This paper document is being filed pursuent to Rule 902(g) of Regulation S-T SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1997 Commission file number 0-26596 Computational Systems, Incorporated ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) Tennessee 62-1198047 - ------------------------------- ------------------------------------ (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 835 Innovation Drive Knoxville, Tennessee 37932 - --------------------------------------- ---------- (Address of Principal Executive Office) (Zip Code) Registrant's Telephone Number, Including Area Code: (423) 675-2110 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Common Stock outstanding - 5,003,845 shares at March 31, 1997 Page of pages. Exhibit Index on page . PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements. Consolidated Condensed Balance Sheets Consolidated Condensed Statements of Operations Consolidated Condensed Statements of Cash Flows Notes to Consolidated Condensed Financial Statements COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MARCH 31, DECEMBER 31, 1997 1996 (Unaudited) (Audited) ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 692,174 $ 4,576,801 Trade accounts receivable, less allowance for doubtful accounts 16,062,089 15,656,516 Inventories 3,144,321 3,190,964 Prepaid expenses and other current assets 903,485 906,733 ----------- ----------- Total current assets 20,802,069 24,331,014 ----------- ----------- Property, plant and equipment: Land 729,204 729,204 Building and improvements 7,812,000 6,714,979 Equipment and furniture 12,008,329 10,625,614 Construction-in-Progress ------- 1,293,587 ----------- ----------- 20,549,533 19,363,384 Less accumulated depreciation (6,479,637) (5,879,464) ----------- ----------- Property, plant and equipment, net 14,069,896 13,483,920 ----------- ----------- Other assets Other assets 826,226 552,777 Goodwill 6,194,663 6,292,490 Other intangible assets 664,288 612,646 ----------- ----------- Total assets $42,557,142 $45,272,847 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,193,819 $ 2,598,425 Accrued liabilities 3,975,925 7,222,579 Income taxes payable (31,938) 1,026,110 Deferred maintenance contract revenue 2,329,947 2,070,411 Line of credit 519,000 ------- ----------- ----------- Total current liabilities 8,986,753 12,917,525 Deferred maintenance contract revenue 612,661 668,862 ----------- ----------- Total liabilities 9,599,414 13,586,387 ----------- ----------- Shareholders' equity: Common stock,no par value, 50,000,000 shares authorized, 18,508,561 18,034,208 5,003,845 and 4,991,618 shares issued and outstanding in 1997 and 1996, respectively Additional paid-in capital 951,230 865,805 Retained earnings 13,497,937 12,786,447 ----------- ----------- Total shareholders' equity 32,957,728 31,686,460 ----------- ----------- Total liabilities and shareholders' equity $42,557,142 $45,272,847 =========== =========== The accompanying notes are an integral part of these consolidated financial statements. COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended March 31, March 31, 1997 1996 ----------- ----------- Revenues, net: Product $ 8,721,280 $ 7,932,848 Services 5,753,268 2,798,445 ----------- ----------- 14,474,548 10,731,293 Cost of revenues: Product 2,178,165 2,316,055 Services 4,018,907 2,180,255 ----------- ----------- 6,197,072 4,496,310 Gross margin 8,277,476 6,234,983 Costs and expenses: Selling, general and administrative 5,634,274 4,355,000 Research & development 1,611,124 1,206,196 ----------- ----------- 7,245,398 5,561,196 ----------- ----------- Income from operations 1,032,078 673,787 Other income (expense) Interest expense (10,477) (1,146) Interest income 48,173 117,589 Other income (expense), net 8,242 (5,859) ----------- ----------- 45,938 110,584 ----------- ----------- Income before taxes 1,078,016 784,371 Provision for income taxes 366,526 282,375 ----------- ----------- Income after taxes $711,490 $501,996 =========== =========== Earnings per share $0.14 $0.10 =========== =========== Weighted average shares and equivalents outstanding 5,266,400 5,018,945 =========== =========== The accompanying notes are an integral part of these consolidated financial statements COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Three Months Ended March 31, March 31, 1997 1996 ---------- ---------- Cash flows from operating activities: Net income $711,490 $501,996 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation and amortization 732,395 403,656 Deferred income taxes 2,000 (176,000) Changes in operating assets and liabilities: Accounts receivable (396,535) 553,405 Income taxes (payable) (981,661) (72,073) Inventories 37,334 (264,864) Prepaids & other current assets 3,248 71,587 Other assets 5,697 (40,703) Accounts payable (399,763) (16,760) Accrued liabilities (428,359) (516,951) Deferred maintenance contract revenue 203,335 347,497 ---------- ---------- Net cash (used) provided by operating activities (510,819) 790,790 ---------- ---------- Cash flows from investing activities: Purchase of property, plant