SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                   FORM 10KSB


|X|      Annual Report pursuant to Section 13 or 15(d) of the
         Securities Exchange Act of 1934

For the fiscal year ended December 31, 1997

|_|      Transition  report  pursuant  to Section 13 or 15(d) of the  Securities
         Exchange Act of 1934 (no fee required)

For the transition period from _________ to __________.

Commission File Number:  0-12575

                         ARIZONA INSTRUMENT CORPORATION
--------------------------------------------------------------------------------
           (Name of small business issuer as specified in its charter)

         Delaware                                               86-0410138
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(State or other jurisdiction of                                (IRS Employer
incorporation or organization)                               Identification No.)

4114 East Wood Street, Phoenix, AZ                            85040
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(Address of principal executive offices)                    (Zip Code)

Issuer's telephone number:  (602) 470-1414

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  Common Stock, $.01
par value

Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days.

                 Yes  |X|               No |_|

Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure  will be contained,  to
the  best  of  Registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  In Part III of this Form 10-IKSB or any
amendment to this Form 10-KSB. |_|
                                       1
<PAGE>
As of March 23,  1998,  the  aggregate  market value of the voting stock held by
non-affiliates  of the registrant was $7,771,285.  The aggregate market value is
computed with  reference to the average bid and asked  prices.  Shares of Common
Stock held by each  officer and director and by such person who owns 10% or more
of the  outstanding  Common Stock have been excluded in that such persons may be
deemed  to  be  affiliates.  This  determination  of  affiliate  status  is  not
necessarily conclusive.

Issuers revenues for its most recent fiscal year were $15,232,319

As of March 20,  1998,  6,717,086  shares of Common  Stock ($.01 par value) were
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

         Part III:         Portions  of the Proxy  Statement for the 1998 Annual
                  Shareholders' Meeting (to be filed).
                                       2
<PAGE>
Unless the context  indicates  otherwise,  the term "Company" or "AZI" refers to
Arizona Instrument Corporation and its wholly-owned subsidiaries.

Except for the historical  information  contained herein, the discussion in this
Form 10-KSB contains certain  forward-looking  statements  within the meaning of
the Private  Securities  Litigation  Reform Act of 1995, and the Company intends
that such  forward-looking  statements  be subject to the safe  harbors  created
thereby.   The   forward-looking   statements   include   statements   regarding
management's  anticipation of the Company's future market position,  development
of additional products,  product introduction and delivery dates, reliability of
products, adequate sources of supplies,  acquisition of related product lines or
companies, positive responses to new developments, and availability and terms of
credit.  The  forward-looking  statements  included  herein are based on current
expectations  that  involve  a  number  of  risks  and  uncertainties,   and  on
assumptions that involve  judgments with respect to, among other things,  future
economic,  competitive and market conditions,  research and development results,
product introduction and delivery schedules,  raw materials,  market conditions,
stability of the  regulatory  environment,  future  business  decisions  and the
outcome  of  negotiations  with  its  lender,  all of  which  are  difficult  or
impossible to predict accurately and many of which are beyond the control of the
Company.  Although the Company  believes  that the  assumptions  underlying  the
forward-looking statements, many of which are beyond the control of the Company,
are reasonable,  any of the assumptions  could prove inaccurate and,  therefore,
there can be no  assurance  that the  results  contemplated  in  forward-looking
information will be realized.  Important  factors which may cause actual results
to differ materially from those contemplated or implied by such  forward-looking
statements  are  discussed in more detail in this form 10-KSB and the  Company's
1997 Annual Report to  Shareholders.  In light of the significant  uncertainties
inherent in the  forward-looking  information  included herein, the inclusion of
such information  should not be regarded as a  representation  by the Company or
any other person that the objectives or plans of the Company will be achieved.


                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS

General
-------

         Arizona  Instrument  Corporation  designs  and  manufactures  precision
instruments  used in  quality  control,  industrial  control  and  environmental
monitoring  applications.  The  operations  of  AZI's  wholly-owned  subsidiary,
Horizon  Engineering  and Testing,  Inc.  ("Horizon"),  which had specialized in
testing and  engineering  services  for the  underground  storage  tank  ("UST")
market, were discontinued during 1997.

         AZI completed its initial  public stock  offering on September 22, 1983
as Computrac Instruments,  Inc. Later that year, the Company changed its name to
Quintel  Corporation.  In March  1987,  to reflect new  product  offerings,  the
Company was renamed Arizona Instrument Corporation.

         AZI's initial  product was the Computrac  moisture  analyzer for use in
process control industries, but the Company has successfully expanded into other
product  areas.  In December 1986, AZI acquired  Jerome  Instrument  Corporation
("Jerome"),  a manufacturer  of mercury and hydrogen  sulfide gas analyzers.  In
January 1988, AZI completed the acquisition of certain assets from Genelco, Inc.
("Genelco")  including the Soil Sentry line of UST leak  detection  systems.  In
June 1994, the Company introduced the ENCOMPASS(TM) product, its next generation
of fuel management and leak detection compliance systems. In September 1992, the
Company
                                       3
<PAGE>
acquired Horizon, a company that specialized in testing and engineering services
for USTs; however, the Company discontinued Horizon's operations during 1997.

         Sales of the Company's  Encompass and Soil Sentry products,  as well as
similar products of the Company's  competitors,  have been slower than predicted
by industry  analysts.  Many UST  operators  have chosen the less  expensive but
temporary,  regulatory  option of annual tank  testing,  combined  with  monthly
inventory  reconciliation,  thus delaying their move to more expensive permanent
monitoring.  By December 1998, the law will require  virtually all UST operators
to move  from the  temporary,  annual  testing  option  to a  monthly  inventory
reconciliation service or permanent leak monitoring.

ENCOMPASS(TM)  and Soil Sentry Product Line
-------------  ----------------------------

         Products - ENCOMPASS and the Soil Sentry line of UST monitoring systems
include  various  products that allow UST  operators  with diverse site needs to
automate  fuel  management  and comply  with  federal  and local leak  detection
regulations.

         In June 1994, the Company  introduced the ENCOMPASS product, a personal
computer-based fuel inventory reporting and environmental compliance system that
utilizes on-site  personal  computers to manage fuel inventory and meet EPA leak
detection  requirements.  The ENCOMPASS system is compatible with other business
software and runs in the computer's  background without  interrupting other site
activities.  In the  event  of an  alarm  condition,  the  system  automatically
notifies the operator. The ENCOMPASS system runs in a Windows-based environment.

         In 1996, the Company expanded the ENCOMPASS system to include line leak
detection and  continuous  statistical  tank testing  products.  The addition of
statistical inventory  reconciliation  ("SIR"), as well as additional interfaces
to hardware produced by third parties is scheduled for 1998.

         The Soil Sentry  Twelve-X,  improved in 1993,  combines  aspirated  and
dynamic vapor monitoring  technologies to monitor both tanks and piping at sites
which have existing hydrocarbon contamination.  It uses a unique aspirated vapor
technology to measure for the presence of leak-indicating  hydrocarbon vapors in
the soil surrounding  underground and aboveground tanks.  Sampling points placed
at strategic locations  throughout a site are connected with transport tubing to
a Twelve-X  console.  A pump inside the system console  automatically  draws air
samples  from  each  sampling  point,  one at a time,  back to the  console  for
analysis by the sensor. The microprocessor  establishes a baseline contamination
level, then employs a series of statistical  tests and mathematical  modeling to
differentiate between new leaks, spills and existing background contamination to
eliminate false alarms. If thresholds are exceeded, an alarm is sounded. Because
the  monitoring  wells are  located  throughout  the  site,  the user is able to
pinpoint the problem area quickly, greatly reducing costs to repair tanks and/or
piping and remediate the site.

         Primary  features of all ENCOMPASS and Soil Sentry products include the
ability to  remotely  access and  control  the  system  through a modem  using a
personal computer.

         Market  and  Applications  - In 1984,  Congress  amended  the  Resource
Conservation  and  Recovery  Act,   requiring  the   implementation   of  strict
registration and monitoring regulations for all underground storage tanks in the
United  States.  For the purpose of these  regulations,  the EPA has defined any
storage tank system with
                                       4
<PAGE>
more than 10 percent of its total volume  underground as a UST. Estimates of the
total number of USTs affected by the federal  regulations vary, ranging from 1.8
to 2.1 million, with an average of 3.3 USTs per site.

         The markets and applications for UST leak detection include:  major oil
company service stations;  major oil company production and storage  facilities;
independent  retail  service  stations;  convenience  stores that sell gasoline;
shipping and trucking firms;  manufacturing and distribution  firms with fleets;
airports;  government and military sites equipped with underground storage tanks
and pipelines,  and facilities with back-up power systems.  All of these markets
contain  applications  appropriate  for  ENCOMPASS and Soil Sentry  systems.  In
addition,  non-regulated fuel systems such as aboveground storage tanks can also
be monitored with the ENCOMPASS and Soil Sentry products.


Horizon
-------

         Services - Horizon was acquired in 1992 to facilitate  the  penetration
of the UST market by the Company's Soil Sentry  products.  Horizon provided tank
testing  services using a tracer testing system for USTs,  which was licensed to
Horizon by Tracer Research Corp. ("Tracer") of Tucson, Arizona.

         In 1996, Horizon began offering a complete set of products and services
which were  required  by its tank  testing  customers  choosing  to convert to a
permanent  method of leak  detection.  Offering  ENCOMPASS as the leak detection
compliance method, Horizon also provided installation  management of the system,
cathodic protection,  interior tank lining, spill/overfill protection as well as
other  services  and  products  required to upgrade the site to meet federal and
local leak detection requirements.

         Markets  - Horizon  had been  engaged  since  1990 in the  business  of
testing  USTs for  leakage  using  EPA-recognized  testing  methods.  Due to its
declining  market share in tank testing,  and its inability to generate  profits
from tank upgrades, Horizon was discontinued in 1997.


Jerome Product Line
-------------------

         Products - The first Jerome product was developed in 1976 as a portable
mercury detector for mining applications. The initial "mercury in soil" detector
spawned a line of hand-held, battery powered, field portable instruments capable
of detecting mercury vapor and hydrogen sulfide in minute quantities.

         The Jerome 431-X mercury vapor  analyzer  ("Jerome  Mercury  Analyzer")
quickly  and  accurately  quantifies  low levels of  mercury in ambient  air for
on-site  environmental  testing,  clean-up  and  analysis.  Using the  Company's
gold-film sensing technology, the unit can be carried to sources of mercury, and
displays results in seconds with the push of a button. After spill clean-up, the
analyzer can be used to verify that no hazardous residue remains.

         The Jerome 631-X  hydrogen  sulfide  analyzer  ("Jerome H2S  Analyzer")
detects and measures low levels of ambient hydrogen  sulfide ("H2S").  Using the
Company's  gold-film  sensing  technology,   the  hand-held  instrument  quickly
quantifies H2S levels down to  parts-per-billion,  allowing corrective action to
reduce  complaints which arise at noxious-odor  levels.  The  simple-to-operate,
push  button  unit is easily  carried to sources  of H2S where it  monitors  gas
levels to meet air quality standards.
                                       5
<PAGE>
         The Company is working on developing new proprietary  gold film sensors
for future generations of the Company's Jerome line of toxic gas monitors.

