purchase method and, accordingly, the operating
results of M&D have been included in the consolidated operating results
since the date of acquisition. The purchase price consisted of $3.88 million
in cash to owners of M&D including $2.385 million of which was paid on
January 2, 1997. The issuance of an aggregate of 51,047 shares of CSI
common stock to the owners of M&D and 49,805 shares to the third party
(for the rights to use certain technology and other rights). The Company
also repaid $1.48 million for amounts owed under M&D's line of credit
agreement with one of its owners. CSI also issued options to certain of the
owners of M&D (such options are valued at $750,000). M&D operates
research, service and training facilities for the electric power industry. The
purchase price was allocated to the assets and liabilities based on their fair
market value as follows:
Cash $ 68,035
Accounts Receivable 1,521,073
Prepaid Expenses 33,232
Fixed Assets 491,257
Deposits 13,903
Goodwill (20 year life) 6,346,130
Other Assets 38,384
Accounts Payable (303,469)
Accruals (518,360)
----------
$7,690,185
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
10. PURCHASE OF BUSINESS - (Continued):
The unaudited consolidated results of operations on a pro forma basis
as though M&D had been acquired as of the beginning of the year are as follows:
(Unaudited) (Unaudited)
1996 1995
----------- -----------
Net Sales $56,274,408 $45,837,752
Gross Profit $31,584,439 $26,167,483
Net Income $ 4,685,791 $ 2,611,695
Earnings Per Share $ 0.91 $ 0.62
The pro forma financial information is presented for informational
purposes only and is not necessarily indicative of the operating results that
would have occurred had the acquisition been consummated as of the
above date, nor is it necessarily indicative of future operating results.
11. CASH FLOW INFORMATION:
1996 1995 1994
---------- ---------- ----------
Supplemental disclosures of cash flows:
Interest paid $ 3,985 $ 184,975 $ 486,166
========== ========== ==========
Income taxes paid (refunded), net $1,883,000 $1,321,000 $ (38,000)
========== ========== ==========
The Company entered into the following noncash transactions to
purchase M&D: promissory notes totaling $2,385,250, common stock
valued at $1,576,317 and stock options valued at $750,000.
12. EXPORT SALES:
Export sales were as follows for the years ended December 31, (in
thousands):
1996 1995 1994
------- ------- ------
Middle East $ 868 $ 772 $ 513
Europe 2,418 3,804 2,288
Latin America 3,621 2,652 2,649
Asia 3,258 3,437 2,088
Other areas 1,124 1,739 1,686
------- ------- ------
$11,289 $12,404 $9,224
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
We have audited the accompanying consolidated balance sheets of Computational
Systems, Incorporated and Subsidiaries (the Company) as of December 31, 1996 and
1995, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statments 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 wsed and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Computational
Systems, Incorporated and Subsidiaries as of December 31, 1996 and 1995, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
Knoxville, Tennessee
January 24, 1997
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
No events have occurred that would require disclosure under this item.
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information regarding the directors and executive offices of the Company
is hereby incorporated by reference to pages 3 through 5 of the Company's
Proxy Statement relating to the 1997 Annual Meeting of Shareholders (the
"1996 Proxy Statement").
Item 11. Executive Compensation
Information regarding executive compensation is hereby incorporated to
the Executive Compensation section, pages 6 through 12, of the 1996
Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and
Management
Information regarding security ownership of certain beneficial owners
and management is hereby incorporated by reference to page 3 of the
1996 Proxy Statement.
Item 13. Certain Relationships and Related Transactions
James F. Smith, Jr., a director of the Company, is also a director of First
American Corp., the holding company for First American National Bank.
First American National Bank is a lendor to the Company under an
Amended and Restated Credit Agreement (Agreement) for a line of credit
with available borrowings up to $12,000,000. The Agreement expires on
April 30, 1999.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
(a)(1) The following Consolidated Financial Statements of Computational
Systems, Incorporated are included in Part II, Item 8.
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Operations for the years ended
December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
Report of Independent Accountants
(2) Financial Statement Schedules:
Report of Independent Accountants
Schedule II - Valuation and Qualifying Accounts and Reserves is
included herein.