and equipment (1,184,973) (1,108,041) Purchase of business (2,385,250) Investment in other assets (359,050) ------ ---------- ---------- Net cash used in investing activities (3,929,273) (1,108,041) ---------- ---------- Cash flows from financing activities: Net borrowings under (repayments on) line of credit 519,000 ------ Repayments of long-term debt (4,843) (5,821) Proceeds from issuance of common stock 41,308 59,610 ---------- ---------- Net cash provided by financing activities 555,465 53,789 ---------- ---------- Net (decrease) in cash and cash equivalents (3,884,627) (263,462) Cash and cash equivalents, at beginning of period 4,576,801 8,824,332 ---------- ---------- Cash and cash equivalents, at end of period $692,174 $8,560,870 ========== ========== The accompanying notes are an integral part of these consolidated financial statements. COMPUTATIONAL SYSTEMS, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. INTERIM FINANCIAL STATEMENTS: Information in the accompanying financial statements and notes to the financial statements for the interim periods is unaudited. The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 1997, are not necessarily indicative of the results that may be expected for the year ended December 31, 1997. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Form 10-K for December 31, 1996. 2. INVENTORIES: Inventories consist of the following: March 31, December 31, 1997 1996 (Unaudited) (Audited) ----------- ----------- Raw Materials 1,428,088 $1,406,893 Work in-process 574,127 649,589 Finished goods, net 1,142,106 1,134,482 ----------- ----------- $3,144,321 $3,190,964 =========== =========== 3. CASH FLOW INFORMATION: March 31, March 31, 1997 1996 -------- -------- (Unaudited) (Unaudited) Supplemental disclosures of cash flows: Interest paid $ 362 $ 1,473 Income taxes paid, net $609,000 $461,899 On January 2, 1997 CSI issued the remaining stock to the former owners of Maintenance & Diagnostic L.L.C. per the purchase agreement dated October 28, 1996. The value of the stock transferred was $433,045. 4. RESEARCH AND DEVELOPMENT: The majority of research and development costs are expensed as incurred. Other research and development costs incurred in developing a product during the period that begins when the product's prototype has been established and ending when the product is available for general release are capitalized and are amortized over the economic life of the product. Such costs capitalized in the three months ended March 31, 1997 amounted to $281,146. These costs will be amortized on a per unit sold basis. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Comparison of Three Months Ended March 31, 1997 and March 31, 1996 Revenues, Net. Net revenues increased 34.9% in the three months ended March 31, 1997 ("the 1997 quarter") to $14.5 million, compared to $10.7 million during the three months ended March 31, 1996 ("the 1996 quarter"). Revenue from the sale of products increased 9.9% to $8.7 million in the 1997 quarter from $7.9 million in the 1996 quarter. The increase in product revenues is due primarily to significant increases in the 2120 two channel vibration analysis product line, the latest version of the Company's original product line. Service revenues increased 105.6% to $5.8 million in the 1997 quarter from $2.8 million in the 1996 quarter primarily as a result of the acquisition of Maintenance and Diagnostics LLC ("M&D"), an operator of research, service and training centers for the electric power industry, late in 1996 and increases in technical and customer services driven by the increase in product sales. Cost of Revenue. Total costs of revenues increased 37.8% to $6.2 million in the 1997 quarter from $4.5 million in the 1996 quarter. As a percentage of net revenues, total cost of revenue increased from 41.9% in the 1996 quarter to 42.8% in the 1997 quarter due to the increase in the level of services activity which has a lower gross margin than product revenues. Product costs decreased 6.0% to $2.2 million in the 1997 quarter from $2.3 million in the 1996 quarter primarily due to favorable pricing that resulted from purchasing negotiations and improved efficiencies in the manufacturing process. Service costs increased 84.3% to $4.0 million in the 1997 quarter from $2.2 million in the 1996 quarter primarily due to the acquisition of M&D as well as the increase in activity associated with the overall increase in services revenues. Selling, General and Administrative. SG&A expense increased 29.4% to $5.6 million in the 1997 quarter from $4.4 million in the 1996 quarter. The increase was due primarily to an increase in investments in market development related to the corresponding increase in net revenues. SG&A expense, as a percentage of net revenues, decreased to 38.9% in the 1997 quarter from 40.6% in the 1996 quarter. Research and Development. Research and development expenses increased by $404,928 or 33.6% to $1.6 million in the 1997 quarter from $1.2 million in the 1996 quarter, reflecting increases in the level of support of a more diverse