         Markets  and  Applications  - Mercury - The market  for Jerome  Mercury
Analyzer comprises customers in three major groups:

         Industrial Hygiene - These applications  involve workplace screening to
ensure  employees are not  subjected to  unacceptable  mercury risk.  The United
States Occupational Safety and Health Administration requires industries such as
battery  and caustic  soda  manufacturers,  thermometer  and  fluorescent  light
manufacturers, hospitals and laboratories to monitor for mercury.

         Industrial  Process  Quality Control - These customers test for mercury
in  products  where  even trace  amounts  can have  toxic  effects,  such as the
confined  environments of submarines,  engine rooms or spacecraft.  Suppliers to
the National Aeronautics and Space Administration and the United States Navy are
required  under   procurement   contracts  to  certify  that  certain  equipment
components are mercury free.

         Mercury Dental Amalgam  Screening - Mercury and silver dental  amalgams
have become the subject of intense scrutiny and controversy.  The Jerome Mercury
Analyzer has been used in research on this topic,  and the Company believes that
it is  recognized  in the dental and medical  professions  as the only  portable
instrument that provides accurate mercury vapor readings at the required levels.

         Markets and  Applications - Hydrogen  Sulfide - The Jerome H2S Analyzer
allows  industries  to monitor H2S in low parts per billion  levels for odor and
corrosion control.

         Odor Control - Jerome H2S  Analyzers  effectively  quantify the noxious
odor of H2S  given off from  industrial  processes  in order to manage  customer
complaints or potential  litigation.  The most common  market is the  wastewater
treatment industry.

         Corrosion  Control - Searching for and  quantifying the presence of H2S
near costly  industrial  equipment is critical  since H2S and its byproducts are
highly  corrosive.  Industries  utilizing  the Jerome H2S Analyzer for corrosion
control include wastewater treatment,  oil and gas refining,  and pulp and paper
processing.

Computrac Product Line
----------------------

         Products - AZI was founded on the Computrac line of moisture analyzers.
The  Computrac  moisture  analyzers  simplify and automate a tedious  industrial
quality control procedure.  Typically,  a sample material is weighed, then dried
in an oven for several hours to drive off moisture.  The sample is weighed again
and the initial  moisture content of the sample is computed based on the loss of
water weight. Computrac instruments house a heating chamber to dry the sample, a
precision balance to measure sample weight change and a microprocessor that uses
an algorithm to quickly extrapolate moisture content based on the rate of weight
loss. This technology is named the loss on drying or LOD technique.

         Computrac instruments are rugged enough to be used on the factory floor
for quick batch  analysis and accurate  enough for precise  laboratory  testing.
They do not require a trained  technician  for  operation.  Thus,  they can save
customers both time and money.
                                       6
<PAGE>
         In 1994, the Company  completed  development of the Computrac  MAX-2000
and MAX-1000 moisture analyzers. The MAX-2000 uses the latest digital technology
to detect moisture levels  accurately down to .005% in as little as two minutes.
The  MAX-2000 is  programmable  from an  easy-to-use  front  panel menu  system,
allowing the user to store test parameters for 30 different sample materials. It
features a real-time front panel display of moisture  values,  the elapsing test
time and drying-curve graph, a statistical  software package, and the ability to
send test results to a PC or printer.

         In December  1995,  the Company  announced  that it completed  proof of
concept  of its new line of  Computrac  moisture  analyzers  with Alpha and Beta
production  units completed in 1996. The new product,  targeted at the worldwide
titration market, requires no toxic reagents, is simple to use and maintain, and
offers excellent  correlation and  repeatability.  The new Computrac product was
released for sale to customers during 1997 and additional  product  enhancements
are under development.

         The MAX-500 was introduced in 1996 as a lower priced,  reduced  feature
version of the MAX-1000 and  MAX-2000.  The MAX-500 is for  customers who do not
need  all  the  features  or the  resolution  of the  other  Computrac  moisture
analyzers.

         Markets and  Applications - The markets for Computrac  instruments tend
to be niche  applications in various  industries.  Three primary industries have
yielded the Company's  historical sales:  Foods - measuring the moisture content
of cookie dough,  cigarette  tobacco,  pasta and numerous other raw and finished
food products;  Chemicals - measuring  moisture and total solids content of such
chemical products as adhesives,  coatings,  and paints; and Plastics - measuring
the water  content of resins used in molding or  extrusion.  Other  applications
include pharmaceutical production and forestry management.

Product Reliability and Quality Control
---------------------------------------

         The Company  believes its products are highly  reliable.  The Company's
products have built-in  self-test features which are designed to insure that the
instrument is functioning  properly and will provide an accurate result.  If any
of the self-tests  indicate  abnormal  conditions,  the operator is alerted by a
light,  and a coded  display  indicates the type of  malfunction.  The Company's
products have one-, two- and five-year parts and labor warranties.  For the year
ended December 31, 1997, warranty expense approximated 2% of net sales.
                                       7
<PAGE>
         In February  1996,  the  Company  announced  that it achieved  ISO 9001
Quality  System  Certification.  This  certification  is registered  through SGS
International  Certification  Services,  Inc., an ANSI-RAB accredited registrar.
The ISO 9001  certification  defines models for quality assurance in every phase
of business operations including design, development,  quality control, customer
service,  production,  installation and service.  Certification to the worldwide
ISO 9001 standard  documents that the Company has in place  policies,  practices
and  procedures  to  provide  services  using  quality   management  systems  in
compliance with International Organization of Standardization (ISO) model.

Manufacturing and Sources of Supply
-----------------------------------

         The majority of the  Company's  manufacturing  costs are for  purchased
components. Certain of the components are then provided to outside companies for
subassembly,  with final assembly and testing performed by the Company. Although
two  vendors  currently  supply in excess  of 45% of the raw  materials  used in
Jerome's instrumentation, secondary vendors are available. The raw materials and
component parts are supplied by the two vendors  pursuant to  specifications  by
the Company.  The Company has  prequalified  certain  other vendors and believes
that, if necessary,  the raw materials and components  could be supplied by such
other vendors without  disruption of the manufacturing  process or other adverse
effect on the Company.

Marketing and Sales; Backlog
----------------------------

         The Company's marketing and sales strategy is to identify major markets
its products can serve, evaluate the sales potential of each market segment, and
conduct  specialized  promotional  campaigns,  market by market, to elicit sales
inquiries from prospective  customers.  The majority of the Company's  promotion
budget  is  spent on trade  advertising,  public  relations  and  exhibiting  at
industry trade shows.

         Inquiries are processed  through an in-house  inquiry  handling system.
Sales  representatives  are  trained to follow up on  inquiries  and qualify the
applicability of the Company's products to the prospect's need.

         Historically,  due to the relatively  short time period between receipt
of customer  orders and shipment of  products,  the  Company's  backlog has been
quite low. Since 1988, the dollar amount of unfilled  orders at the beginning of
any quarter has not exceeded 15% of sales for that quarter.

         The Company  markets its  instruments  for export through its own sales
force, as well as through foreign  distributors  in Canada,  Europe,  the Middle
East, the Far East, and Latin America.

Industries Served - Customers
-----------------------------

         The  specific  industries  served  domestically  by  each  product  are
detailed in the specific Markets and Applications sections presented earlier.

         One customer  represented  approximately  29% of net sales in 1997. The
Company  is  actively  seeking  to  diversify  sales  of this  product  to other
customers and anticipates that additional customers will be added in the next 12
months.

         Most export sales are to foreign distributors. The Company is unable to
determine which  industries are served by the export sales, but believes them to
be similar in pattern to domestic sales.  Export sales were
                                       8
<PAGE>
approximately 14% of total sales in 1997, with no sales to any country exceeding
10% of net sales. (See Note I to the Consolidated Financial Statements)

         The  Company's  business  with  United  States  government  agencies is
effected  through two contracts with the General Services  Administration.  Both
Jerome and Soil Sentry  products are available for purchase by federal  agencies
through these  contracts.  None of the contracts  provide for  renegotiation  of
profits,  except upon renewal of such contract or termination at the election of
the  government.  The  contracts  will  expire in January  1999.  The  Company's
products and services are not subject to government approval. The Company is not
aware of any pending  government  regulations  which would materially affect its
business.

Competition
-----------

         ENCOMPASS  and  Soil  Sentry  - There  are a  number  of  suppliers  of
permanent  storage tank monitoring  systems which compete with the ENCOMPASS and
Soil Sentry  product  line.  These  companies  are  nationwide in scope and many
operate in foreign markets. Channels of distribution for the competition include
direct account sales,  distributors,  and  manufacturers'  representatives.  The
ENCOMPASS and Soil Sentry  products  overlap the products of these  competitors,
except that AZI  believes  that it is the only  provider of an  aspirated  vapor
monitoring system.

         Computrac - A number of  companies  have  products  which  compete with
Computrac  moisture  analyzers.  For applications where very low moisture levels
are  measured,  titrators  provide  the  greatest  competition.  Many  of  these
companies operate both domestically and internationally.

         Jerome - There is no significant competition for Jerome in applications
where low levels of hydrogen  sulfide  gas or mercury  vapor need to be measured
with a hand-held  ambient air  analyzer.  When a less  sensitive  instrument  is
needed, the level of competition increases.


Research and Development
------------------------

         The Company believes that the development of new products, enhancements
for existing products,  and the development of new applications for its existing
products  are  critical  to  its  success.  Research  and  development  expenses
increased  37%  in  1997  compared  to  1996.   Expenditures  for  research  and
development  for the years ended December 31, 1997, 1996 and 1995 were $984,628,
$720,133,  and $605,628,  respectively.  This represented 6.5% of sales in 1997,
6.8% of sales in 1996,  and 5.7% of sales in 1995.  The  Company's  research and
development  expenditures  for 1997 were channeled  into the  development of new
products  in all three  product  lines.  The  Company  also  intends  to develop
additional  instrumentation  products and services through OEM relationships and
the acquisition of related product lines or instrument companies.


Patents, Licenses and Trademarks
--------------------------------

         The  Company  owns two  patents  directed  to aspects of its  Computrac
product,  one patent directed to aspects of its Soil Sentry product,  one patent
directed to its  ENCOMPASS  product and one domestic  and five  foreign  patents
directed  to aspects of its  Jerome  product.  Two  additional  domestic  Jerome
patents,  one domestic  ENCOMPASS  patent and one Computrac patent are currently
pending.  The Company does not
                                       9
<PAGE>
believe that patents are a  significant  long-term  competitive  factor in these
businesses  and intends to rely more on its on-going  research and  development,
engineering and customer service to maintain a long-term  competitive  advantage
in the market  place.  The  Company has not  granted  licenses  under any of its
patents and such patents have not been challenged or upheld in court.  There can
be no assurance  that the validity of the patents will be upheld if  challenged.
The Company has trademarked its ENCOMPASS(TM) product.

Employees
---------

         As of  December  31,  1997,  the  Company  had a total of 86 full  time
employees and 2 part-time  employees.  The Company  provides ongoing training to
its  technical  and  sales  personnel.  None  of  the  Company's  employees  are
represented by a union.  Management  believes that relations between the Company
and its employees are excellent.


