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, 19951996            
                         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.)
 of
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:

                                    Title of class
                                 --------------
                                    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 10-Kl0-K 
or any amendment to this Form 10-K. [ X ]

     As of February 22, 1996March 6, 1997  there were 4,747,2095,002,845 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 $48,222,792.


$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

ITEMItem 1.   BUSINESSBusiness

  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, 1995,1996, the Company employed 350430 persons, of whom 336416
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. 
AllSubstantially 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 19941995 or 1995.

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,
allmost of which use the Company's common software platform, to provide
Reliability-Based Maintenance capabilities to its target customers.


PRODUCTS AND SERVICESProducts 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's
MasterTrend software is the PC-based common software platform linking all of
the Company's productsCompany also provides consulting services that assist customers in
developing 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.

PRODUCTSimplementing 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.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
$30,000$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 systemssystem incorporating the Company's model 3130
analyzer.

  OIL ANALYSIS (TRIBOLOGY)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.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.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,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.MasterTrend Software.   The Company's proprietary MasterTrend
software is the PC-based common software platform forlinking 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 andan 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

     In addition to its patented products and proprietary software,Services

  During 1996, the Company created a new subsidiary, CSI has aServices, Inc.
(CSI Services), consisting of two divisions; Paragon Services (Paragon),
formerly known as the Company's technical service division, whichand
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.    CSIReliability Services.    Paragon provides contract services tailored
to a customer's needs and budget.  The Company'sdivision'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, the CompanyParagon provides shorter-termshort-term troubleshooting services.  The CompanyParagon
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.Training Services.   Each year, CSIParagon offers more than 175250 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.  In 1996, training facilities
are opening in San Diego and Detroit. The
Company offers courses in vibration analysis, tribology, infrared
thermography, alignment/balancing, electric motor analysis, multichannel
analysis and industry specific topics.  During 1995,1996, approximately 2,5002,700
people attended the Company's technical courses at the Company's
training facilities and at various customer sites.

  TRIBOLOGY SERVICES.Tribology Services.   In addition to the Company's oil analysis products
the CompanyParagon offers services designed to provide synergy to the on-site tribology
program.  As described above, in the tribology total solution, CSIParagon
consultants are available for on-site advisory services.  In addition, CSI
recently opened an
advanced fluid analysis lab at its principalthe facility in Knoxville, which 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'sManagement 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'sCSI 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.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.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
6075 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 projectproduct
"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
(beta testing).

     PRODUCTS UNDER DEVELOPMENT.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.Motor Analysis.  The Company is developing an electric motor
     diagnostic
   system designedanalyzer that utilizes smart sensor technology to provide
     early warning of faults with respect to both
   rotatinginformation about run time, starts, operating temperature, load
     electrical condition and stationary windings without disassembly or interception of
   operation of the motor.  This system consists of an analyzing software
   package which accepts data from a variety of electrical inputs including
   flux sensors, current transformers and other sensors.

   ULTRASONIC ANALYSIS.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 ASSURANCEManufacturing 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 BACKLOGCustomer Concentration and Backlog

  No customer of CSI accounted for more than 3% of the Company's
revenues in 19941995 or 1995.1996.  Approximately 70%77% of the Company's sales are
made in the United States  and 30%23% are international.  The Company's
backlog was $2.5
million at December 31, 1993, $5.1 million at December 31, 1994, and $5.1 million at December
31, 1995.1995 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.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 sevenfourteen patents and has eighteenseventeen
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.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 andan 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.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 UltraSpec"Changing the Way the World Performs Maintenance"
(collectively, the "Marks") in the United SatesStates 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.


COMPETITIONCompetition

  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 Mechanalysis,International, Inc. ("Entek/IRD"), Entek Scientific Corporation, 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 predicitvepredictive
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
predicitvepredictive 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.


REGULATIONRegulation

  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 FACTORSRisk 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.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.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.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.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.Significant Expenditures for Research and Development.  In the last
three fiscal years, the Company has spent an aggregate of approximately
$13.2$14.1 million on research and development.  For the same period, the
Company's net income aggregated approximately $5$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.  FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONS.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.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.

  The
Company does not have employment agreements with any membersVolatility of senior
management.  See "MANAGEMENT."

     VOLATILITY OF MARKET PRICE FOR COMMON STOCK.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 inof 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.


ITEMItem 2.   PROPERTIESProperties

  The Company's operations are primarily conducted from its 69,000129,000
square foot headquarters and manufacturing facility in Knoxville, which the
Company owns.  The Company has plans to expand the facility to 129,000 square feet to
better suit the Company's expanding needs.  The expansion of the headquarters
and manufacturing facility will be financed with a portion of the proceeds

from the Initial Public Offering (see Part II, Item 5).  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. 


The Company
also leases a 5,000 square foot facility for Reliability Services.

ITEMItem 3.  LEGAL PROCEEDINGSLegal 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.


ITEMItem 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSSubmission 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 1995.

1996.


                            PART II


ITEMItem 5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
         MATTERS.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 February 19, 1996,March 6, 1997,
there were approximately 261315 record holders of common stock.

     The following table sets forth, for the periods indicated, the highstock and
low prices of the Company's Common Shares as reported by the Nasdaq National
Market:
                                                PRICE RANGE
          COMMON STOCK                        HIGH       LOW
          ----------------------             ------     ------
          Third Quarter 1995                 $17.25     $12.50
          Fourth Quarter 1995                $16.87     $14.63approximately 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.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 ncommon 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 any cash
dividends on its outstanding Common Stock.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   