(3) Exhibits:
A. Incorporated by reference to the Company's Registration
Statement on Form S-1 (No. 33-94172)
Exhibit
Number Description
3.1 -- Restated Charter of Registrant.
3.2 -- Restated Bylaws of Registrant.
4.1 -- Specimen Common Stock certificate.
4.2 -- Article 5 of the Registrant's Restated Charter
(included in Exhibit 3.1).
4.3 -- Article 6 of the Registrant's Restated Bylaws
(included in Exhibit 3.2).
10.1 -- 1995 Employee Stock Incentive Plan.
10.2 -- 1987 Incentive Stock Option Plan.
10.3 -- Computational Systems, Incorporated Employee Stock
Purchase Plan.
10.4 -- 1990 Employee Stock Purchase Plan.
10.5 -- 1995 Amended and Restated Non-Employee Directors'
Stock Option Plan.
10.6 -- Non-Employee Directors' Stock Option Plan.
10.7 -- Senior Executive Incentive Compensation Plan.
10.8 -- Letter Agreement dated June 6, 1995 between Third
National Bank of East Tennessee and Computational
Systems, Incorporated
10.9 -- Amended and Restated Loan Agreement and Security
Agreement dated October 21, 1993 between Third National
Bank of Tennessee and Computational Systems,
Incorporated.
10.10 -- Amended and Restated Promissory Note (Building
Loan) dated October 21, 1993 between Third
National Bank of Tennessee and Computational
Systems, Incorporated.
10.11 -- Term Loan Agreement dated October 15, 1991
between Computational Systems, Incorporated and
Third National Bank of East Tennessee.
10.12 -- Construction Loan Agreement by and between
Computational Systems, Incorporated and Third
National Bank of East Tennessee.
10.13 -- Deed of Trust executed October 15, 1991 in favor of
Third National Bank of East Tennessee, as
amended.
10.14 -- Letter Agreement dated September 30, 1994
between First American National Bank and
Computational Systems, Incorporated.
10.15 -- Loan Agreement dated April 1, 1994 between First
American National Bank and Computational
Systems, Incorporated.
10.16 -- Master Promissory Note executed September 30,
1994 in favor of First American National Bank.
10.17 -- Master Promissory Note executed April 1, 1994 in
favor of First American National Bank.
10.18 -- Patent Agreement dated September 30, 1994
between Technology for Energy Corporation and
Computational Systems, Incorporated.
10.19 -- Release of Claims dated September 30, 1994
between Technology for Energy Corporation and
Computational Systems, Incorporated.
10.20 -- Amendment to Software Agreement dated
September 30, 1994 between Technology for
Energy Corporation and Computational Systems,
Incorporated.
10.21 -- Assumption of Obligations dated September 30,
1994 between Computational Systems,
Incorporated and Technology for Energy
Corporation.
10.22 -- Purchaser's Covenant Not to Compete executed
September 30, 1994 in favor of Technology for
Energy Corporation.
10.23 -- Seller's Covenant Not to Compete executed
September 30, 1994 in favor Computational
Systems, Technology for Energy Corporation.
10.24 -- Letter Agreement dated September 18, 1992
between VFQ, Inc. and Computational Systems,
Incorporated.
10.25 -- Software License Agreement dated September 8,
1992 between VFQ, Inc. and Computational
Systems, Incorporated.
10.26 -- Agreement dated April 6, 1987 between
Computational Systems, Incorporated and Intellitech
Systems, Inc., as amended by Letter Agreement
dated January 23, 1989.
10.27 -- Agreement dated June 11, 1985 between
Technology for Energy Corporation and
Computational Systems, Incorporated.
10.28 -- FLIR Systems, Inc. OEM Contract dated January 21, 1993.
10.29 -- Asset Purchase Agreement dated September 30,
1994 between Computational Systems,
Incorporated and Technology for Energy
Corporation.
10.30 -- Memorandum of Agreement between
Computational Systems, Incorporated and
Technology for Energy Corporation dated July 20,
1994 and related Bill and Sale of Assignment
executed July 20, 1994 in favor of Computational
Systems, Incorporated by TEC Tribology Systems
(by Condition Marketing Services and Technology
for Energy Corporation).