ITEM 2.  DESCRIPTION OF PROPERTY

         The  Company  currently  leases  approximately  35,000  square  feet in
Phoenix, Arizona. All administration,  sales, customer service,  engineering and
manufacturing  for the Company are in the  Phoenix  facility.  The lease on this
building  expires in August 2003.  The Company  believes that its facilities are
modern, well-maintained and adequate for current needs.


ITEM 3.  LEGAL PROCEEDINGS

         On March 7,  1997,  the  Company  was served  with a summons  and first
amended  complaint  which was filed in the United States  District Court for the
District of Idaho on February 28, 1997 by United Co-op, Inc. and Idaho Petroleum
Clean Water Trust Fund. The complaint alleges breach of contractual promises and
breach of warranties  in a commercial  transaction  for tank and line  tightness
services.  The Company does not believe that the  resolution  of this claim will
have a material adverse effect.

         From time to time, the Company is involved in routine  litigation  that
is  incidental to its  business.  The Company is not  currently  involved in any
other legal  proceedings,  the result of which the Company believes would have a
material adverse effect upon the Company.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         The Company did not submit any matters to a vote of security holders in
the fourth quarter of 1997.

EXECUTIVE OFFICERS OF THE REGISTRANT

         Set forth below is certain information  regarding executive officers of
the Company.

         George G. Hays, age 42, is the President,  Chief Executive  Officer and
Chairman of the Board of Directors.  Mr. Hays joined the Company in 1997 as Vice
President  of  Finance,   Chief  Financial   Officer,   and  Vice  President  of
Manufacturing.  In  November  1997,  Mr. Hays was  elected  President  and Chief
Executive
                                       10
<PAGE>
Officer for the Company.  In January 1998, Mr. Hays was elected  Chairman of the
Board  of  Directors.  Prior to his  position  with the  Company,  Mr.  Hays was
president and founder of Hays Financial Group, Inc., an investment banking firm,
since 1986.

         Walfred R.  Raisanen,  age 62, is the Vice  President of Engineering of
the Company and a member of the Board of Directors. He served as Chairman of the
Board of  Directors  since the  Company's  inception in January 1981 until early
1998. Prior to his position with the Company, he was President and a Director of
Motorola Process Control, Inc., a predecessor to the Company.

         Susan Berry,  age 49, was named Secretary in early 1989. She has served
as Human  Resources  Manager for the Company  since 1985.  Prior to her position
with the Company, Ms. Berry was in corporate administration for Inter-Tel, Inc.

         Allen  Porter,  age 40, was named Vice  President of Marketing in 1996.
Mr.  Porter  has been with the  Company  since  1985,  working  in sales,  sales
management and product  management.  Prior to his position with the Company,  he
was program director for an Arizona-based behavioral health agency.

         Linda  Shepherd,  age 46,  was named  Controller  and Chief  Accounting
Officer in mid-1997.  Ms.  Shepherd has been an accountant for the Company since
1984. Prior to her position with the Company,  she served as an accountant for a
local trucking firm for nine years.

         Executive  officers are elected annually and serve at the discretion of
the Board of Directors.
                                       11
<PAGE>
                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS


         The Company's Common Stock trades on the Nasdaq Small Cap Market. As of
March 20,  1998,  there were  approximately  400  shareholders  of record of the
Company's common stock, its only class of common equity. The high and low prices
set forth below are derived from the Nasdaq Monthly  Statistical Report prepared
by the National Association of Securities Dealers, Inc., represent quotations by
dealers,  may not reflect applicable markups,  markdowns or commissions,  and do
not necessarily represent actual transactions.


                                                Bid
                                    ----------------------------

               1997                    HIGH             LOW
        --------------------        ------------    ------------

        First Quarter                      2.56            2.44
        Second Quarter                     1.81            1.75
        Third Quarter                      1.65            1.50
        Fourth Quarter                     0.96            0.84


               1996                    HIGH             LOW
        --------------------        ------------    ------------

        First Quarter                      2.71            2.51
        Second Quarter                     3.42            3.11
        Third Quarter                      2.84            2.64
        Fourth Quarter                     2.63            2.38


         The Company has never paid a cash  dividend  and  currently  intends to
retain all  earnings for use in its  business.  The  declaration  and payment of
dividends in the future will be determined by the Board of Directors in light of
conditions then existing, including the Company's earnings, financial condition,
capital  requirements  and other factors.  Dividends are also  restricted by the
Company's lines of credit agreements with Silicon Valley Bank. See "Management's
Discussion and Analysis or Plan of Operation."
                                       12
<PAGE>
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

Except for the historical  information  contained herein, the discussion in this
Form 10-KSB contains certain  forward-looking  statements  within the meaning of
the Private  Securities  Litigation  Reform Act of 1995, and the Company intends
that such  forward-looking  statements  be subject to the safe  harbors  created
thereby.   The   forward-looking   statements   include   statements   regarding
management's  anticipation of the Company's future market position,  development
of additional products,  product introduction and delivery dates, reliability of
products, adequate sources of supplies,  acquisition of related product lines or
companies positive responses to new developments,  and availability and terms of
credit.  The  forward-looking  statements  included  herein are based on current
expectations  that  involve  a  number  of  risks  and  uncertainties,   and  on
assumptions that involve  judgments with respect to, among other things,  future
economic,  competitive and market conditions,  research and development results,
product introduction and delivery schedules,  raw materials,  market conditions,
stability of the regulatory environment,  and future business decisions,  all of
which are difficult or impossible  to predict  accurately  and many of which are
beyond the  control of the  Company.  Although  the  Company  believes  that the
assumptions underlying the forward-looking  statements, many of which are beyond
the control of the Company,  are reasonable,  any of the assumptions could prove
inaccurate  and,  therefore,   there  can  be  no  assurance  that  the  results
contemplated in forward-looking information will be realized.  Important factors
which may cause actual results to differ  materially from those  contemplated or
implied by such forward-looking  statements are discussed in more detail in this
form 10-KSB and the Company's  1997 Annual Report to  Shareholders.  In light of
the  significant  uncertainties  inherent  in  the  forward-looking  information
included herein,  the inclusion of such information  should not be regarded as a
representation  by the Company or any other person that the  objectives or plans
of the Company will be achieved.

Results of Operations

The following table sets forth items in the Company's Consolidated Statements of
Operations as a percent of total net sales for the years ended December 31 1997,
1996 and 1995. See ITEM 7 FINANCIAL STATEMENTS.
                                       13
<PAGE>
<TABLE>
<CAPTION>
                                                 Percentage of Net Sales
                                               --------------------------      Percentage change
                                                 Year Ended December 31,       -------------------
                                               --------------------------      1997 vs    1996 vs
                                                 1997      1996     1995        1996       1995
                                               -------   -------  -------      -------    -------
<S>                                             <C>     <C>      <C>           <C>         <C>
NET SALES                                         100%    100.0%   100.0%        42.8%       0.7%

COST OF GOODS SOLD                               51.8%     41.4%    40.6%        78.8%       2.6%
                                               -------   -------  -------      -------    -------
              Gross margin                       48.2%     58.6%    59.4%        17.5%      -0.7%
                                               -------   -------  -------      -------    -------
EXPENSES
     Marketing                                   25.5%     26.1%    24.9%        39.4%       5.4%
     General & administrative                    17.9%     15.8%    12.4%        61.6%      28.5%
     Research & development                       6.5%      6.8%     5.7%        36.7%      18.9%
     Amortization & depreciation                  4.0%      5.4%     4.7%         5.5%      14.5%
                                               -------   -------  -------      -------    -------

              Total Expenses                     53.8%     54.0%    47.7%        42.2%      13.9%
                                               -------   -------  -------      -------    -------

OPERATING INCOME (LOSS)                          -5.5%      4.6%    11.7%      -271.0%     -60.2%
                                               -------   -------  -------      -------    -------

OTHER REVENUE (EXPENSE)
     Interest income                              0.1%      0.2%     0.2%       -33.3%       0.4%
     Interest expense                            -0.9%     -1.9%    -3.7%       -31.2%     -48.6%
     Settlement of litigation                     0.0%      9.4%     0.0%      -100.0%
     Other                                        0.0%      0.6%     0.9%      -103.2%     -34.9%
                                               -------   -------  -------      -------    -------

              Total other income (expense)       -0.8%      8.3%    -2.6%      -114.2%    -425.2%

INCOME (LOSS) BEFORE INCOME TAXES                -6.4%     12.9%     9.1%      -170.4%      42.1%
                                               -------   -------  -------      -------    -------

INCOME TAXES (BENEFIT)                           -2.4%     -4.1%     0.1%       -17.0%   -4109.1%
                                               -------   -------  -------      -------    -------

NET INCOME (LOSS) FROM CONTINUING OPERATIONS     -4.0%     17.0%     9.0%      -133.1%      89.8%

GAIN (LOSS) FROM DISCONTINUED OPERATIONS         -4.2%     -0.6%    -4.0%      -788.7%      90.2%
                                               -------   -------  -------      -------    -------

NET INCOME                                       -8.1%     16.4%     5.0%      -171.0%     227.7%
                                               =======   =======  =======      =======    =======
</TABLE>

1997 vs. 1996
-------------


         Net sales  increased by $4,568,830 or 42.8% to $15,232,319 in 1997 from
$10,663,489  in  1996.  Sales  increased  primarily  due to  increased  sales of
Encompass installations, Encompass systems, and Computrac instruments. Net sales
of Jerome  instruments  declined  slightly,  while sales generated from customer
service activities were essentially flat.

         Cost of goods sold  increased by  $3,474,626 or 78.8% to $7,885,507  in
1997  from  $4,410,881  in 1996.  Cost of goods  sold was 51.8% of sales in 1997
compared to 41.4% of sales in 1996. Gross margin decreased  primarily due to the
substantially  larger  portion  of sales  represented  by low  margin  Encompass
installations,  and to a lesser  extent,  a price  reductions  in the  Computrac
product line and increases in material costs.

         Operating  expenses  in  1997  increased  by  $2,428,791  or  42.2%  to
$8,188,933  from  $5,760,142  in 1996.  The  percentage  increase  in  operating
expenses for 1997 over 1996 was in line with sales  growth.  Operating  expenses
were 53.8% of sales in 1997,  as compared  to 54.0% of sales in 1996.  Marketing
expenses increased by $1,096,572 or 39.4% to $3,881,984 from $2,785,412 in 1996.
Marketing expenses increased primarily due
                                       14
<PAGE>
to increased activities necessary to support the growth in sales, and were 25.5%
of  sales  in  1997  as  compared  to  26.1%  of  sales  in  1996.  General  and
administrative  expenses  increased by $1,036,512  or 61.6% to  $2,720,249  from
$1,683,737 in 1996. General and  administrative  expenses were 17.9% of sales in
1997 as compared to 15.8% of sales in 1996. General and administrative  expenses
increased  in 1997 due to the costs  associated  with  efforts  taken to improve
profitability  including severance packages to terminated  employees,  the write
off of bad debt,  increased reserves for bad debt and other  contingencies,  the
shutting down of the  Company's  office in  Singapore,  and increased  personnel
expenses.  Research and development  expenses  increased by $264,495 or 36.7% in
1997 to $984,628 from $720,133 in 1996. The increase in research and development
expenses  was  primarily  the  result  of a planned  increase  in  research  and
development  personnel  to  support  the  new  product  activities  for  all the
Company's various product lines.  Research and development expenses were 6.5% of
sales  in  1997  as  compared  to  6.8%  of  sales  in  1996.  Amortization  and
depreciation  expenses increased by $31,212 or 5.5% to $602,072 from $570,860 in
1996,  due  to  the  purchase  of  additional   capital   equipment,   including
demonstration  units  of the  Company's  own  instruments  as well  as  computer
equipment.