ITEMItem 6.  SELECTED FINANCIAL DATA.
FOR THE YEARS ENDED DECEMBER 31, ------------------------------- 1991 1992 1993 ------- ------- ------- (In thousands, except per share data) STATEMENT OF INCOME DATA: Revenue, net: Products $16,731 $19,738 $21,566 Services 2,790 3,765 4,784 ------- ------- ------- Total 19,521 23,503 26,350 ------- ------- ------- Cost of revenues: Products 4,702 5,188 5,368 Services 1,589 2,061 2,938 ------- ------- ------- Total 6,291 7,249 8,306 ------- ------- ------- Gross margin 13,230 16,254 18,044 Operating expenses: Selling, general and administrative 8,498 9,759 11,382 Research and development expenses 3,412 3,436 4,123 Litigation costs 2,265 831 1,617 ------- ------- ------- Income from operations (945) 2,228 922 Other income (expenses): Interest expense (70) (584) (485) Interest income 152 140 145 Other income, net 47 70 73 Minority share of income ----- (8) (1) ------- ------- ------- Income (loss) before taxes (816) 1,846 654 Provision (benefit) for income taxes (282) 753 347 ------- ------- ------- Net income (loss) $ (534)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 $ 307 ======= ======= ======= Net income per share $ (0.14) $ 0.29 $ 0.08 ======= ======= ======= Pro forma earnings per share (1) Weighted average number of common and common equivalent shares outstanding 3,804 3,795 3,794 ======= ======= =======
FOR THE YEARS ENDED DECEMBER 31, ------------------------------- 1994 1995 ------- ------- (In thousands, except per share data) STATEMENT OF INCOME DATA: Revenue, net: Products $25,063 $31,990 Services 6,102 9,782 ------- ------- Total 31,165 41,772 ------- ------- Cost of revenues: Products 6,343 9,220 Services 4,312 7,442 ------- ------- Total 10,655 16,662 ------- ------- Gross margin 20,510 25,110 Operating expenses: Selling, general and administrative 13,211 15,909 Research and development expenses 4,493 4,563 Litigation costs 137 ----- ------- ------- Income from operations 2,669 4,638 Other income (expenses): Interest expense (458) (373) Interest income 109 261 Other income, net 37 76 Minority share of income ----- ----- ------- ------- Income (loss) before taxes 2,357 4,602 Provision (benefit) for income taxes 559 1,655 ------- ------- Net income (loss) $ 1,798 $ 2,947 ======= ======= Net income per share $ 0.51 $ 0.72 ======= ======= Pro forma earnings per share (1) $ 0.68 ======= Weighted average number of common and common equivalent shares outstanding 3,503 4,117 ======= =======
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) AS OF DECEMBER 31, --------------------------- 1991 1992 1993 ------- ------- -------
Net Operating Net Total Debt (Including Retained Earnings Sales Income Income Assets current maturities) Earnings Per Share ----- ------ ------ ------ ------------------- -------- --------- BALANCE SHEET DATA: Working capital $ 2,238 $ 3,343 $ 3,231 Total assets 12,423 15,145 15,361 Long-term debt, including current maturities 3,268 3,769 5,326 Total shareholders equity 4,376 5,498 4,822
AS OF DECEMBER 31, --------------------------- 1994 1995 ------- ------- BALANCE SHEET DATA: Working capital $ 2,417 $16,432 Total assets 19,725 32,151 Long-term debt, including current maturities 3,600 32 Total shareholders equity 6,870 24,527 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
ITEMItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEWManagement'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 salesales of its products and services. During the last six fiscal years, theThe Company's net revenues have increased from $16.1 million in 1990 to $41.8$50.0 million in 1995,1996, an average annual increase of approximately 32%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, and the Company continues to expand and enhance this product line.period. In the last threefour years, however, the Company has also developed an array of non-vibration products utilizing a variety of technologies as well asand concentrated on the marketing of services incorporating those productsall 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 1994,1996, the Company completed the acquisition of certain assets related toMaintenance & Diagnostics, LLC ("M&D"), an operator of research, service and training centers for the services division of Technology for Energy Corporation ("TEC"),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 and servicesoftware. Service revenues include revenues relatedrelating to the Company's training programs, the performance of contract maintenance services, and 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 1995,1996, approximately 30%23% of the Company's revenues were generated in international markets. No individual customer accounted for more than 3% of revenues during 1995.1996. 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. AAt present, the principal reasonreasons for the difference in growth rates on both areas isare due to the relatively small Services revenue base, the fourth quarter acquisition of services revenuesM&D Services and product revenues from products other than vibration analysis products at the present.analysis. Cost of revenue includesrevenues 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 costscost of revenue.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 revenuerevenues associated with the Company's products other than vibration analysis products is higher than the Company's costscost of revenuerevenues 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 materialsmaterial costs associated with the development of new products and services offered by the Company. These costsCompany 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. From 1991 through 1993 the Company incurred litigation costs associated with litigating patent infringement claims and settling those claims to secure licenses to use certain technologies which were the subject of the litigated patents. Interest expense includes costs and expenses associated with working capital indebtedness and various debt-financed capital expenditures, 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 DECEMBERComparison of Fiscal Years Ended December 31, 1996 and December 31, 1995 AND DECEMBERRevenues, 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.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 REVENUE.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 costscost of revenuerevenues 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, but adds very little to the Company's SG&A expense.business. Costs associated with the Company's service business are accounted for almost entirely in cost of revenue.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 reflectsreflect net additions to the Company's staff to support increased service demands. SELLING, GENERAL AND ADMINISTRATIVE.Selling, General and Administrative. SG&A expense increased 20.4%19.2% to $15.9 million in 1995 from $13.2$13.3 million in 1994. The increase resulted in part from the shift in the composition of the Company's sales force away 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 42.4%42.8% in 1994. RESEARCH AND DEVELOPMENT.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 product revenues, research &and development expense declined to 14.3%10.9% in 1995 from 17.9%14.4% in 1994, reflecting increased revenues in 1995. LITIGATION COSTS. There were no litigation costs in 1995, with $137,000 in litigation costs in 1994. INCOME FROM OPERATIONS.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 AND OTHER INCOME.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.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 Company. COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1993 REVENUES, NET. Net revenues for 1994 increased 18.3% to $31.2 million from $26.3 million in 1993. Product revenues increased 16.2% to $25.1 million in 1994 from $21.6 million in 1993 as a result of the Company's expansion into non-vibration product lines as well as an increase in the Company's sales force. Non-vibration product revenues grew 144.2% to $3.7 million from $1.5 million in 1993. Service revenues increased 27.6% to $6.1 million in 1994 from $4.8 million in 1993 as a result of an increase in the number of Regional Service Officescorporation and the TEC acquisition in October 1994 which accounted for approximately $267,000 of the increase. COST OF REVENUE. Direct product and services costs increased 28.3% to $10.7 million in 1994 from $8.3 million in 1993. Product costs increased 18.2% to $6.3 million in 1994 from $5.4 million in 1993, and service costs increased 46.8% to $4.3 million in 1994 from $2.9 million in 1993. Total costs of revenue as a percentage of net revenues increased from 31.5% in 1993 to 34.2% in 1994 for several reasons. First, the expansion into non-vibration product lines increased revenues, but involved products with lower margins. In addition, the TEC acquisition generated