10.31 -- Lease Agreement dated April 26, 1995 between
N.V. Apollo Development and CSI Europe (and
English language summation thereof).
10.32 -- Lease Agreement dated February 16, 1995 between
Patrick Schacki and Computational Systems,
Incorporated.
10.33 -- Lease Agreement dated January 18, 1995 between
Michael E. Schaad, Trustee and Computational
Systems, Incorporated.
10.34 -- Lease Agreement dated September 24, 1993
between the Clwyd County Council (United
Kingdom) and A.C. Tudor, on behalf of
Computational Systems UK Limited.
10.35 -- Lease Agreement dated October 7, 1991 between
Weingarten Realty Investors and Computational
Systems, Incorporated.
10.36 -- Teaming Agreement dated April 30, 1995 between
Computational Systems, Incorporated and the
Facility and Plant Services Division of Fluor Daniel, Inc.
10.37 -- Settlement Order dated October 6, 1993 from the
United States District Court to the Eastern District of
Tennessee in the case of Computational Systems,
Inc. v. IRD Mechanalysis, Inc. v. Ronald G. Canada.
10.38 -- Form of Indemnification Agreement.
B. Incorporated by reference to the Company's second quarter Form 10-Q
10 -- Amended and Restated Credit Agreement with
First American National Bank and NationsBank of
Tennessee
C. Incorporated by reference to the Company's Form 8-K filed on
November 13, 1996
2 -- Agreement and Plan of Merger dated October 28, 1996
among Computational Systems, Incorporated,
Paragon Services, Inc. and Maintenance & Diagnostics, L.L.C.
D. Filed herewith
Exhibit
Number Description
11.0 -- Statement re: Computation of Per Share Earnings
21.0 -- List of subsidiaries
23.1 -- Independent Accountants' Consent
27.1 -- Financial Data Schedule
(b) Reports on Form 8-K filed in the fourth quarter - a current report on 8-K
reporting the M&D acquisition was filed on November 13, 1996.
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.
Computational Systems, Incorporated
By /S/ Bryan J. Collier
--------------------------------
Bryan J. Collier
Vice President of Finance and
Chief Financial Officer
Date March 27, 1997
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.
Signature Title Date
/s/ Ronald G. Canada Chairman, Chief Executive Officer and March 27, 1997
Ronald G. Canada Director (Principal Executive Officer)
/s/ Kenneth R. Piety Vice Chairman, Vice President of March 27, 1997
Kenneth R. Piety Engineering, Secretary, and Director
/s/ Carlo Gorla President and Chief Operating Officer March 27, 1997
Carlo Gorla
/s/ Bryan J. Collier Vice President of Finance and Chief March 27, 1997
Bryan J. Collier Financial Officer (Principal Financial and
Accounting Officer)
/s/ John J. Cioffi Director March 27, 1997
John J. Cioffi
Director
Richard E. Ray
/s/ William S. Rukeyser Director March 26, 1997
William S. Rukeyser
/s/ James F. Smith, Jr. Director March 27, 1997
James F. Smith, Jr.
Director
Thomas A. Valunas, Jr.
INDEPENDENT ACCOUNTANTS REPORT ON FINANCIAL STATEMENT SCHEDULE
In connectin with our audits of the consolidated financial statements of
Computational Systems, Incorporated and Subsidiaries as of December 31, 1996 and
1995, and for each of the three years in the period ended December 31, 1996, we
have also audited the financial statement Schedule II - Valuation and Qualifying
Accounts and Reserves for the three years ended December 31, 1996.
In our opinion, this financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
materail respects, the information required to be included therein.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
Knoxville, Tennessee
January 24, 1997
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
AND RESERVES
FOR THE YEAR ENDED DECEMBER 31
<TABLE>
<CAPTION>
Balance at Charged Balance
beginning costs and to other at end
Description of period expenses accounts Deductions of period
- -------------------------------- --------- -------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts:
1994 $125,000 $272,491 $80,120 $345,135 $132,476
1995 $132,476 $143,208 ------ $143,207 $132,477
1996 $132,477 $104,513 $30,000 $ 68,514 $198,476
</TABLE>
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES
EXHIBIT INDEX
Sequential
Exhibit Number Description Page
No.