         Other revenue  (expense) in 1997  decreased by $1,007,722 or 114.2.% to
an expense of $125,600 as compared to income of $882,122 in 1996.  The  decrease
in other revenue was due  primarily to other  revenue of $997,096  recognized in
1996  related  to the  settlement  of  litigation,  which did not recur in 1997.
Interest expense in 1997 decreased by $62,713 or 31.2% to $138,314 from $201,027
in 1996,due to a decrease in average borrowings.

         As a result income from continuing operations before taxes decreased by
$2,342,309  or  170.4%  to a loss  of  $967,721  from  income  before  taxes  of
$1,374,589 for 1996.

         Income  taxes  from  continuing  operations  for 1997 were a benefit of
$366,000 which  approximated  the statutory rate. For 1996, the Company realized
an income tax  benefit  from  continuing  operations  of $441,000 as a result of
reducing the  Company's  deferred tax  valuation  allowance  and  recognizing  a
deferred tax asset.

         As a result,  income from continuing  operations for 1997 was a loss of
$601,721,  a decrease of  $2,417,310  or 133.1% from the income from  continuing
operations of $1,815,589 generated for 1996.

         Loss from discontinued  operations for 1997 was $636,799 as the Company
discontinued its tank testing  business which was performed  through its Horizon
Engineering and Testing, Inc. subsidiary.  The loss from discontinued operations
in 1996 was $71,652.  The increased loss in 1997 of $565,147 as compared to 1996
was due  primarily  to expenses  associated  in shutting  down the tank  testing
business and the write off of intangible  assets associated with the purchase of
Horizon in 1992.

         As a result, net income decreased by $2,982,457 or 171.0% to a net loss
of $1,238,520 in 1997 from net income of $1,743,937 in 1996.


1996 vs. 1995
-------------

         Net sales  increased  by  $70,931 or 0.7% to  $10,663,489  in 1996 from
$10,592,558  in 1995.  Sales  increased for Encompass and Jerome  products which
offset a decrease in sales of Computrac products.  Sales generated from customer
service activities were essentially flat.
                                       15
<PAGE>
         Cost of goods sold  increased by $113,155 or 2.6% to $4,410,881 in 1996
from  $4,297,726 in 1995. Cost of goods sold was 41.4% of sales in 1996 compared
to 40.6% of sales in 1995.  Gross margin  decreased  slightly due to the a lower
mix of sales of Computrac products.

         Operating expenses in 1996 increased by $704,109 or 13.9% to $5,760,142
from  $5,056,033  in 1995.  Operating  expenses  were 54.0% of sales in 1996, as
compared to 47.7% of sales in 1995.  Marketing expenses increased by $143,791 or
5.4% to  $2,785,412  for 1996 as  compared  to  $2,641,621  in  1995.  Marketing
expenses  increased  primarily due to increased  personnel  expenses.  Marketing
expenses  were  26.1% of sales  in 1996 as  compared  to 24.9% of sales in 1995.
General and administrative expenses increased by $373,449 or 28.5% to $1,683,737
from $1,310,288 in 1995. General and administrative expenses were 15.8% of sales
in 1996 as  compared  to 12.4% of sales  in  1995.  General  and  administrative
expenses increased in 1996 due to the increased personnel expenses. Research and
development  expenses  increased  by $114,505 or 18.9% in 1996 to $720,133  from
$605,628  in 1995.  The  increase  in  research  and  development  expenses  was
primarily  the  result  of  a  planned  increase  in  research  and  development
activities to support new product  development  including the development of the
Computrac 3000 moisture analyzer. Research and development expenses were 6.8% of
sales  in  1996  as  compared  to  5.7%  of  sales  in  1995.  Amortization  and
depreciation expenses increased by $72,365 or 14.5% to $570,860 from $498,495 in
1995, due to the purchase of additional capital equipment.

Other  revenue  (expense) in 1996  increased by $1,153,383 to income of $882,122
from an expense of  $271,261  in 1995.  The  increase  in other  revenue was due
primarily  to other  revenue  of  $997,096  recognized  in 1996  related  to the
settlement of litigation,  which did not occur in 1995. Interest expense in 1996
decreased  by  $190,455  or 48.6% to  $201,027  from  $391,482  in 1995,due to a
decrease in average borrowings.

         As a result income from continuing operations before taxes increased by
$407,051 or 42.1% to $1,374,589 compared to $967,538 for 1995.

         Income  taxes  from  continuing  operations  for 1996 were a benefit of
$441,000  which  resulted  from the  reduction  in the  Company's  deferred  tax
valuation  allowance and the  recognition of a deferred tax asset.  Income taxes
for 1995 were $11,000 which  differed from the amount  computed at the statutory
rate due to a change in valuation allowance.

         As a result,  income from continuing operations for 1996 was $1,815,589
an increase of $859,051 or 89.8% from the income from  continuing  operations of
$956,538 generated in 1995.

         Loss from discontinued  operations for 1996 was $71,652, an improvement
of $352,748 from the loss from  discontinued  operations of $424,400 incurred by
the Company in 1995. In 1997, the Company discontinued its tank testing business
which  was  performed  through  its  Horizon   Engineering  and  Testing,   Inc.
subsidiary.

         As a result, net income increased by $1,211,799 or 227.7% to $1,743,937
in 1995 from net income of $532,138 in 1995.



Liquidity and Capital Resources
-------------------------------
                                       16
<PAGE>
         Working  capital  decreased  35.2% to  $2,556,983  at December 31, 1997
compared to $3,947,282 at December 31 1996.  The current ratio  decreased to 1.6
at December  31, 1997 from 2.8 at December  31,  1996.  The  decrease in working
capital and the current ratio was primarily due to the Company's net loss.

         At December 31, 1997,  accounts  receivable were $3,990,192 an increase
of  $1,072,716  from the accounts  receivable  of  $2,917,476 as of December 31,
1996.  Receivables  increased to support the increased level of sales. The ratio
of net sales to ending  accounts  receivable for 1997 was 3.8 as compared to 3.7
for 1996.  This ratio  increased due to a greater  amount of sales being shipped
during the last part of 1997 as compared to 1996. Inventory at December 31, 1997
was  $2,556,992  an increase of $507,010  from the inventory of $2,049,982 as of
December 31, 1996.  Inventory  increased due to  substantially  higher levels of
component  inventory,  primarily for the Encompass product line, which more than
offset a reduction in finished goods inventory.

         Cash and cash  equivalents  at  December  31,  1997  were  $143,173,  a
decrease of $454,758  from cash of $597,931 at December 31,  1996.  Cash used by
operating  activities  was  $283,093  for  1997.  Cash  was  used  by  operating
activities  primarily  to  fund  the net  loss of  $1,238,520,  an  increase  in
inventory ,  receivables,  and the  increase in deferred  tax asset,  which were
partially offset by depreciation  and amortization of $1,167,514,  a decrease in
other assets, and increases in accounts payable and accrued expenses.  Cash used
by  investing  activities  was  $565,405  in  1997,  which  was  due to  capital
expenditures. Cash provided by financing activities was $393,739, as the Company
borrowed  $1,066,000  under its line of credit and repaid  $794,031 in long term
debt and capital leases.

         As of December 31, 1997, the Company was operating  under a forbearance
agreement  with Silicon  Valley Bank (the "Bank"),  as a result of the breach of
certain  financial  covenants  by the  Company  during  1997.  This  forbearance
agreement  expired in February 1998. At December 31, 1997, the Company had lines
of credit with the Bank  aggregating  $3,500,000  which were  collateralized  by
accounts receivable, inventory and property, plant and equipment. These lines of
credit  expired on March 15,  1998.  At  December  31,  1997,  the  Company  had
$1,066,000  outstanding  under  these  lines of  credit.  Of  these  borrowings,
$996,000 was at the Bank's prime rate of interest plus 1.5% (10% at December 31,
1997),  and $70,000 was at the  international  borrowing  rate.  As part of this
credit  facility  the  Company  was able to borrow at prime  plus 1.0%  (9.5% at
December 31, 1997) to support  international  receivables  90% guaranteed by the
Export-Import  Bank of the United States.  The Company is currently  negotiating
with the Bank to renew the lines of credit and revise  the  financial  covenants
previously breached by the Company.  Although there can be no assurance that the
Bank will  renew the lines of credit  or revise  the  financial  covenants,  the
Company  believes that the Bank will continue to make credit available to it. It
is likely that any continuing  borrowing  arrangement with the Bank will contain
certain covenants,  including minimum net income ratios and financial covenants.
There  can be no  assurance  that  the  Company  will be able to meet  any  such
covenants under any future borrowing  arrangement with the Bank.  Failure by the
Company  to renew the lines of credit or the  default of the  Company  under the
terms  of  the  renewed   borrowing   arrangement  will  likely  result  in  the
acceleration of all amounts payable under the borrowing arrangement. The failure
to maintain  adequate credit  facilities would have a material adverse effect on
the Company.

         On November 17, 1995,  the Company  entered into a Loan  Agreement with
the Bank.  Pursuant to the Loan Agreement,  at December 31, 1997 the Bank held a
note in the principal amount of $231,757 at an interest rate of prime plus 2%
                                       17
<PAGE>
(10.5% at December  31,  1997) and a warrant to purchase up to 62,500  shares of
the Company's  Common Stock at an exercise price of $2,08 per share. The Company
is  required  to pay 28 monthly  principal  payments  of  $13,633  and one final
payment of $13,629 in addition to monthly interest payments from January 7, 1997
through May 7, 1999.  The note is  cross-collateralized  with the Company's bank
lines of credit with accounts  receivable,  inventory,  and property,  plant and
equipment.  The note contains certain  covenants,  including  minimum net income
levels and certain  financial  ratios.  On a quarterly basis, half of any excess
cash  flow that the  Company  generates  is  required  to be used to prepay  any
remaining principal balance due on this note. Excess cash flow is defined as net
income plus non-cash  expenses less capital  expenditures,  scheduled  principal
payments and increases in net working capital. At December 31, 1997, the Company
was not in compliance with certain covenants of this agreement and was operating
under a forebearance agreement with the Bank. The forebearance agreement expired
in  February  1998.  In  connection  with the  renewal  of the  lines of  credit
discussed  above,  the  Company  is  negotiating  with  the Bank to  revise  the
financial covenants  previously breached by the Company. See the paragraph above
for a discussion of the likelihood and effects of obtaining a renewed  borrowing
arrangement.