greater service revenues, but gross margins in the services area are lower than margins in the product area. SELLING, GENERAL AND ADMINISTRATIVE. SG&A expense increased 16.1% to $13.2 million in 1994 from $11.4 million in 1993, as the resultutilization of a planned increase in selling expenses to increase the size of the Company'sforeign sales force, as well as the incremental expense for equipping sales personnel with demonstration equipment for the sale of the Company's non-vibration product lines, the addition of senior management personnelcompany. Liquidity and the costs associated with an emissions monitoring program that the Company ultimately decided not to pursue. As a result of strong revenues in 1994, however, SG&A expense as a percentage of net revenues decreased slightly to 42.4% in 1994 from 43.3% in 1993. RESEARCH AND DEVELOPMENT. Research and development expense increased by approximately $400,000 or 9.0% to $4.5 million in 1994 from $4.1 million in 1993, reflecting the additions to the Company's staff in this area. As a percentage of net product revenues, research & development expense declined to 17.9% in 1994 from 19.1% in 1993, reflecting increased revenues in 1994. LITIGATION COSTS. Litigation costs were $137,000 in 1994, a decline of 91.5% from $1.6 million in 1993. The decrease reflects the resolution of the patent litigation to which the Company was a party. INCOME FROM OPERATIONS. Income from operations for 1994 increased by $1.7 million to $2.7 million, or 8.6% of net revenues, from $922,000, or 3.5% of net revenues, in 1993. INTEREST EXPENSE AND OTHER INCOME. Interest expense decreased 5.7% in 1994 to $458,000 from $485,000 in 1993, primarily as a result of lower average balances on the Company's outstanding indebtedness. Other income decreased by $36,000 to $37,000 in 1994 compared to $73,000 in 1993. INCOME TAXES. The Company's effective tax rate was 23.7% in the 1994 period as compared to a rate in 1993 of 53.1%, principally due to a change in the deferred income tax valuation allowance. LIQUIDITY AND CAPITAL RESOURCESCapital 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 makeshas made significant expenditures each year for research and development and market development. Net cash provided by operating activities in 19951996 increased to $2,545,766$5,331,000 from $1,367,764$2,546,000 in 19941995 primarily due to increases in net income and an increase in accruedcurrent liabilities reflecting the higher level of business activity. InvestingCash used in investing activities includeincreased from $1.6 million in 1995 to $10.1 million in 1996, reflecting additions to property, plant and equipment and the acquisition of businesses. 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 atwo bank linelines of credit that providesprovide for borrowings of up to $4.0$12.0 million based on a minimum current ratio of 1.25 or better and bearsbearing interest at the lender's base rate. The Company's principal commitments decreased to $7.6 million as of December 31,1995 as compared to $12.8 million as of December 31, 1994 due torate or the extinguishment of long-term debt and line of credit fromadjusted LIBOR rate plus the proceeds of the IPO. Of the $14.1 million net proceeds ofapplicable LIBOR margin at the Company's IPO, approximately $4.4 million was used to pay off the Company's long-term debt and line of credit.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. INFLATIONInflation 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. ITEMItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAFinancial Statements and Supplementary Data INDEX Consolidated Financial Statements: Page -------- Consolidated Balance Sheets - December 31, 19941996 and 1995 16 Consolidated Statements of Operations for each of the Three Years in the period ended December 31, 1995 171996 Consolidated Statements of Cash Flows for each of the Three Years in the period ended December 31, 1995 181996 Consolidated Statements of Shareholder'sShareholders' Equity for each of the Three Years in the period ended December 31, 1995 191996 Notes to Consolidated Financial Statements 20 - 26 Independent Accountants' Report 27 Financial Statement Schedule: Independent AccountantsAccountants' Report S-1 Supplemental Schedule II - Valuation and Qualifying Accounts S-2
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, DECEMBER 31, 19941996 1995 ----------- ----------------------- 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 1994 and 1995 6,621,61015,656,516 9,980,006 Refundable income taxes 160,000------- 160,000 Inventories 3,578,2313,190,964 3,623,124 Deferred income taxes 785,000740,000 703,000 Prepaid expenses and other current assets 317,017166,733 239,369 ----------- ----------- Total current assets 11,461,85824,331,014 23,529,831 ----------- ----------- Property, plant and equipment: Land 487,145729,204 729,204 Building and improvements 4,460,4206,714,979 4,488,421 Equipment and furniture 5,451,402 6,850,42810,625,614 6,763,103 Construction-in-Progress 1,293,587 87,325 ----------- ----------- 10,398,96719,363,384 12,068,053 Less accumulated depreciation (3,282,729)(5,879,464) (4,129,812) ----------- ----------- Property, plant and equipment, net 7,116,23813,483,920 7,938,241 ----------- ----------- Notes receivable from shareholders 245,756 ----- Deferred income taxes 51,000 4,000Other assets: Other assets including intangibles 850,259 678,701552,777 43,193 Goodwill 6,292,490 ------- Other intangible assets 612,646 639,508 ----------- ----------- Total assets $19,725,111$45,272,847 $32,150,773 =========== =========== COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, DECEMBER 31, 1994 1995 ----------- ------------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Checks outstanding in excess of bank balances $ 43,388 $ ------- Current maturities of long-term debt 142,468 18,377 Revolving line of credit 3,193,664 ------- Accounts payable 1,187,129 1,142,125$ 2,598,425 $ 1,160,502 Accrued liabilities 2,861,6267,222,579 3,977,241 Income taxes payable 272,0001,026,110 492,010 Deferred maintenance contract revenue 1,344,6222,070,411 1,468,238 ----------- ----------- Total current liabilities 9,044,89712,917,525 7,097,991 Long-term debt, less current maturities 3,457,501Other liabilities ------- 13,172 Deferred maintenance contract revenue 352,875668,862 512,159 ----------- ----------- Total liabilities 12,855,27313,586,387 7,623,322 ----------- ----------- Commitments and contingencies (Notes 7, and 9) Shareholders' equity: Common stock, no par value, 50,000,000 shares authorized, 3,318,6654,991,618 and 4,743,209 shares issued and outstanding in 19941996 and 1995, respectively 726,24818,034,208 15,459,192 Additional paid-in capital 838,494865,805 815,862 Retained earnings 5,305,09612,786,447 8,252,397 ----------- ----------- Total shareholders' equity 6,869,83831,686,460 24,527,451 ----------- ----------- Total liabilities and shareholders' equity $19,725,111$45,272,847 $32,150,773 =========== ===========
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, --------------------------------------------- 1993
1996 1995 1994 1995 ----------- ----------- ----------- Revenues, net: Product $21,565,945$36,275,150 $31,990,239 $25,063,227 $31,990,239 Services 4,783,79513,770,973 9,782,244 6,102,050 9,782,244 ----------- ----------- ----------- 26,349,74050,046,123 41,772,483 31,165,277 41,772,483 Cost of revenues: Product 5,367,5449,339,308 9,219,753 6,343,261 9,219,753 Services 2,938,20810,731,998 7,442,778 4,312,237 7,442,778 ----------- ----------- ----------- 8,305,75220,071,306 16,662,531 10,655,498 16,662,531----------- ----------- ----------- Gross margin 18,043,98829,974,817 25,109,952 20,509,779 25,109,952 Costs and expenses: Selling, general and administrative expenses 11,382,003 13,211,34318,245,737 15,909,203 13,348,015 Research & development expenses 4,123,2805,075,674 4,562,481 4,492,988 4,562,481 Litigation costs 1,616,750 136,672 ----- ----------- ----------- ----------- Income from operations 921,9556,653,406 4,638,268 2,668,776 4,638,268 Other income (expenses): Interest expense (485,199)(3,985) (373,451) (457,547) (373,451) Interest income 145,187457,560 261,184 108,865 261,184 Other income,income(expense), net 72,741(22,525) 76,795 36,857 76,795 Minority share of income (837) ----- ----- ----------- ----------- ----------- Income before taxes 653,8477,084,456 4,602,796 2,356,951 4,602,796 Provision for income taxes 347,0372,550,406 1,655,495 558,684 1,655,495 ----------- ----------- ----------- Income after taxes $ 306,8104,534,050 $ 1,798,2672,947,301 $ 2,947,3011,798,267 =========== =========== =========== Earnings per share $ 0.080.90 $ 0.510.72 $ 0.720.51 =========== =========== =========== Weighted average shares and equivalents outstanding (in thousands) 3,794 3,503 4,1175,065,510 4,117,251 3,503,329 =========== =========== ===========