product line as well as expenditures for the development of new products. As a percentage of net product revenues, research and development expenses increased to 18.5% in the 1997 quarter from 15.2% in the 1996 quarter. Income from Operations. Income from operations for the 1997 quarter increased 53.2% to $1.0 million, or 7.1% of net revenue, from $674,000, or 6.3% of net revenue, in the 1996 quarter. Total operating expenses increased by $1,684,202 or 30.3% to $7.2 million in the 1997 quarter from $5.6 million in the 1996 quarter. Interest Expense/Income. Interest expense increased in the 1997 quarter to $10,477 from $1,146 in the 1996 quarter, primarily as a result of draws on the Company's bank line of credit to finance continuing growth. Interest income decreased 59.0% in the 1997 quarter to $48,173 from $117,589 in the 1996 quarter due to lower cash levels being available for investment. Income Taxes. The Company's effective tax rate for the 1997 quarter was approximately 34% versus the 1996 quarter rate of approximately 36%. The rate has improved due to the utilization of available research and development tax credits as well as a foreign sales corporation. Liquidity and Capital Resources Since its inception, the Company has financed its operations through a combination of cash flow from operations, bank borrowings and equity capital. The Company's capital requirements have arisen primarily in connection with purchases of fixed and intangible assets, including acquisitions, and the Company makes significant expenditures each year for research and development and market development. Net cash utilized by operating activities in the 1997 quarter was $510,819. Net cash provided by operating activities was $790,790 in the 1996 quarter. The change was caused primarily by the payment of accrued expenses from the previous year. Investing activities primarily include additions to property, plant and equipment and cash payments made to close the acquisition of M&D. The Company maintains bank lines of credit that provide for borrowings of up to $12.0 million based on a minimum current ratio of 1.25 or better and bearing interest at the lender's base rate or the adjusted LIBOR rate plus the applicable LIBOR margin at the Company's discretion. The Company's total liabilities decreased to $9.6 million as of March 31,1997 as compared to $13.6 million as of December 31, 1996 reflecting payments on obligations incurred in connection with the acquisition of M&D as well as the payment of outstanding tax liabilities. Although the Company presently has neither 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. In February 1997, the FASB issued Statement of Accounting Standards No. 128, Earnings Per Share (EPS). The Statement simplifies the standards for computing earnings per share by replacing the presentation of primary earnings per share with a presentation of basic earnings per share. Additionally, the Statement requires dual presentation of basic and diluted EPS on the face of the income statement and requires a reconciliation of the numerator and denominator of the diluted EPS calculation. The Company plans to adopt the provisions of Statement 128 in fiscal year 1997 and the impact on the Company's financial statements has not been determined. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: (11) Statement re: computation of per share earnings (27) Financial data schedule (b) No reports on Form 8-K were filed for the quarter ended March 31, 1996. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMPUTATIONAL SYSTEMS, INCORPORATED Date: May 13, 1997 By: /s/ Ronald G. Canada ------------------------------------ Ronald G. Canada, Chairman and Chief Executive Officer By: /s/ Bryan J. Collier ------------------------------------ Bryan J. Collier, Vice President of Finance and Chief Financial Officer Exhibit Index Sequential Item No. Description ---------- ------------------------------------------------ (11) Statement re: Computation of per share earnings (27) Financial data schedule EXHIBIT 11 - EARNINGS PER SHARE THREE MONTHS ENDED MARCH 31, MARCH 31, 1997 1996 --------- --------- PRIMARY: Weighted average number of common shares outstanding 5,000,064 4,752,611 Net effect of dilutive stock options based on the treasury stock method using the average market price 266,336 266,334 --------- --------- Weighted average number of common and common equivalent shares outstanding 5,266,400 5,018,945 Net income $711,490 $501,996 --------- --------- Primary net income per common share as reported $0.14 $0.10 FULLY DILUTED: Weighted average number of common shares outstanding 5,000,064 4,752,611 Net effect of dilutive stock options based on the treasury 	stock method using the period-end market price if higher than average price 266,336 272,174 --------- --------- Weighted average number of common and common equivalent shares outstanding 5,266,400 5,024,785 Net income $711,490 $501,996 --------- --------- Fully diluted net income per common share as reported $0.14 $0.10 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.