         On April  14,  1995,  the  Company  entered  into a  Subordinated  Loan
Agreement with Classic Syndicate, Inc. ("Classic"). Pursuant to the Subordinated
Loan Agreement, Classic held a 10% Note in the principal amount of $375,000 with
a maturity date of April 30, 1997. This Loan was repaid in 1997.

The   inability   of   computers,   software  and  other   equipment   utilizing
microprocessors  to recognize  and properly  process data fields  containing a 2
digit year is commonly  referred to as the Year 2000  problem.  As the year 2000
approaches,  such systems may be unable to accurately process certain date-based
information.

The Company has identified some applications  that will require  modification to
address the Year 2000 problem.  Internal and external  resources will be used to
make the required modifications and test these modifications.  The Company plans
on completing the modifications and testing of these modifications by mid 1999.

The total cost to the Company of these Year 2000 problem  related  activities is
not  anticipated  to be material.  These costs and the date on which the Company
plans to complete the  modifications  and testing to solve the Year 2000 problem
are based upon management's  estimates.  However, there can be no assurance that
these  estimates will be achieved and the costs of solving the Year 2000 problem
could differ significantly from management's estimates.
                                       18
<PAGE>
ITEM 7.  FINANCIAL STATEMENTS


                                      INDEX

                                      Page
Independent Auditors' Report ............................................ 20

Consolidated Balance Sheets ............................................. 21

Consolidated Statements of Operations ................................... 22

Consolidated Statements of Shareholders' Equity ......................... 23

Consolidated Statements of Cash Flows ................................... 24

Notes to Consolidated Financial Statements .............................. 26
                                       19
<PAGE>
                          INDEPENDENT AUDITORS' REPORT



To the Board of Directors of
Arizona Instrument Corporation:

We  have  audited  the  accompanying  consolidated  balance  sheets  of  Arizona
Instrument  Corporation  and  subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended  December 31, 1997.  These
financial  statements are the  responsibility of the Company's  management.  Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  such consolidated  financial  statements present fairly, in all
material respects,  the financial position of Arizona Instrument Corporation and
subsidiaries  as of  December  31,  1997  and  1996  and the  results  of  their
operations  and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.


/s/  Deloitte & Touche LLP

Phoenix, Arizona
March 15, 1998
                                       20
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
--------------------------------------------------------------------------------
                           CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                                      December 31,
                                                              ----------------------------
                                                                   1997          1996
                                                              ----------------------------
                          ASSETS
             -------------------------------------
<S>                                                           <C>             <C>
CURRENT ASSETS:
  Cash and cash equivalents                                   $    143,173    $    597,931
  Receivables, less allowance for doubtful
    accounts of $279,000 and $165,000                            3,990,192       2,917,476
  Inventories:
    Components                                                   1,974,553       1,369,007
    Finished Goods                                                 582,439         680,975
                                                              ----------------------------
  Total Inventories                                              2,556,992       2,049,982

  Current portion of notes receivable related party                                 45,501
  Prepaid expenses and other current assets                         49,942         550,840
                                                              ----------------------------
    Total current assets                                         6,740,299       6,161,730

PROPERTY, PLANT AND EQUIPMENT, net                                 975,180         846,458
GOODWILL, net of accumulated amortization                        1,680,261       2,209,650
  of $2,650,655 and $2,121,266
COVENANT NOT TO COMPETE, net of accumulated                           --           102,084
  amortization of $350,000 and $247,917
DEFERRED INCOME TAXES                                            1,431,237         641,437
OTHER ASSETS                                                       764,739       1,062,805
                                                              ----------------------------
TOTAL ASSETS                                                  $ 11,591,716    $ 11,024,164
                                                              ============================

             LIABILITIES AND SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------

CURRENT LIABILITIES
  Lines of credit                                             $  1,066,000    $       --
  Accounts payable                                               1,342,539         771,679
  Current portion of long-term debt and
    capital lease obligations                                      284,801         794,268
  Other accrued expenses                                         1,489,976         648,501
                                                              ----------------------------
    Total current liabilities                                    4,183,316       2,214,448

LONG-TERM DEBT AND CAPITAL LEASE
  OBLIGATIONS - less current portions                               93,444         378,010

SHAREHOLDERS' EQUITY
Common stock, .01 par value per share:
    Authorized, 10,000,000 shares;
    Issued, 6,774,696 and 6,677,680 shares                          67,747          66,777
  Preferred stock, $.01 par value per share:
    Authorized, 1,000,000 shares
  Additional paid-in capital                                     9,826,963       9,706,163
  Deficit                                                       (2,357,303)     (1,118,783)
                                                              ----------------------------
                                                                 7,537,407       8,654,157
  Less treasury stock, 86,165 shares at cost                      (222,451)       (222,451)
                                                              ----------------------------
    Total shareholders' equity                                   7,314,956       8,431,706
                                                              ============================
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                    $ 11,591,716    $ 11,024,164
                                                              ============================
</TABLE>
             SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                       21
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
                 -----------------------------------------------
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      -------------------------------------
<TABLE>
<CAPTION>
                                                                           Year Ended December 31,
                                                                 --------------------------------------------
                                                                     1997            1996            1995
                                                                 ------------    ------------    ------------
<S>                                                              <C>             <C>             <C>
NET SALES                                                        $ 15,232,319    $ 10,663,489    $ 10,592,558
COST OF GOODS SOLD                                                  7,885,507       4,410,881       4,297,726
                                                                 ------------    ------------    ------------

              Gross margin                                          7,346,812       6,252,608       6,294,832
                                                                 ------------    ------------    ------------

EXPENSES
     Marketing                                                      3,881,984       2,785,412       2,641,621
     General & administrative                                       2,720,249       1,683,737       1,310,288
     Research & development                                           984,628         720,133         605,628
     Amortization & depreciation                                      602,072         570,860         498,495
                                                                 ------------    ------------    ------------
TOTAL EXPENSES                                                      8,188,933       5,760,142       5,056,033
                                                                 ------------    ------------    ------------
OPERATING INCOME (LOSS)                                              (842,121)        492,466       1,238,799
                                                                 ------------    ------------    ------------

OTHER REVENUE (EXPENSE)
     Interest income                                                   14,751          22,124          22,038
     Interest expense                                                (138,314)       (201,027)       (391,482)
     Settlement of litigation (Note J)                                   --           997,096
     Other                                                             (2,037)         63,929          98,183
                                                                 ------------    ------------    ------------

TOTAL OTHER INCOME (EXPENSE)                                         (125,600)        882,122        (271,261)
                                                                 ------------    ------------    ------------

INCOME (LOSS) FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES                                             (967,721)      1,374,589         967,538
                                                                 ------------    ------------    ------------

INCOME TAXES (BENEFIT)                                               (366,000)       (441,000)         11,000
                                                                 ------------    ------------    ------------

NET INCOME (LOSS) FROM CONTINUING OPERATIONS                         (601,721)      1,815,589         956,538
                                                                 ------------    ------------    ------------

LOSS FROM DISCONTINUED OPERATIONS, NET OF INCOME
      TAX BENEFIT OF $388,000, $47,000, AND $0                       (636,799)        (71,652)       (424,400)

                                                                 ------------    ------------    ------------
NET INCOME                                                       $ (1,238,520)   $  1,743,937    $    532,138
                                                                 ============    ============    ============

NET INCOME (LOSS) PER SHARE - BASIC:
     FROM CONTINUING OPERATIONS                                  $      (0.09)   $       0.28    $       0.15
                                                                 ============    ============    ============

     FROM DISCONTINUED OPERATIONS                                $      (0.10)   $      (0.01)   $      (0.07)
                                                                 ============    ============    ============

     NET INCOME (LOSS)                                           $      (0.19)   $       0.27    $       0.08
                                                                 ============    ============    ============

NET INCOME (LOSS) PER SHARE - DILUTED:
     FROM CONTINUING OPERATIONS                                  $       0.09    $       0.26    $       0.14
                                                                 ============    ============    ============

     FROM DISCONTINUED OPERATIONS                                $       0.10    $      (0.01)   $      (0.06)
                                                                 ============    ============    ============

     NET INCOME (LOSS)                                           $       0.19    $       0.25    $       0.08
                                                                 ============    ============    ============
BASIC SHARES OUTSTANDING                                            6,647,689       6,507,112       6,186,966
EQUIVALENT SHARES - STOCK OPTIONS                                        --           444,699         397,894
                                                                 ------------    ------------    ------------
DILUTED SHARES OUTSTANDING                                          6,647,689       6,951,811       6,584,860
                                                                 ============    ============    ============
</TABLE>
                 SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                       22
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
--------------------------------------------------------------------------------
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                                    Additional        (Deficit)
                                             Common Stock             paid-in          retained        Treasury
                                        Shares         Amount         capital          earnings         stock        TOTAL
                                     -------------  -----------   --------------  -----------------  ------------ -------------
<S>                                  <C>            <C>           <C>             <C>                <C>          <C>
BALANCE JANUARY 1,1995                  6,195,484   $   61,955    $   9,294,400   $     (3,395,306)  $  (222,451) $  5,738,598

Issuance of stock pursuant to:
  Stock purchase plan                      46,476          465           37,806                                         38,271
  Exercise of warrants                    105,603        1,056           21,444                                         22,500
  Exercise of stock options                 5,000           50            7,300                                          7,350
Net Income                                                                                 532,585                     532,585
                                     -------------  -----------   --------------  -----------------  ------------ -------------
BALANCE DECEMBER 31, 1995               6,352,563       63,526        9,360,950         (2,862,721)     (222,451)    6,339,304

Issuance of stock pursuant to:
  Stock purchase plan                      40,637          406           57,207                                         57,613
  Exercise of warrants                     22,714          227           27,773                                         28,000
  Earnout agreement                       208,424        2,084          200,501                                        202,585
  Exercise of stock options                53,342          534           59,732                                         60,266
Net Income                                                                               1,743,938                   1,743,938
                                     -------------  -----------   --------------  -----------------  ------------ -------------
BALANCE DECEMBER 31, 1996               6,677,680       66,777        9,706,163         (1,118,783)     (222,451)    8,431,706

Issuance of stock pursuant to:
  Stock purchase plan                      43,756          437           72,367                                         72,804
  Exercise of stock options                53,260          533           48,433                                         48,966
Net Income                                                                              (1,238,520)                 (1,238,520)
                                     -------------  -----------   --------------  -----------------  ------------ -------------
BALANCE DECEMBER 31, 1997               6,774,696   $   67,747    $   9,826,963   $     (2,357,303)  $  (222,451) $  7,314,956
                                     =============  ===========   ==============  =================  ============ =============
</TABLE>
                 SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                       23
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                 Year ended December 31,
                                                      ---------------------------------------------
                                                         1997             1996            1995
                                                      ------------     ------------    ------------
<S>                                                   <C>              <C>             <C>
OPERATING ACTIVITIES:
  Net income (loss)                                   $(1,238,520)     $ 1,743,937     $   532,138

  Adjustments to reconcile net income to net cash
    provided  (used) by operating activities:
    Depreciation and amortization                       1,167,514          804,495         779,577
    Gain on sale or abandonment of property,
      plant and equipment                                       0          (34,570)        (62,294)
    Provision for losses on receivables                   113,855          (25,289)          4,257
    Provision for inventory obsolesence                    35,035