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, 1993
1996 1995 1994 1995 ----------- ----------- --------------------- ---------- ---------- Cash flows from operating activities: Net income $ 306,810 $ 1,798,267 $ 2,947,301$4,534,050 $2,947,301 $1,798,267 Adjustments to reconcile net income to net cash provided (used) by operating activities: Charge equivalent to tax benefit of exercised stock options 87,000 ----- ----- Depreciation and amortization 702,2912,021,041 1,321,191 927,803 1,321,191 Deferred income taxes 385,0002,000 129,000 (342,000) 129,000 Accrued interest on notes from shareholders ----- (12,191) ----- Minority share of income 837 ----- -----(12,191) Changes in operating assets and liabilities: Accounts receivable (401,541)(4,155,437) (3,358,396) (1,079,624) (3,358,396) Income taxes refundable or payable (652,000)771,183 220,010 612,000 220,010 Inventories (206,526)165,676 (136,895) (1,490,401) (136,895) Prepaid expenses and other current assets (40,523)105,868 77,648 (60,720) 77,648 Other assets 10,0046,438 (7,604) 2,924 (7,604) Accounts payable 446,2301,134,454 (45,004) (290,370) (45,004) Accrued liabilities (1,549,674)(13,455) 1,115,615 916,220 1,115,615 Deferred maintenance contract revenue 324,252758,876 282,900 385,856 282,900 ----------- ----------- --------------------- ---------- ---------- Net cash provided (used) by operating activities (587,840)5,330,694 2,545,766 1,367,764 2,545,766 ----------- ----------- --------------------- ---------- ---------- Cash flows from investing activities: Purchase of property, plant and equipment (639,564)(6,576,186) (1,872,030) (1,754,940) (1,872,030) Purchase of service business and related assets(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) repayments from shareholders 203,685----- 245,756 (13,000) 245,756 ----------- ----------- --------------------- ---------- ---------- Net cash used in investing activities (435,879)(10,106,798) (1,626,274) (2,867,940) (1,626,274) ----------- ----------- --------------------- ---------- ---------- Cash flows from financing activities: Net borrowings under (repayments on) line of credit 410,020----- (3,193,664) 2,783,644 (3,193,664) Borrowings under long-term debt 1,463,467 ----- ----- Repayment of long-term debt (225,182)(13,172) (3,568,420) (1,726,393) (3,568,420) Net proceeds from issuance of common stock 270,443541,745 14,739,152 333,520 14,739,152 Purchases of common stock (1,021,140)----- (28,840) (84,240) (28,840) Checks outstanding in excess of bank balances ----- (43,388) 43,338 (43,388) ----------- ----------- --------------------- ---------- ---------- Net cash provided by financing activities 897,608528,573 7,904,840 1,349,869 7,904,840 ----------- ----------- --------------------- ---------- ---------- Net increase (decrease) in cash and cash equivalents (126,111)(4,247,531) 8,824,332 (150,307) 8,824,332 Cash and cash equivalents, at beginning of year 276,4188,824,332 ----- 150,307 ----- ----------- ----------- --------------------- ---------- ---------- Cash and cash equivalents, at end of year $ 150,307$4,576,801 $8,824,332 $ ----- $ 8,824,332 =========== =========== ===================== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Additional Total Common Paid-In Retained Treasury Shareholders' Stock Capital Earnings Stock Equity ----------- ----------- ----------- ---------- ----------- Balance, January 1, 19931994 $ 413,184471,283 $ 755,244842,244 $ 4,337,4863,508,764 $ (7,581) $ 5,498,333 Issuance of 11,855 shares under employee stock purchase plan 29,163 ----- ----- ----- 29,163 Issuance of 145,205 shares under stock option plans 166,280 ----- ----- ----- 166,280 Issuance of 25,000 shares 75,000 ----- ----- ----- 75,000 Purchase of 446,765 shares for treasury ----- ----- ----- (1,340,295) (1,340,295) Retirement of 449,425 treasury shares (212,344) ----- (1,135,532) 1,347,876 0 Income tax benefits related to exercised stock options ----- 87,000 ----- ----- 87,000 Net Income ----- ----- 306,810 ----- 306,810 ----------- ----------- ----------- ---------- ----------- Balance, December 31, 1993 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 and underwriting discounts 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 $15,459,19215,459,192 815,862 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 $ 815,862 $ 8,252,397 $ ----- $24,527,451865,805 $12,786,447 $31,686,460 =========== =========== =========== ========== ===========
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 and services 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 CONSOLIDATIONPrinciples 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 EQUIVALENTSCash 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. INVENTORIESInventories - 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 EQUIPMENTProperty, 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. INTANGIBLESIntangibles - Intangible assets consisting principally of goodwill and acquired patents and noncompete agreements are being amortized on a straight-line basis over their useful lives ranging from three to eighttwenty years. Amortization of these intangibles was $232,794 in 1996, $179,162 in 1995 and $49,551 in 1994 and $179,162 in 1995.1994. 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 is less thanare inadequate to fully recover their carrying value. RETIREMENTS OF COMMON SHARESRetirements 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. COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued): REVENUE RECOGNITIONRevenue 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. RESEARCHCOMPUTATIONAL SYSTEMS, INCORPORATED AND DEVELOPMENTSUBSIDIARIES 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. CostsOther research and development costs incurred in developing a product during the period that begins when the product's technological feasibilityprototype 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. Historically suchSuch costs have not been material. INCOME TAXEScapitalized 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 Company accounts for income taxes under thestatement applies an asset and liability method. The asset and liability method establishesapproach that requires the recognition of deferred tax assets and liabilities forbased on the temporary differences between the financial reporting basesstatements and the tax basesbasis of the Company's assets and liabilities using taxenacted 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 in effect when such amounts are realized or settled. Tax credits are reflected as a reduction of income tax expense inpaid through the period earned. EARNINGS PER SHAREyear 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$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 proformapro 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 SPLITStock 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 STOCKPreferred 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. COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued): MANAGEMENT ESTIMATESManagement 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. NEW ACCOUNTING PRONOUNCEMENTSAccounting for Stock Based Compensation - Financial Accounting Standards BoardOn January 1, 1996, the Company adopted Statement of Financial Accounting Standard No. 123, Accounting for Stock Based Compensation was issued(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 1995 to be effective beginning January 1, 1996accounting for the Company. Management intends to comply with, at a minimum, the disclosure requirements of this statement, but has not yet determined if the provisionsits Plans. The pro forma disclosures of the statement will be adopted. If adopted, it is the opinionimpact of management that the statement will not have a material impact on the Company's financial position of results of operations since the Company's stock and option plansSFAS 123 are generally tied to the fair valuedescribed in Note 7 of the Company's stock. 3. INVENTORIES: Inventories consist of the following:
December 31, December 31, 1994 1995 ----------- ----------- Raw materials $1,873,433 $1,835,885 Work-in-process 517,969 736,109 Finished goods, net 1,186,829 1,051,130 ----------- ----------- $3,578,231 $3,623,124 =========== ===========
Finished goods includes certain inventory used for promotional and demonstration purposes while being held for sale ($486,253 and $255,376 at December 31, 1994 and 1995, respectively). Such inventory is being amortized to cost of sales over two years. 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: December 31, December 31, 1994 1995 ----------- ----------- Accrued payroll $ 785,650 $ 882,192 Accrued vacation 503,943 624,596 Commissions payable 451,121 392,108 Accrued bonus 250,217 542,772 Other liabilities 870,695 1,535,573 ---------- ---------- $2,861,626Accrued 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's debt is summarized as follows: December 31, December 31, 1994 1995 ----------- ----------- 7.75% bank term note payable, monthly payments of $31,645, including interest, through October 1996, with the remaining balance due in November 1996. The estimated fair value of the debt at December 31, 1994 was $3,432,000, based on the present value of future payments discounted at the estimated current market rate of 9.5%. $ 3,536,640 $ ------ Other notes payable 63,329 31,549 ----------- ---------- 3,599,969 31,549 Less current maturities (142,468) (18,377) ----------- ---------- $ 3,457,501 $ 13,172