11.0 Statement re: Computation of per share earnings
21.0 List of Subsidiaries
23.1 Independent Accountants' Consent
Exhibit 11
COMPUTATION OF EARNINGS PER SHARE
FOR THE YEAR ENDED DECEMBER 31
<TABLE>
<CAPTION>
1994 1995 1996
<S> <C> <C> <C>
PRIMARY:
Weighted average number of common shares outstanding 3,366,734 3,824,996 4,836,221
Net effect of dilutive stock options based on the treasury
stock method using the average market and initial
public offering prices, as appropriate 136,595 292,255 229,289
---------- ---------- ----------
Weighted average number of common and common
equivalent shares outstanding 3,503,329 4,117,251 5,065,510
Net income $1,798,267 $2,947,301 $4,534,050
Primary net income per common share $0.51 $0.72 $0.90
FULLY DILUTED:
Weighted average number of common shares outstanding 3,366,734 3,824,996 4,836,221
Net effect of dilutive stock options based on the treasury
stock method using the period-end market price if higher
than average price 136,595 303,825 242,274
---------- ---------- ----------
Weighted average number of common and common
equivalent shares outstanding 3,503,329 4,128,821 5,078,495
Net income $1,798,267 $2,947,301 $4,534,050
Fully diluted net income per common share $0.51 $0.71 $0.89
</TABLE>
The difference between fully diluted earnings per share and primary earnings
per share is immaterial. Therefore, fully diluted earnings per share have not
been disclosed in the financial statements.
Exhibt 21.0
Computational Systems, Incorporated
List of Subsidiaries
Names under which
Business Conducted,if
Name of Subsidiary Jurisdiction of Incorporation different
- -------------------- ----------------------------- ---------------------
CSI Services, Inc. Tennessee N/A
Status Technologies, Inc. Tennessee N/A
CSI International, Inc. Virgin Islands N/A
Computational Systems, United Kingdom N/A
UK Limited
Computational Systems, Belgium CSI Europe
Inc. Europe
CSI Technology, Inc. Delaware N/A
CSI Delaware I, Inc. Delaware N/A
CSI Delaware II, Inc. Delaware N/A
CSI Real Property, LLC Delaware N/A
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
Computational Systems, Inc. on Form S-8 of our report dated January 24, 1997, on
our audits of the consolidated financial statements and financial statement
schedules of Computational Systems, Inc. as of December 31, 1996 and 1995, and
for the years ended December 31, 1996, 1995 and 1994, which report is included
in this Annual Report on Form 10-K.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
Knoxville, Tennessee
March 25, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1995
<PERIOD-END> DEC-31-1996 DEC-31-1995
<CASH> 4,576,801 8,824,332
<SECURITIES> 0 0
<RECEIVABLES> 15,855,016 10,112,006
<ALLOWANCES> (198,500) (132,000)
<INVENTORY> 3,190,964 3,623,124
<CURRENT-ASSETS> 24,331,014 23,529,831
<PP&E> 19,363,384 12,068,053
<DEPRECIATION> (5,879,464) (4,129,812)
<TOTAL-ASSETS> 45,272,847 32,150,773
<CURRENT-LIABILITIES> 12,179,525 7,097,991
<BONDS> 0 13,172
0 0
0 0
<COMMON> 18,034,208 15,459,192
<OTHER-SE> 13,652,252 9,068,259
<TOTAL-LIABILITY-AND-EQUITY> 45,272,847 32,150,773
<SALES> 36,275,150 31,990,239
<TOTAL-REVENUES> 50,046,123 41,772,483
<CGS> 9,339,308 9,219,753
<TOTAL-COSTS> 20,071,306 16,662,531
<OTHER-EXPENSES> 23,321,411 20,471,684
<LOSS-PROVISION> 272,491 143,208
<INTEREST-EXPENSE> 3,985 373,451
<INCOME-PRETAX> 7,084,456 4,602,796
<INCOME-TAX> 2,550,406 1,655,495
<INCOME-CONTINUING> 4,534,050 2,947,301
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 4,534,050 2,947,301
<EPS-PRIMARY> 0.90 0.72
<EPS-DILUTED> 0.89 0.71