  Change in operating assets and liabilities:
   (Increase) decrease in receivables                  (1,186,571)         479,650         486,164
    (Increase) decrease in inventories                   (542,046)        (256,212)        296,388
    Decrease in other current assets                      546,400           46,257          11,639
    Increase in settlement receivable                           0         (364,419)
    Increase in deferred tax asset                       (789,800)        (518,000)
    (Increase) decrease in other assets                   198,707         (330,412)         21,011
    (Decrease) increase in accounts payable               570,860          (91,707)         47,025
    (Decrease) increase in accrued expenses               841,474         (222,635)        125,836
                                                      ------------     ------------    ------------

NET CASH PROVIDED (USED) BY
  OPERATING ACTIVITIES                                   (283,092)       1,231,095       2,241,741
                                                      ------------     ------------    ------------

INVESTING ACTIVITIES:
  Purchases of property, plant
    and equipment and other assets                       (565,405)        (207,354)       (106,523)
  Proceeds from sale of property, plant
    and equipment and other assets                              0           77,897          80,553
                                                      ------------     ------------    ------------

NET CASH USED BY
  INVESTING ACTIVITIES                                   (565,405)        (129,457)        (25,970)
                                                      ------------     ------------    ------------
</TABLE>
                                                                     (continued)
                                       24
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (continued)
<TABLE>
<CAPTION>
                                                                Year ended December 31,
                                                      ---------------------------------------------
                                                         1997             1996            1995
                                                      ------------     ------------    ------------
<S>                                                   <C>              <C>             <C>
FINANCING ACTIVITIES:
  Borrowings of long-term debt                        $       -        $       -       $ 1,625,000
  Payments of long-term debt and capital leases          (794,031)      (1,104,058)     (2,441,192)
  Net (payments) borrowings under bank
    lines of credit                                     1,066,000         (250,000)     (1,375,000)
  Proceeds received on notes receivable                         0           15,506           5,703
  Stock issued for warrants and options                         0           88,265          29,850
  Sale of common stock, net proceeds                       48,966
  Issuance of common stock for earnout agreement                0          202,585
  Issuance of common stock pursuant
    to stock purchase plan                                 72,804           57,613          38,271
                                                      ------------     ------------    ------------

NET CASH (USED) PROVIDED BY
  FINANCING ACTIVITIES                                    393,739         (990,089)     (2,117,368)
                                                      ------------     ------------    ------------

NET INCREASE (DECREASE) IN CASH
  AND CASH EQUIVALENTS                                   (454,758)         111,549          98,403

CASH AND CASH EQUIVALENTS,
  beginning of year                                       597,931          486,382         387,979
                                                      ------------     ------------    ------------

CASH AND CASH EQUIVALENTS
  end of year                                             143,173          597,931         486,382
                                                      ============     ============    ============


SUPPLEMENTAL CASH FLOW INFORMATION:
  Transfer of inventories to property, plant and
    equipment to be used as demonstration units           315,354           57,057         100,589
  Property, plant and equipment acquired through
    capital lease obligations                                                               51,524
  Interest paid                                           153,736          126,172         502,759
  Income taxes paid                                        90,000            5,025           4,669
</TABLE>
                                       25
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
                 -----------------------------------------------

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                   ------------------------------------------

                       THREE YEARS ENDED DECEMBER 31, 1997
                       -----------------------------------


A.        SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Consolidated  financial  statements  include  the  accounts  of Arizona
         Instrument Corporation and its wholly-owned subsidiaries (collectively,
         the "Company").  All material  intercompany  profits,  transactions and
         balances have been eliminated upon consolidation.

         Description  of  business.   Arizona  Instrument  Corporation  designs,
         manufactures and markets the Computrac line of automated microprocessor
         controlled analytical  instruments used to measure the moisture content
         of  various   materials,   the   ENCOMPASS  and  Soil  Sentry  line  of
         computer-based   fuel   management   and   compliance   leak  detection
         instruments  for  monitoring  underground  storage tanks (USTs) and the
         Jerome line of toxic gas detection instruments primarily used to detect
         mercury and hydrogen  sulfide.  The Company also  provided tank testing
         and related  services for the  underground  storage tank market through
         its  subsidiary,  Horizon  Engineering  and Testing,  Inc. In 1997, the
         Company discontinued the operations of Horizon Engineering and Testing,
         Inc.  See Note K. The  Company  sells in the United  States and also in
         international markets.

         Sales of instruments are recognized once the shipment is made.

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

         Property,  plant and  equipment are recorded at cost.  Depreciation  is
         provided by the straight-line method over the estimated useful lives of
         the various  classes of assets.  Equipment and  furniture/fixtures  are
         estimated  to  have  5  and  7  year  lives,  respectively.   Leasehold
         improvements  are amortized  over the shorter of the  estimated  useful
         life or the period of the lease.  Equipment  under  capital  leases are
         generally amortized over the estimated lives of the related equipment.

         Goodwill is the cost of investments in purchased companies in excess of
         the fair value of net assets of the  businesses  acquired.  Goodwill is
         amortized  on a  straight-line  basis  over 20  years  for  the  Jerome
         goodwill and over 10 years for the Horizon  goodwill  (See Note K). The
         Financial  Accounting  Standards  Board  issued  Statement of Financial
         Accounting   Standards  (SFAS)  No.  121  during  1995.  SFAS  No.  121
         establishes  the  accounting  standard for the impairment of long-lived
         assets, certain identifiable intangibles, and goodwill related to those
         assets  to  be  held  and  used  for  long-lived   assets  and  certain
         identifiable  intangibles  to be disposed of. The Company  adopted SFAS
         No. 121 effective January 1, 1996.

         Covenant not to compete resulted as part of the Horizon  acquisition in
         1992 and had been amortized on a straight line basis. See Note K.

         Debt issue costs are amortized  using the interest method over the term
         of the related debt.
                                       26
<PAGE>
         Stock-based  compensation.  In October 1995,  the Financial  Accounting
         Standards  Board  issued  SFAS No.  123  "Accounting  for  Stock  Based
         Compensation".  The Company has  determined  that it will not change to
         the fair value method and will  continue to use  Accounting  Principles
         Board Opinion No. 25 for  measurement and recognition of employee stock
         based  compensation.  SFAS No.  123  additional  disclosures  have been
         included in the financial statements.

         Income (Loss) per share is computed on the weighted  average  number of
         common or common and common equivalent shares  outstanding  during each
         year.  Basic  EPS is  computed  as net  income  (loss)  divided  by the
         weighted  average number of common shares  outstanding  for the period.
         Diluted  EPS  reflects  the  potential  dilution  that could occur from
         common shares  issuable  through  stock  options,  warrants,  and other
         convertible  securities and includes  shares  issuable upon exercise of
         stock options when dilutive.

         Statements of cash flows - For purposes of the consolidated  statements
         of cash flows,  cash and cash  equivalents  represent  cash in bank and
         money market funds.

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

         New  accounting  pronouncements  -  In  February  1997,  the  Financial
         Accounting  Standards  Board  ("FASB")  issued  Statement  of Financial
         Accounting Standards ("SFAS") No. 128, "Earnings per Share",  effective
         for both interim and annual  periods  ending  after  December 15, 1997.
         This statement  specifies the computation,  presentation and disclosure
         of earnings per share for entities  with  publicly held common stock or
         potential  common  stock.  Prior year  disclosure of earnings per share
         have been restated to comply with SFAS No. 128.

         The Financial  Accounting  Standards Board recently issued SFAS No. 130
         on "Reporting  Comprehensive  Income" and SFAS No. 131 on  "Disclosures
         about  Segments  of  an  Enterprise  and  Related   Information."   The
         "Reporting Comprehensive Income" standard is effective for fiscal years
         beginning  after December 15, 1997. The standard  changes the reporting
         of certain items currently reported in the stockholders' equity section
         of the balance sheet.  The Company is currently  evaluating what impact
         this  standard  will have on the Company's  financial  statements.  The
         "Disclosures  about Segments on an Enterprise and Related  Information"
         standard is effective  for fiscal years  beginning  after  December 15,
         1997.  This standard  requires  that public  companies  report  certain
         information about operating segments in their financial statements.  It
         also  establishes  related  disclosures  about  products and  services,
         geographic  areas,  and  major  customers.  The  Company  is  currently
         evaluating  what  impact  this  standard  will  have  on its  financial
         statements and related disclosures.

B.       PROPERTY, PLANT AND EQUIPMENT

         Property, plant and equipment at December 31 consists of the following;
                                       27
<PAGE>
                                              1997                 1996
                                        -----------------     ---------------

Leasehold Improvements                  $        169,654      $      157,604
Furniture, fixtures and equipment              4,452,959           3,936,984
Automobiles                                       99,358              99,359
                                        -----------------     ---------------
                                               4,721,971           4,193,947

Less accumulated depreciation                 (3,746,791)         (3,347,489)
                                        -----------------     ---------------
  and amortization
                                        $        975,180      $      846,458
                                        =================     ===============


C.       BANK LINES OF CREDIT

         At December  31,  1997,  the Company had two lines of credit  available
         (one for  domestic  operations  and one for  international  operations)
         collateralized by accounts receivable,  inventory,  and property, plant
         and equipment  which  provided for an aggregate  maximum  commitment of
         $3,500,000  through March 15, 1998.  At December 31, 1997,  the Company
         had  $996,000  outstanding  under  its  domestic  line of credit at the
         bank's prime rate of interest plus 1.5% (10% at December 31, 1997). The
         Company also had $70,000  outstanding under the  international  line of
         credit at December 31, 1997.  Borrowings under this line of credit were
         at the bank's  prime rate of interest  plus 1.0% (9.5% at December  31,
         1997).  The  lines of credit  contained  certain  covenants,  including
         minimum net income levels and certain  financial  ratios.  The lines of
         credit  expired on March 15,  1998 and have not yet been  renewed.  The
         Company was not in compliance  with certain bank  covenants at December
         31, 1997, and was operating under a forbearance agreement which expired
         in February 1998.


D.       LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

         Long-term debt and capital lease  obligations at December 31 consist of
         the following:


                                                   1997              1996
                                              ---------------     ------------
Capital lease obligation                      $      146,487      $   398,557

Notes payable                                              0          375,000

Notes payable to the bank                            231,758          398,721
                                              ---------------     ------------

Total Debt and Capital Leases                        378,245        1,172,278

  Less current position                              284,801          794,268
                                              ---------------     ------------

Long-Term Portion of Debt and Capital Leases  $       93,444      $   378,010
                                              ===============     ============
                                       28
<PAGE>
         On April 14, 1995,  the Company  entered into an agreement with Classic
         Syndicate,   Inc.  ("Classic").   Pursuant  to  the  Subordinated  Loan
         Agreement,  Classic held a 10% Note in the principal amount of $375,000
         The loan matured during 1997 and was repaid in full.