Unless otherwise indicated, at December 31, 1994 and 1995, the estimated fair value of the Company's debt approximated its carrying value. The Company haspreviously had available a $4,000,000 Revolving Credit Agreement (Agreement) expiring on December 31, 1996. The Agreement had a balance due of $3,193,664 as of December 31, 1994 and a balance due of $0 as of December 31, 1995. Borrowings under the Agreement bearbore interest at the bank's base rate (8.5% at December 31, 1994). The Company's debt is collateralized by substantially all of the Company's assets. The Company's debt agreements contain 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.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:
1996 1995 Current Noncurrent Current Noncurrent -------- ---------- ------- ---------- 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 ======== =========== ======= ==========
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 6. INCOME TAXES:
The provision (benefit) for income taxes, all of which relates to continuing operations, is comprised of the following: 1993 1994 1995 ---------- ---------- ---------- Current: Federal $ (125,000) $ 775,684 $1,214,495 State 87,037 125,000 312,000 ---------- ---------- ---------- (37,963) 900,684 1,526,495 Deferred: Federal 323,000 (335,000) 115,000 State 62,000 (7,000) 14,000 ---------- ---------- ---------- 385,000 (342,000) 129,000 ---------- ---------- ---------- $ 347,037 $ 558,684 $1,655,495 ========== ========== ==========
The components of deferred income tax assets and liabilities at December 31, 1994 and 1995, are as follows: 1994 1995 ------------------- ------------------- Current Noncurrent Current Noncurrent Deferred income tax assets: Allowance for doubtful accounts $ 50,000 $ $ 50,000 $ Demonstration equipment 96,000 77,000 Inventories 28,000 38,000 Warranty, bonus and other accruals 338,000 538,000 Deferred revenue 153,000 182,000 Tax credit carryforwards 273,000 Intangibles 23,000 ------- ------- ------- ------- 785,000 153,000 703,000 205,000 Deferred income tax liabilities: Property, plant and equipment (78,000) (201,000) Intangibles (24,000) ------- ------- ------- ------- ---- (102,000) ---- (201,000) ------- ------- ------- ------- Net deferred tax asset $785,000 $ 51,000 $703,000 $ 4,000 ======= ======= ======= =======
TAXES - (Continued) Management believes that a valuation allowance is not considered necessary at December 31, 19941996 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. COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 6. INCOME TAXES - (Continued): The provision for income taxes in 1993,1996, 1995 and 1994, and 1995, 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: 1993 1994 1995 ---------- ---------- ---------- Computed "expected" tax expense $ 222,000 $ 801,000 $1,565,000 State income taxes, net of federal income tax benefit 26,0001996 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 95,000 184,000 Research and development tax credits (138,000) (184,000) (66,000) Change in valuation allowance 188,000 (228,000) ----- Other provision for income taxes 49,037 74,684 (27,505) ---------- ---------- ---------- $ 347,037 $ 558,684 $1,655,495 ========== ========== ==========
The Company's 1989 and 1990development tax returns are currently under examination by the Internal Revenue Service (IRS). Management does not believe the examination will resultcredits (123,000) (66,000) (184,000) Change in a material impact on the Company's financial position or results of operations.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 at a price not less than the fair value of the common stock at the date of grant.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 management,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 and management also havehas the ability to grant stock options that are not covered under any of the stock option plans on a discretionary basis. Information with respect to all outstanding options at December 31, is summarized as follows: 1994 1995 -------------------- ---------------------- Shares Price Shares Price ------- ----------- ------- ------------ Under option at beginning of period 196,500 $1.22-$3.00 384,800 $1.22-$4.00 Options granted 220,000 $3.00-$4.00 91,730 $4.00-$16.87 Options exercised (12,200) $1.22-$2.85 87,300 $2.46-$4.00 Options canceled (19,500) $1.22-$3.00 16,500 $2.85-$3.00 ------- ----------- ------- ------------ Under option at end of period 384,800 $1.22-$4.00 372,730 $1.22-$16.87 ======= =========== ======= ============
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 7. EMPLOYEE STOCK AND BENEFITSBENEFIT PLANS - (Continued): Information with respect to all outstanding options at December 31, is summarized as follows:
Weighted Weighted Average Average Weighted of Grant Stock Average Number Exercise Date Fair Options Exercise of Options Prices Value Exercisable Price ---------- -------- --------- ----------- -------- 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 ========= ========
1996 1995 ------- ------- Options exercisable at end of period 85,465 65,046 ======= ======= Shares available for future grant under the 1987 Plan 71,000 ----- ======= =======----- 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:
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 - --------------- ---------------- ------------------- -------------- ----------- -------------- $ 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
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 1994 and 1995, 71,185 and 60,834 shares respectively, were issued to employees under this plan at a price of $3.00 and $4.00 per share, respectively.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 $169,780,$380,249, $265,397 and $216,092 in 1996, 1995 and $265,397 in 1993, 1994, and 1995, 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 $90,267$353,780 in 1993,1996, $100,163 in 1995 and $86,561 in 1994 and $100,163 in 1995. Commitments1994. Minimum commitments under operating leases with terms in excess of one year are approximately $32,000 as of December 31, 1995.follows: Year Amount 1997 $207,008 1998 207,008 1999 204,281 2000 196,100 2001 94,552 -------- Total $908,949 10. PATENT LITIGATION AND ROYALTIES: In 1992, a competitor ofPURCHASE OF BUSINESS: On October 28, 1996, the Company threatenedacquired the assets and assumed certain liabilities of Maintenance & Diagnostics, L.L.C. ("M&D"), and the rights to use certain technology from a lawsuit alleging infringementthird 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 competitor's patents.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 Company responded by filing a declaratory judgement lawsuit against the competitor. The matterpurchase price was settled in 1993, when the Company paid a lump sum amountallocated to the competitorassets and agreed to pay royalties in each of the years 1993 through 2001, in which the Company sells certain productsliabilities based on their fair market value as specified in the settlement agreement. 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. PATENT LITIGATION AND ROYALTIESPURCHASE OF BUSINESS - (Continued): The Company also pays royalties in connection with the use of certain other patents. Royalties included in cost of sales for 1993, 1994 and 1995 were approximately $623,000, $574,000 and $843,000 respectively. Legal fees associated with defending the settlement paid in 1993 have been reflected in theunaudited consolidated statementresults of operations on a pro forma basis as "litigation". 11. PURCHASE OF BUSINESS: In 1994, the Company purchased the assetsthough M&D had been acquired as of the service business of a competitor. The historical revenues and operating profitbeginning of the businessyear are immaterial to the Company. The purchase price was allocated to the assets acquired as follows: Contracts in progress(Unaudited) (Unaudited) 1996 1995 ----------- ----------- Net Sales $56,274,408 $45,837,752 Gross Profit $31,584,439 $26,167,483 Net Income $ 138,000 Furniture4,685,791 $ 2,611,695 Earnings Per Share $ 0.91 $ 0.62 The pro forma financial information is presented for informational purposes only and software 142,000 Intangible assets, principally patents and a noncompete agreement 820,000 ---------- $1,100,000 ========== 12.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: 1993 1994 1995 ---------- ---------- ---------- Supplemental disclosures of cash flows: Interest paid $ 339,816 $ 468,166 $ 184,975 Income taxes paid (refunded), net $ 470,000 $ (38,000)1996 1995 1994 ---------- ---------- ---------- Supplemental disclosures of cash flows: Interest paid $ 3,985 $ 184,975 $ 486,166 ========== ========== ========== Income taxes paid (refunded), net $1,883,000 $1,321,000