         On November 17, 1995, the Company entered into an agreement with a bank
         ("Bank").  Pursuant to the Loan Agreement, the Bank holds a Note in the
         principal  amount of  $231,758  at an  interest  rate of prime  plus 2%
         (10.5% at  December  31,  1997) and a warrant to  purchase up to 62,500
         unregistered  shares of the Company's Common Stock at an exercise price
         of $2.08 per share. The Company is required to pay 28 monthly principal
         payments  of $13,633  and one final  payment of $13,629 in  addition to
         monthly interest payments from January 7, 1997 through May 7, 1999. The
         Note is  cross-collateralized  with the Company's  bank lines of credit
         with accounts receivable, inventory, and property, plant and equipment.
         The Note  contains  certain  covenants,  including  minimum  net income
         levels and certain  financial ratios. On a quarterly basis, half of any
         excess cash flow that the Company generates,  is required to be used to
         prepay any remaining  principal  balance due on this Note.  Excess cash
         flow is defined as net  income  plus  non-cash  expenses  less  capital
         expenditures, scheduled principal payments and increases in net working
         capital.  At December 31, 1997, the Company was not in compliance  with
         certain   covenants  of  this  agreement  and  was  operating  under  a
         forbearance agreement with the Bank. The forebearance agreement expired
         in February 1998.

         Long-term  debt and capital lease  obligations at December 31, 1997 are
         payable as follows:


          1998               $        284,801
          1999                         81,618
          2000                         11,826
                             -----------------
                             $        378,245
                             =================



E.       ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

         Statement   of   Financial   Accounting   Standard   ("SFAS")  No.  107
         "Disclosures About Fair Value of Financial Instruments" was adopted for
         the year ending December 31, 1995. SFAS No. 107 requires  disclosure of
         the estimated fair value of certain financial instruments.  The Company
         has  estimated  the  fair  value  of its  financial  instruments  using
         available market data. However,  considerable  judgement is required in
         interpreting market data to develop estimates of fair value. The use of
         different  market  assumptions  or  methodologies  may have a  material
         effect on the  estimates of fair values.  The carrying  values of cash,
         receivables,  lines of credit, accounts payable,  accrued expenses, and
         long term debt and capital lease  obligations  approximate  fair values
         due to the short-term maturities or market rates of interest.

F.       SHAREHOLDERS' EQUITY

         In March 1985,  the Company  adopted a Stock Option Plan ("SOP")  under
         which the Company  could,  for a period of ten years,  grant options to
         purchase  up to  250,000  shares of the  Company's  Common  Stock.  SOP
         options  may be granted to  employees,  officers  or  directors  of the
         Company or any
                                       29
<PAGE>
         subsidiary.  The  exercise  price of options  must be at least the fair
         market value of the Company's Common Stock on the date of grant and the
         options must be exercised within 11 years from the date of grant.

         In April 1991,  the Company  adopted the 1991 Stock  Option Plan ("OP")
         under which the Company may, for a period of ten years, grant incentive
         stock options and nonstatutory  stock options to purchase up to 450,000
         shares  of the  Company's  Common  Stock.  In May,  1996  the  Board of
         Directors  amended  this  Plan to  increase  the  shares  reserved  for
         issuance  by 300,000  shares.  Additionally,  each year,  the number of
         shares of stock that may be issued is increased  automatically by 1% on
         January 1 if certain  conditions  are met. Stock options may be granted
         to employees, directors and other persons whose participation is deemed
         to be in the Company's best interest, but only employees may be granted
         incentive stock options. Incentive stock options granted under the plan
         have a maximum  term of ten years and  nonstatutory  options may have a
         maximum term of twenty years. The exercise price for an incentive stock
         option must be at least the fair market value of the  Company's  common
         stock on the date of  grant.  The  exercise  price  for a  nonstatutory
         option may be any amount  above the par value of the  Company's  Common
         Stock determined in good faith.

         The following is a summary of stock option activity:

                                                            Weighted
                                                             Average
                                                            Exercise
                                             Number            Price
                                          Of Shares        Per Share

Outstanding January 1, 1995                 377,884     $       2.39
             Granted                        678,903             0.92
             Canceled                     (332,884)             2.39
             Exercised                      (5,000)             1.47
                                        -----------
Outstanding December 31, 1995               718,903             1.00
             Granted                        145,000             2.57
             Canceled                      (17,850)             0.92
             Exercised                     (53,342)             0.96
                                        -----------
Outstanding December 31, 1996               792,711             1.29
             Granted                         97,500             1.91
             Canceled                     (182,240)             0.96
             Exercised                     (53,260)             0.99
                                        -----------
Outstanding December 31, 1997               654,711     $       1.50
                                        ============    =============
                                       30
<PAGE>
         At December 31, 1997, 225,083 options were exercisable. At December 31,
         1996, 141,544 options were exercisable.

         In January 1985,  the Company  adopted an Employee  Stock Purchase Plan
         which  provides for the sale of up to 200,000 shares of common stock to
         qualifying  employees  of the  Company.  In  May,  1996  the  Board  of
         Directors  amended  this  Plan to  increase  the  shares  reserved  for
         issuance by 200,000 shares.

         The purchase price of the stock is 85% of the lesser of the fair market
         value at the beginning or the end of the offering  period,  January and
         July of each year.  During the years ended December 31, 1997,  1996 and
         1995 a total of 43,756,  40,637 and 46,476  shares of common stock have
         been  purchased at average  prices of $1.66,  $1.42 and $.82 per share,
         respectively.  As of December  31, 1997 a total of 137,507  shares were
         available under this plan.

         The estimated  fair value of options  granted during 1997 was $0.57 per
         share,  while the estimated  fair value of options  granted during 1996
         was $1.15 per share.  The Company applies  Accounting  Principles Board
         Opinion No. 25 and related  interpretations in accounting for its stock
         option and purchase plans.  Accordingly,  no compensation cost has been
         recognized for its fixed stock option plans. Had compensation  cost for
         the  Company's  stock  option plans been  determined  based on the fair
         value at the grant dates for awards under those plans  consistent  with
         the method of FASB Statement 123, the Company's net income and earnings
         per share for the years ended  December  31 would have been  reduced to
         the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                                                    1997              1996             1995
<S>                                                                         <C>                 <C>                <C>
         Net income (loss) to common shareholders
                  As reported                                               ($1,238,520)        $1,743,937         $532,138
                  Pro forma                                                 ($1,266,730)        $1,671,943         $485,340

         Net income (loss) per common and dilutive share
                  As reported                                                    ($0.19)             $0.25            $0.08
                  Pro forma                                                      ($0.19)             $0.24            $0.07
</TABLE>

         The fair  values of options  granted  under the  Company's  fixed stock
         option   plans  were   estimated   on  the  date  of  grant  using  the
         Black-Scholes  option-pricing model with the following weighted average
         assumptions used: No dividend yield,  expected  volatility of 35%, risk
         free  interest  rate of 6.4% and  expected  lives of 3 years  from vest
         date.

         Stock Private Placement
         -----------------------

         At  November  30, 1993 the Company  completed  a private  placement  of
         2,090,000  shares of common stock raising gross  proceeds of $2,612,550
         and net proceeds  after fees and expenses of  $2,195,523.  The proceeds
         were  used  to  reduce  debt,  to  obtain  certain   European   product
         certifications,  and for new  product  development.  The  Company  also
         utilized  $159,999 of the net proceeds to redeem  73,845  shares of its
         common  stock held  primarily  by Mr.  Quinn  Johnson,  a director  and
         executive  officer of the Company.  On November  30, 1993,  the Company
         issued a warrant to purchase up to 209,000  shares at an exercise price
         of $1.25  per  share to the  placement  agent  in  connection  with the
         private placement of the Company's stock.
                                       31
<PAGE>
         A shelf  registration  statement  covering  3,781,000  shares of common
         stock issued in the private placement described above in a 1992 private
         placement and in connection  with the Horizon  acquisition was declared
         effective by the  Securities  and Exchange  Commission  on February 11,
         1994.

G.       INCOME TAXES

         The (benefit)  provision for income taxes for the years ended  December
         31, consists of the following:

                                   1997             1996             1995
                               --------------    ------------     ------------

                 Current       $      35,800     $     30,000     $     11,000
                 Deferred           (789,800)        (518,000)

                               $    (754,000)    $   (488,000)    $     11,000
                               ==============    ============     ============


         The   provision   for  income  taxes  as  shown  in  the   accompanying
         consolidated statements of operations differs from the amounts computed
         by applying  the federal  statutory  income tax rates to income  before
         income taxes. A  reconciliation  of the (benefit)  provision for income
         taxes and the  amounts  that  would be  computed  using  the  statutory
         federal  income tax rates for the years ended  December 31 is set forth
         below:

                                          1997          1996          1995
                                      -------------  ------------  ------------
    Provision (benefit) computed at
        Federal statutory rates       $   (678,000)  $   427,000   $    185,000
    State taxes                           (120,000)      (15,500)         9,000
    Goodwill                                63,000        63,500         63,000
    Other                                  (19,000)      (19,000)        66,000
    Change in valuation allowance                -      (944,000)      (312,000)
                                      -------------  ------------  ------------

                                      $   (754,000)  $  (488,000)  $     11,000
                                      =============  ============  ============

         Deferred  income  taxes  reflect the net tax  effects of (a)  temporary
         differences  between the carrying amounts of assets and liabilities for
         financial  reporting  purposes  and the  amounts  used for  income  tax
         purposes,  and (b) operating loss and tax credit  carryforwards The tax
         effects of significant  items comprising the Company's net deferred tax
         asset as of December 31 are as follows:
                                       32
<PAGE>
                                                 1997           1996
                                             -----------    -----------
Deferred tax assets:
    Reserves not currently deductible        $   323,000    $   216,000
    Operating loss carryforwards                 636,000        123,000
    Tax credit carryforwards                     380,000        380,000
    Difference between book and tax basis
    of property                                   94,000          4,000
                                             -----------    -----------
Total deferred tax assets                      1,433,000        723,000

Deferred tax liabilities
   Other intangibles                                   0        (43,000)
    Other                                         (1,763)       (39,500)
                                             -----------    -----------
Total deferred tax liabilities                    (1,763)       (82,500)

Valuation allowance                                 --             --
                                             ===========    ===========
Net deferred tax asset                       $ 1,431,237    $   640,500
                                             ===========    ===========

         The Company has evaluated its past earnings  history and trends,  sales
         backlog and budgets and determined that it is more likely than not that
         its deferred tax assets will be realized.

         At December 31, 1997, the Company had net operating loss  carryforwards
         of approximately $1,600,000 available to reduce federal taxable income.
         These net operating losses begin to expire in 2005.

H.       PROFIT SHARING PLAN

         Full  time  employees  with  greater  than six  months of  service  are
         eligible to participate in the Company's 401K profit sharing retirement
         plan adopted in 1981 whereby,  at the Board of  Directors'  discretion,
         contributions are made on an annual basis. Contributions made in any of
         the three years ended December 31, 1997 have not been material.

I.       SALES

         Export sales,  primarily to Canada, Korea and Sweden were approximately
         $2,118,975,  $2,191,000 and $1,950,000 for the years ended December 31,
         1997, 1996 and 1995, respectively.

         The  Company  has a  concentration  of sales of a product to a customer
         that makes up approximately 29% of net sales during 1997. The potential
         for a negative  financial  impact  could result from a partial or total
         loss  of the  business  relationship  with  this  customer.  Management
         believes that the relationship between the Company and the customer was
         good at December 31, 1997.  Management is actively seeking to diversify
         sales of this product to a number of other customers.

J.       COMMITMENTS AND CONTINGENCIES

         Leases
         ------

         Certain  office  facilities  and  equipment  are held under capital and
         operating  leases.  These  leases  expire in periods  through  2004 and
         include  renewal  options.  Capital  leases  included in  Property  and
                                       33
<PAGE>
         Equipment   total   $1,281,374   and   $1,281,374   (less   accumulated
         amortization  of  $1,160,190  and $945,105) as of December 31, 1997 and
         1996, respectively.

         At December 31, 1997,  future  minimum lease payments under such leases
         having  non-cancelable  terms in excess of one year are  summarized  as
         follows:

                                                                Operating
Minimum Lease Payments                    Capital leases        Leases
                                          -----------------     ---------------

                                   1998            131,000             333,422
                                   1999             13,500             338,991
                                   2000             12,000             328,182
                                   2001                  0             317,604
                                   2002                  0             304,900
                             Thereafter                  0             568,511
                                          -----------------     ---------------
Total minimum lease payments                       156,500           2,191,610
                                                                ===============
Less amount representing interest                  10,012
                                          -----------------
Net present value of future minimum
  Lease payments                                  146,488
                                          =================


         Rent expense for operating leases was approximately $289,598,  $325,000
         and  $360,000 for the years ended  December  31,  1997,  1996 and 1995,
         respectively.

         Genelco Earnout Agreement
         -------------------------

         In connection with the Company's  purchase of Genelco,  Inc. on January
         30,  1988,  the  Company  entered  into a  potential  $700,000  earnout
         agreement based on future sales. The agreement was modified on December
         31, 1992 for a remaining  earnout of  $202,585 to be  compensated  with
         208,421 shares of unregistered  common stock in 1996.  Through December
         31, 1991,  $155,669 has been earned under the prior earnout  agreement.
         Under the  modified  agreement,  the expense was  $33,765,  $33,764 and
         $33,764  for  the  years  ended  December  31,  1997,  1996  and  1995,
         respectively.  In March  1996 the  Company  issued  208,421  shares  of
         unregistered  common  stock under the modified  agreement.  The earnout
         period under the modified agreement was completed on December 31, 1997.

         Litigation
         ----------

         In a prior year,  litigation was commenced in Superior Court,  Maricopa
         County,  Arizona with respect to certain  matters arising in connection
         with a technology  development agreement and related agreements entered
         into by the Company  and a state  organization  in 1988  related to the
         Company's  Jerome  product line and  providing the Company with certain
         rights  thereunder.   The  Company  believed,   not  withstanding  such
         agreements,   the  state  organization  exclusively  licensed  relevant
         technology to another firm in February  1993. The Company filed suit in
         February 1996 against this firm and, the state organization and certain
         other  defendants  requesting a declaratory  judgement,  confirming the
                                       34
<PAGE>
         Company's right to the contested  technology and seeking  damages.  The
         firm also filed suit in January  1996  against the state  organization,
         AZI and certain executive officers of AZI seeking declaratory judgement
         confirming  the  validity  of its  license  agreement  with  the  state
         organization and seeking  damages.  The parties reached a settlement in
         June, 1996 under which the Company would receive $1,000,000 and certain
         free education rights, in addition to exclusive rights to the contested
         technology. The Company has received full payment of this settlement as
         of January 30, 1997.

         From time to time,  the Company may become a defendant as the result of
         a claim filed by a customer alleging breach of contractual promises and
         warranties in a commercial  transaction.  While the outcome of any such
         claim cannot be determined at this time, management of the Company does
         not believe that the ultimate  disposition  of these claims will have a
         material  effect on the financial  position or results of operations or
         cash flows of the Company.

K.       DISCONTINUED OPERATIONS

         In  August  1997,  the  Company  adopted  a  plan  to  discontinue  the
         operations of Horizon Engineering and Testing,  Inc.  ("Horizon").  The
         disposition  of Horizon was  substantially  completed  by December  31,
         1997. Net assets of the discontinued operation at December 31, 1997 and
         1996 were $0 and  $541,146  respectively.  Such assets  were  primarily
         goodwill and other  intangibles.  The Company  estimates that the final
         disposal of Horizon  will not have a material  effect on the  Company's
         operations during 1998. The loss from discontinued  operations for 1997
         (before income tax benefit)  includes a write-off of goodwill and other
         intangibles of $444,705 and a loss from operations of $580,713.

L.       RELATED PARTY TRANSACTIONS

         During  September  1993,  the  Company  loaned  $45,000  to  one of its
         officers.  The loan was  collateralized by a pledge of 15,000 shares of
         common  stock of the  Company  and the cash  value of a life  insurance
         policy.  During 1996, a $10,000 principal payment was made on this loan
         leaving a remaining balance of $35,000.  The note bears interest at 10%
         per annum and the  remaining  balance was due  December,  1997.  During
         April  1994,  the  Company  loaned  approximately  $10,000  to  another
         officer.  The note bears  interest at 10% and was due  December,  1997.
         These loans have been repaid.
                                       35
<PAGE>
ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
         AND FINANCIAL DISCLOSURE

         Not applicable


                                    PART III

ITEMS 9 THROUGH 12.

         Within 120 days after the close of the fiscal year, the Company intends
to file with the Securities and Exchange Commission a definitive proxy statement
pursuant to  Regulation  14A which will involve the election of  directors.  The
answers to Items 9 through 12 are incorporated by reference  pursuant to General
Instruction E(3).


                                     PART IV

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

Financial  Statements.  The  following is a list of the  consolidated  financial
statements of Arizona  Instrument  Corporation and its subsidiaries  included in
Item 8 of Part II.

Independent auditors' report

Consolidated balance sheets - December 31, 1997 and 1996

Consolidated  statements of operations - Years ended December 31, 1997, 1996 and
1995

Consolidated statements of shareholders' equity - Years ended December 31, 1997,
1996 and 1995

Consolidated  statements of cash flows - Years ended December 31, 1997, 1996 and
1995

Notes to consolidated financial statements








(a) The following  exhibits are incorporated by reference or are filed with this
Form 10-KSB, as indicated.

3.1      Composite of Certificate of  Incorporation  of  Registrant,  as amended
         through July 5, 1994.  Incorporated by reference from Registrant's Form
         8-A filed on June 26, 1996 (the "June 1996 8-A").
                                       36
<PAGE>
3.2      Bylaws of Registrant,  as amended.  Incorporated  by reference from the
         June 1996 8-A.

10.1*    Registrant's  1985 Stock Option Plan.  Incorporated  by reference  from
         Registrant's  Form 10-KSB for the year ended December 31, 1995 filed in
         March 1996.

10.2*    Registrant's  1985 Stock Purchase Plan.  Incorporated by reference from
         Registrant's Form S-8 filed on August 5, 1996.

10.3*    Registrant's  1991 Stock Option Plan.  Incorporated  by reference  from
         Registrant's Form S-8 filed on June 28, 1996.

10.4     Amended and Restated  Export-Import  Guaranteed Business Loan Agreement
         between  Registrant  and  Silicon  Valley  Bank  dated  February  1993.
         Incorporated  by reference From  Registrant's  Form 10-KSB for the year
         ended December 31, 1992, filed in March 1993 (the "1992 10-KSB").

10.5     Warrant Purchase  Agreement between  Registrant and Silicon Valley Bank
         dated  December  14,  1991.  Incorporated  by  reference  from the 1992
         10-KSB.

10.6     Loan Modification  Agreement between Registrant and Silicon Valley Bank
         dated November 7, 1995.  Incorporated by reference to Registrant's Form
         10-KSB for the Year ended  December  31,  1995 filed on March 29,  1996
         (the "1995 10-KSB").

10.7     Promissory  Note  between  Registrant  and  Silicon  Valley  Bank dated
         November 7, 1995. Incorporated by reference to the 1995 10-KSB.

10.8     Loan Modification  Agreement between Registrant and Silicon Valley Bank
         dated March 24, 1997. Filed herewith.

10.9     Promissory Note between  Registrant and Classic  Syndicate,  Inc. dated
         April 15, 1996. Incorporated by reference to the 1995 10-KSB.

10.10    Warrant Agreement  between  Registrant and Cruttenden & Co., Inc. dated
         November 30, 1993.  Incorporated  by reference from  Registrant's  Form
         10-QSB for the quarter  ended  September 30, 1993 filed on November 30,
         1993 (the "September 1993 10-QSB").

10.11    Lease Agreement between Registrant and Wood Street Limited  Partnership
         dated  September 1, 1993.  Incorporated by reference from the September
         1993 10-QSB.

10.12*   Employment  Agreement between  Registrant and Walfred R. Raisanen dated
         November 5, 1992. Incorporated by reference to the 1992 10-KSB.

10.13*   Employment  Agreement between Registrant and George G. Hays dated April
         1, 1997.  Incorporated by reference from  Registrant's  Form 10-QSB for
         the quarter
                                       37
<PAGE>
         Ended March 31, 1997 filed on May 15, 1997.

10.14*   Employment  Agreement  between  Registrant  and  George G.  Hays  dated
         January 1, 1998. Filed herewith.


21.1     Subsidiaries of Registrant. Filed herewith.

23.1     Consent of Deloitte & Touche LLP. Filed herewith.

27.       Financial Data Schedule.  Filed herewith.

------------------
*Management  contract of compensatory  plan or arrangement  required to be filed
pursuant to Item 13(a) of Form 10-KSB.

(b)  The following  Form 8-K was filed by Registrant  during the last quarter of
     the period Covered by this Form 10-KSB.

     Form 8-K filed November 26, 1997 reporting under Item 5 that George G. Hays
     had been appointed President and Chief Executive Officer of Registrant, and
     John P. Hudnall had resigned from the Board of Directors and his employment
     as President and Chief Executive Officer of Registrant had been terminated.
                                       38
<PAGE>
                                   SIGNATURES


         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934 the  Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.


                                            ARIZONA INSTRUMENT CORPORATION


Date: March 31, 1998                        By: /s/ George G. Hays
     ------------------                         -----------------------------
                                                George G. Hays,
                                                President

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
             Signature                                   Capacity                             Date
-------------------------------------    -----------------------------------------    ---------------------
<S>                                     <C>                                          <C>
/s/ George G. Hays                       President and Chairman of the Board           March 31, 1998
-------------------------------------    (Principal Executive Officer)                ---------------------
George G. Hays

/s/ Walfred R. Raisanen                  Director, Vice President of                   March 31, 1998
-------------------------------------    Engineering                                  ---------------------
Walfred R. Raisanen

/s/ S. Thomas Emerson                    Director                                      March 31, 1998
-------------------------------------                                                 ---------------------
S. Thomas Emerson

/s/ Steven Zylstra                       Director                                      March 31, 1998
-------------------------------------                                                 ---------------------
Steven Zylstra

/s/ Harold Schwartz                      Director                                      March 31, 1998
-------------------------------------                                                 ---------------------
Harold Schwartz
</TABLE>
                                       39