Noncash financing activity: In 1993,$ (38,000) ========== ========== ========== The Company entered into the Company acquiredfollowing noncash transactions to purchase M&D: promissory notes totaling $2,385,250, common stock valued at $1,576,317 and subsequently retired 106,385 shares of treasury stock through the issuance of a note payable for $319,155. 13.options valued at $750,000. 12. EXPORT SALES: Export sales were as follows for the years ended December 31, (in thousands): 1993 1994 1995 ------ ------ ------ Middle East $1,066 $ 513 $ 772 Europe 4,493 2,288 3,804 Latin America 1,507 2,649 2,652 Asia 2,208 2,088 3,437 Other areas 326 1,686 1,739 ------ ------ ------- $9,600 $9,224 $12,404 ====== ====== =======
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 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 14. INITIAL PUBLIC OFFERING: The Company filed a Form S-1 registration statement under the Securities Act of 1933 with the Securities and Exchange Commission which became effective on August 28, 1995. Pursuant to the registration the Company sold an initial 1,000,000 shares of no par common stock on August 28 and 258,970 shares on September 15 under an over-allotment option. All cash received from the initial public offering has been reported net of expenses directly related to the offering. 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, 19941996 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, 1995.1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statementsstatments 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 usedwsed 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, 19941996 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, 1995,1996, in conformity with generally accepted accounting principles. COOPERS/s/ Coopers & LYBRANDLybrand L.L.P. Knoxville, Tennessee February 1, 1996 ITEMJanuary 24, 1997 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREChanges in and Disagreements with Accountants on Accounting and Financial Disclosure No events have occurred that would require disclosure under this item. PART III ITEMItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The following table sets forth certain information concerningDirectors and Executive Officers of the Registrant. Information regarding the directors and executive officersoffices of the Company. Name Age Position - ------------------- ---- ------------------------------------------------- Ronald G. Canada 40 Chairman, Chief Executive Officer and Director Kenneth R. Piety 47 Vice Chairman, Vice President and Director of Engineering, Secretary and Director John J. Cioffi 56 President, Chief Operating Officer and Director Bryan J. Collier 56 Vice President of Finance and Chief Financial Officer E. Forrest Pardue 41 President, MachineView, Inc. Richard E. Ray 64 Director William S. Rukeyser 56 Director James F. Smith, Jr. 65 Director Thomas A. Valunas 51 Director Under the termsCompany is hereby incorporated by reference to pages 3 through 5 of the Company's Charter, the members of the Board of Directors are elected at the annual meeting of the shareholders and serve until the next annual meeting and until their successors are duly elected and qualified. Executive officers of the Company are elected on an annual basis and serve at the discretion of the Board of Directors. Ronald G. Canada founded the Company in 1984 and has served as Chairman and Chief Executive Officer and as a director since its inception and is a key member of the Company's engineering and product development team. Prior thereto, Mr. Canada was a technical lead engineer at Technology for Energy Corporation ("TEC") in Knoxville, focusing on the development of a comprehensive surveillance system for rotating machinery. Kenneth R. Piety has served as Vice President and Director of Engineering since 1991, and Vice Chairman since 1994. Dr. Piety has been a director of the Company since its inception in 1984 and Secretary since 1985. Dr. Piety has been involved in the development of all of the Company's products. Prior to joining the company in 1985, Dr. Piety worked as a development engineer at TEC and at the Oak Ridge National Laboratory. John J. Cioffi has served as President, Chief Operating Officer and a director of the Company since 1993. Prior to joining the Company, Mr. Cioffi founded and served as the President of Crown Consulting, a Knoxville-based strategic planning and general management consulting firm, from 1988 to 1993. Prior to 1988, Mr. Cioffi served as Senior Vice President of Marketing of Plasti-Line, Inc. ("Plasti-Line"), a publicly-owned sign manufacturing company located in Knoxville, Tennessee. Bryan J. Collier has served as Vice President of Finance since 1993. Mr. Collier served as a director of the Company from 1987 to 1993. Prior to joining the Company as an officer, Mr. Collier worked as a business consultant for Millennium Associates, Inc., a Knoxville-based business consulting firm, from 1988 to 1993. Prior to that time, Mr. Collier was Treasurer and Secretary of Plasti-Line, Inc. E. Forrest Pardue has served as President of MachineView, Inc., a wholly-owned subsidiary of the Company, since 1992. From 1985 to 1992, Mr. Pardue served as Director of Sales and Marketing for the Company. Richard E. Ray has served as director of the Company since April 1994, Mr. Ray is President of Richard E. Ray and Associates, a business consulting firm. Prior to 1992, Mr. Ray served as Manager of Tennessee Operations of Aluminum Company of America ("Alcoa"), a publicly-owned manufacturer of aluminum products. Mr. Ray also serves as a director and Chairman of the Audit Committee of First Tennessee National Corp., a registered bank holding company. William S. Rukeyser has served as a director of the Company since 1994. Mr. Rukeyser is President of William S. Rukeyser, Inc., a Knoxville-based firm engaged in media and other business consulting activities. From 1988 to 1994, Mr. Rukeyser was a senior partner in Whittle Communications, serving as editor-in-chief of the Knoxville-based company's publications and broadcasts and as chairman and chief executive officer of Whittle Books. Prior to such time Mr. Rukeyser worked at Time, Inc. serving as founding managing editor of Money magazine and managing editor of Fortune magazine. James S. Smith, Jr. has served as a director of the Company since 1993. Mr. Smith is also a director of First American Corp. ("First American"), a bank holding company, and from 1991 through December 1994, Mr. Smith served as Chairman of the Board of First American and of First American National Bank. From February 1991 until November 1991, Mr. Smith served as President and Chief Executive Officer of First American and First American National Bank, and from May 1990 until February 1991, as Interim Chairman of the Board, President and Chief Executive Officer of those companies. Prior to that time, Mr. Smith served as Vice Chairman of First American and First American National Bank. Mr. Smith is also a director of Pilot Corporation and Plasti-Line. Thomas A. Valunas, Jr. has served as a director of the Company since 1993 and a member of the Audit Committee and Chairman of the Compensation Committee. Mr. Valunas is the Vice President of Finance and Chief Financial Officer of M4 Environmental Management, Inc. ("M4"), an Oak Ridge, Tennessee company engaged in the recycling business. Prior to joining M4 in 1995, Mr. Valunas was the President of Tennessee Innovation Center, Inc. ("TIC"), a subsidiary of Martin-Marietta Corporation engaged in venture capital financing and one of the initial shareholders of CSI. The Board of Directors holds regular quarterly meetings and meets on other occasions when required by special circumstances. Certain directors also devote their time and attentionProxy Statement relating to the Board's principal standing committees. The committees and their primary functions are as follows. Audit Committee - This committee makes recommendations to the Board1997 Annual Meeting of Directors with respect to the Company's financial statements and the appointment of independent accountants, reviews significant audit and accounting policies and practices, meets with the Company's independent accountants concerning, among other things, the scope of audits and reports, and reviews the performance of the overall accounting and financial controls of the Company. Compensation Committee - This committeeShareholders (the "Compensation Committee""1996 Proxy Statement") has the responsibility of reviewing and approving the salaries, bonuses, and other compensation and benefits of executive officers, advising management regarding benefits and other terms and conditions of compensation, and administering the Company's 1995 Employee Stock Incentive Plan.. Item 11. Executive Compensation The following table summarizesInformation regarding executive compensation earned byis hereby incorporated to the Chief Executive OfficerCompensation section, pages 6 through 12, of the Company1996 Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and the Company's other three most highly compensated executive officers who were serving as executive officers during 1995Management Information regarding security ownership of certain beneficial owners and received over $100,000 in salary and bonus for the year (together with the Chief Executive Officer, the "Named Executive Officers"). SUMMARY COMPENSATION TABLE Long - Term Compensation Awards Securities Annual Compensation Underlying All Other Name and Principal Year Salary Bonus Options Compensation - ------------------- ----- ------ ------ ----------- ------------ Ronald G. Canada 1995 $230,463 $64,638(1) 16,160 $ 0 Chairman and Chief 1994 178,000 32,040(1) 8,015 0 Executive Officer Kenneth R. Piety 1995 170,673 56,020(1) 14,005 4,620(2) Vice-Chairman and 1994 156,000 28,018(1) 31,940 3,972(2) Vice President of Engineering and Secretary John J. Cioffi 1995 146,528 49,556(1) 12,389 4,330(2) President and Chief 1994 134,000 24,564(1) 6,140 3,978(2) Operating Officer Bryan J. Collier 1995 98,111 33,396(1) 8,349 3,415(2) Vice President of 1994 90,000 16,554(1) 4,135 2,690(2) Finance and Chief Financial Officer
(1) The amount listed represents a cash bonus receivedmanagement is hereby incorporated by the officer for the fiscal year 1995 and 1994, as appropriate. (2) The amount listed represents the contributions madereference to the Company's 401(k) plan by the Company on behalfpage 3 of the Named Executive. The following table summarizes certain information regarding stock options issued to the Named Executive Officers under the Company's 1995 Employee Stock Incentive Plan ("Employee Incentive Plan") pursuant to criteria set forth in the Company's Senior Executive Compensation Plan (the "Bonus Plan") during 1995.
OPTION GRANTS IN FISCAL YEAR 1995 Individual Grants ----------------------------------------------------------- Number of Percent of Securities Total Options Underlying Granted to Exercise or Options Employees in Base Price Expiration Name Granted (#) Fiscal Year ($ / Share) Date - ----------------- ----------- -------------- ------------ ---------- Ronald G. Canada 16,160 17.62% $15.50 1/31/00 Kenneth R. Piety 14,005 15.27% $15.50 1/31/00 John J. Cioffi 12,389 13.51% $15.50 1/31/01 Bryan J. Collier 8,349 9.10% $15.50 1/31/01
OPTION GRANTS IN FISCAL YEAR 1995 Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term -------------------------- Name 5% 10% - ---------------- ----------- ------------ Ronald G. Canada 35,162 80,935 Kenneth R. Piety 30,473 70,142 John J. Cioffi 41,939 91,683 Bryan J. Collier 28,263 61,785
The following table summarizes certain information with respect to stock options issued to the Named Executive Officers under the Company's various stock option plans as to the number of shares covered by both exercisable1996 Proxy Statement. Item 13. Certain Relationships and unexercisable stock options and options exercised during the fiscal year ended December 31, 1995. Also reported are the values for the "in-the-money" options, which represent the positive spread between the exercise price of any such existing stock options and the year-end fair market value of the Common Stock.
AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1995 AND FISCAL YEAR-END OPTION VALUES Number of Value of Securities Unexercised Underlying in-the-Money Shares Options at Fiscal Options at Fiscal Acquired on Value Year-End (#) Year-End Name Exercise (#) Realized ($) Exercisable/Unexercisable Exercisable/Unexercisable - ---------------- ------------ ------------ ------------------------- ------------------------- Ronald G. Canada 0 0 1,603 / 22,572 $ 18,434.50 / $ 73,738.00 Kenneth R. Piety 0 0 6,388 / 39,557 $ 78,462.00 / $313,848.00 John J. Cioffi 30,000 285,000 1,228 / 62,301 $ 14,122.00 / $618,988.00 Bryan J. Collier 10,000 95,000 10,827 / 41,657 $134,510.50 / $413,042.00
DIRECTOR'S COMPENSATION The Company's non-employee directors receive a quarterly fee of $2,000 and reimbursement of expenses. In addition, each of the Company's non-employee directors have received options to purchase 15,000 shares of the Company's common Stock pursuant to the Company's Non-Employee Director Stock Option Plan (the "Plan"). The non-employee directors may exercise the options with respect to 5,000 shares in each of the three years beginning on a date set forth in their option agreements. However, any portion of such 5,000 shares not purchased in any given one-year period does not carry forward to the next one-year period. The Company will however no longer issue options under the Plan. The Board of Directors on July 14, 1995 and the shareholders on July 27, 1995, approved the 1995 Amended and Restated Non-Employee Directors' Stock Option Plan (the "Directors' Plan") which provides for the issuance of up to 60,000 shares of the Company's Common Stock. Under the Directors' Plan, each non-employee director of the Company shall receive on the date of the annual meeting of the Company's shareholders, commencing with the 1996 annual meeting, an option grant for the purchase of 2,000 shares of the Company's Common Stock. All options granted under the Directors' Plan will have an exercise price equal to the fair market value of the Common Shares at the date of grant, will vest one year from the date of grant and will have a term of ten years, subject to the non-employee director's continued service as a director. SENIOR EXECUTIVE INCENTIVE COMPENSATION PLAN The Company has established a Senior Executive Compensation Plan that provides for the payment of cash bonuses and the granting of stock options to the four top executive officers of the Company, Messrs. Canada, Piety, Cioffi and Collier. The amount of bonuses is determined by the Compensation Committee based upon the percentage of the annual budgetary financial goal achieved by the Company in the fiscal year covered. The annual budget goal is determined by the Board of Directors by assigning different percentage weights to such items of Company performance as, among others, consolidated gross margin, consolidated budgeted revenues and consolidated pre-tax profit. No bonuses are payable under the Bonus Plan unless the Company's consolidated pre-tax profit (an individual item of the overall annual budget goal) is at least 75% of its budgeted amount for the fiscal year. As amended in January 1995, the Bonus Plan provides that the top executives are eligible for cash bonuses of 10% to 50% of their annual base salary and a grant of stock options, based upon the Company's achievement of 90% to 110% of the annual budget. The Bonus Plan may be amended, suspended or discontinued at any time. Options granted pursuant to criteria established by the Bonus Plan are granted under the Company's Employee Incentive Plan. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee of the Board of Directors consists of Messrs. Ray, Rukeyser, Smith and Valunas, none of whom is an employee or officer of the Company. No executive officer of the Company served during fiscal 1995 as a member of a compensation committee or as a director of any entity of which any of the Company's directors serves as an executive officer. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table summarizes security ownership by (i) each director of the Company; (ii) the Named Executive Officers; and (iii) all directors and executive officers of the Company as a group as of December 31, 1995. Name and Amount Address of and Nature of Title of Beneficial Beneficial Percent Name Class Owner Ownership (1) of Class (1) - ---------------- -------- -------------------- ------------------- ----------- Ronald G. Canada Common 835 Innovation Drive 1,129,535 shares (2) 23.8% Knoxville, TN. 37932 Kenneth R. Piety Common 835 Innovation Drive 679,789 shares (3) 14.3% Knoxville, TN. 37932 John J. Cioffi Common 835 Innovation Drive 63,086 shares (4) 1.3% Knoxville, TN. 37932 Bryan J. Collier Common 835 Innovation Drive 66,914 shares (5) 1.4% Knoxville, TN. 37932 James F. Smith Jr. Common 835 Innovation Drive 10,000 shares * Knoxville, TN. 37932 Richard E. Ray Common 835 Innovation Drive 10,000 shares (6) * Knoxville, TN. 37932 Thomas A. Valunas Common 835 Innovation Drive 10,000 shares (6) * Knoxville, TN. 37932 William Rukeyser Common 835 Innovation Drive 10,000 shares (6) * Knoxville, TN. 37932 All executive Common 835 Innovation Drive 2,075,659 shares (7) 43.3% officers and Knoxville, TN. 37932 directors as a group (9 persons)
* Represents less than 1% of the Common Stock outstanding. (1) Pursuant to the rules of the Securities and Exchange Commission, certain shares of the Company's Common Stock which a beneficial owner has the right to acquire within 60 days of the date hereof pursuant to the exercise of stock options are deemed to be outstanding for the purposes of computing the percentage ownership of such owner but not deemed outstanding for the purpose of computing percentage ownership of any other person. (2) Includes 4,835 shares which may be acquired upon the exercise of outstanding options, and 45,000 shares that Mr. Canada beneficially owns as trustee for various trusts for the benefit of Dr. Piety's children. (3) Includes 9,189 shares which may be acquired upon the exercise of outstanding options. (4) Includes 3,706 shares which may be acquired upon the exercise of outstanding options. (5) Includes 12,497 shares which may be acquired upon the exercise of outstanding options. (6) Includes 5,000 shares which may be acquired upon the exercise of outstanding options. (7) Includes 45,287 shares which may be acquired upon the exercise of outstanding options. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On April 15, 1992, the Company loaned Ronald G. Canada, Chairman and Chief Executive Officer of the Company, $431,189 for the purpose of constructing a home. The loan was secured by one million shares of the Company's Common Stock, was payable in 231 monthly installments and accrued interest at the prime rate plus one percent on a monthly basis. In 1993, Mr. Canada sold 100,000 shares of Common Stock to the Company for a total consideration of $300,000, of which amount Mr. Canada applied $203,685 towards his indebtedness under the loan. In April 1994, the Company loaned Mr. Canada an additional $12,673. This loan was secured by the same one million shares of the Company's Common Stock securing the 1992 loan. The April, 1994 loan also accrued interest at the prime rate plus one percent and was payable upon demand. On June 28, 1995 Mr. Canada paid $262,772, which was the entire outstanding balance due on the loans to the Company. On April 1, 1994, the Company entered into a Loan Agreement for a revolving line of credit with First American National Bank (the "First American Loan"). At the time of the transaction,Related Transactions James F. Smith, Jr., a director of the Company, served both as a director of the Company and as Chairman of the Board of First American National Bank and its parent corporation First American Corp. At the end of fiscal year 1994, the outstanding balance under the First American Loan was approximately $3.2 million. As of January 1, 1995, Mr. Smith was no longer an executive officer of First American National Bank or First American Corp. although he still occupies a position asis also a director of First American Corp. The balance on, 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 was paid down with a portion of the proceeds from the offering of securities during the third quarter.available borrowings up to $12,000,000. The Board of Directors of the Company has adopted a policy which provides that any transactions between the Company and any of its directors, officers or principal shareholders or affiliates thereof must beAgreement expires on terms no less favorable to the Company than could be obtained from unaffiliated parties, and must be approved by a vote of a majority of the disinterested members of the Board of Directors. April 30, 1999. PART IV ITEMItem 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORMExhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) The following Consolidated Financial Statements of Computational Systems, Incorporated are provided underincluded 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. 21.B. Incorporated by reference to the Company's second quarter Form 10-Q 10 -- ListAmended and Restated Credit Agreement with First American National Bank and NationsBank of Subsidiaries. B.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 rere: 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 - none (c) Exhibits - (a), (3) referenced herein (d) Financial Statement Schedule included herein 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, IncoporatedIncorporated By /S/ Bryan J. Collier By -------------------------------- Bryan J. Collier Vice President of Finance and Chief Financial Officer Date: February 28, 1996Date 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 DATESignature Title Date /s/ Ronald G. Canada Chairman, Chief Executive Officer February 28, 1996 - ---------------------- and March 27, 1997 Ronald G. Canada Director (Principal Executive Ronald G. Canada Officer) /s/ Kenneth R. Piety Vice Chairman, Vice President of February 28, 1996 - ----------------------March 27, 1997 Kenneth R. Piety Engineering, Secretary, and Director Kenneth R. Piety John J. Cioffi/s/ Carlo Gorla President and Director February 28, 1996 - ---------------------- John J. CioffiChief Operating Officer March 27, 1997 Carlo Gorla /s/ Bryan J. Collier Vice President of Finance and February 28, 1996 - ---------------------- Chief Financial OfficerMarch 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 Director February 28, 1996 - ---------------------- Richard E. Ray/s/ William S. Rukeyser Director February 28, 1996 - ----------------------March 26, 1997 William S. Rukeyser /s/ James F. Smith, Jr. Director February 28, 1996 - ----------------------March 27, 1997 James F. Smith, Jr. Director Thomas A. Valunas, Jr. Director February 28, 1996 - ---------------------- Thomas A. Valunas, Jr. INDEPENDENT ACCOUNTANTS REPORT OFON FINANCIAL STATEMENT SCHEDULE In connectionconnectin with our audits of the consolidated financial statements of Computational Systems, Incorporated and Subsidiaries as of December 31, 19941996 and 1995, and for each of the three years in the period ended December 31, 1995,1996, we have also audited the financial statement Schedule II - Valuation and Qualifying Accounts and Reserves for the three years ended December 31, 1995.1996. In our opinion, this financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all materialmaterail respects, the information required to be included therein. COOPERS/s/ Coopers & LYBRANDLybrand L.L.P. Coopers & Lybrand L.L.P. Knoxville, Tennessee February 1, 1996 January 24, 1997 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31 Col. A Col. B Col. C Col. D Col. E Additions -------------------------
Balance at Charged to Charged Balance beginning costs and to other at end Description of period expenses accounts Deductions of period - -------------------------------- ---------- ----------- ------------------- -------- -------- ---------- --------- Allowance for doubtful accounts: 1993 $157,243 $35,869 ------ $68,112 $125,000 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
COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES EXHIBIT INDEX Sequential Exhibit Number Description Page Number -------------- ---------------------------------------- ------------- 11No. 11.0 Statement re: computationComputation of per share earnings 21.0 List of Subsidiaries 23.1 Independent Accountant'sAccountants' Consent Exhibit 11 COMPUTATION OF EARNINGS PER SHARE FOR THE YEAR ENDED DECEMBER 31 1993
1994 1995 --------- --------- ---------1996 PRIMARY: Weighted average number of common shares outstanding 3,569,753 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 224,725 136,595 292,255 229,289 ---------- ---------- ---------- Weighted average number of common and common equivalent shares outstanding 3,794,478 3,503,329 4,117,251 5,065,510 Net income $306,810 $1,798,267 $2,947,301 $4,534,050 Primary net income per common share $0.08 $0.51 $0.72 $0.90 FULLY DILUTED: Weighted average number of common shares outstanding 3,569,753 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 224,725 136,595 303,825 242,274 ---------- ---------- ---------- Weighted average number of common and common equivalent shares outstanding 3,794,478 3,503,329 4,128,821 5,078,495 Net income $306,810 $1,798,267 $2,947,301 $4,534,050 Fully diluted net income per common share $0.08 $0.51 $0.71 $0.89
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. EXHIBITExhibt 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 February 1, 1996,January 24, 1997, on our audits of the consolidated financial statements and financial statement schedules of Computational Systems, Inc. as of December 31, 19951996 and 1994,1995, and for the years ended December 31, 1996, 1995 1994 and 1993,1994, which report is included in this Annual Report on Form 10-K. COOPERS/s/ Coopers & LYBRANDLybrand L.L.P. Coopers & Lybrand L.L.P. Knoxville, Tennessee February 27, 1996March 25, 1997