SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

[x]      Annual Report pursuant to Section 13 or 15 (d) of the
         Securities Exchange Act of 1934 (fee required)

For the fiscal year ended December 31, 1996 or

[ ]      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
--------------------------------------------------------------------------------
State or other jurisdiction of                                (IRS Employer
incorporation or organization)                               Identification No.)

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

Issuer's telephone number, including area code: (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-KSB or any amendment to this Form 10-KSB.

Issuer's revenues for its most recent fiscal year were $12,639,943.

As of February 28, 1997, the aggregate  market value of the voting stock held by
non-affiliates of  the registrant was $19,008,000. 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 each 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.

As of February 28, 1997,  6,611,729 shares of Common Stock ($.01 par value) were
outstanding.
<PAGE>
                         ARIZONA INSTRUMENT CORPORATION

                                TABLE OF CONTENTS




PART I                                                                  Page No.

Item 1                 Description of Business .............................   1
Item 2                 Description of Property .............................  11
Item 3                 Legal Proceedings ...................................  11
Item 4                 Submission of Matters to a Vote of Security Holders .  13
                       Executive Officers of the Registrant ................  13





PART II

Item 5                 Market for Common Equity and Related
                            Stockholder Matters ............................  14
Item 6                 Management's Discussion and Analysis of Financial
                            Condition and Results of Operations.............  16
Item 7                 Financial Statements ................................  21
Item 8                 Changes in and Disagreements with Accountants
                            on Accounting and Financial Disclosure..........  40


PART III

Item 9                 Directors, Executive Officers, Promoters,
                            and Control Persons; Compliance with
                            Section 16(a) of the Exchange Act...............  40
Item 10                Executive Compensation ..............................  40
Item 11                Security Ownership of Certain Beneficial Owners
                            and Management .................................  40
Item 12                Certain Relationships and Related Transactions.......  40


PART IV

Item 13                Exhibits and Reports on Form 8-K.....................  40
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE:

         Part      III:  Portions  of the Proxy  Statement  for the 1997  Annual
                   Shareholders' Meeting (to be filed).
<PAGE>
Unless the context  indicates  otherwise,  the term "Company" or "AZI" refers to
Arizona Instrument Corporation and its wholly-owned subsidiaries.


                                     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.  AZI's wholly-owned subsidiary, Horizon Engineering and
Testing,  Inc.  ("Horizon")  specializes in testing and engineering services for
the underground storage tank ("UST") market.

         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
September  1992, the Company  acquired  Horizon,  a company that  specializes in
testing and engineering services for USTs. Horizon's testing services complement
AZI's  monitoring   systems.   In  June,   1994,  the  Company   introduced  the
ENCOMPASS(TM) product, its next generation of fuel management and leak detection
compliance systems.

          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.  The combination of AZI and Horizon provides customers with periodic
testing until they eventually comply with United States Environmental Protection
Agency ("EPA")  regulations  using a permanent  method such as the ENCOMPASS and
Soil Sentry systems.

         By December 1998,  the law will require  virtually all UST operators to
move from the temporary, annual testing option to a monthly service or permanent
leak  monitoring.  The  acquisition of Horizon and its tank testing  network has
allowed the Company to compete in the current tank testing  market and to pursue
strong  business  relationships  in order to position  the  Company's  permanent
monitoring  products as the systems of choice  when the  operators  are ready to
upgrade.
<PAGE>
 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,  an
all-inclusive,   personal   computer-based  fuel  management  and  environmental
compliance  system that utilizes  existing on-site personal  computers to manage
fuel inventory and meet EPA leak detection  requirements.  Its open-architecture
system is compatible  with other  business  software and runs in the  computer's
background  without  interrupting  other site  activities  and without  need for
intervention.  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")  to  the  ENCOMPASS  system  is
scheduled  for 1997.  This  product  will allow the tank  owner to  perform  SIR
automatically at the site without needing to send the inventory information to a
service provider for analysis.

         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 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.

         The  Liquid 330  provides  leak  detection  for  double-wall  tanks and
piping. Many of the newer steel and fiberglass storage tanks being installed are
manufactured  with a second outer wall,  designed to contain leaking  materials.
The Liquid 330 uses optical  sensing probes to monitor the space between the two
walls,  signaling  an  alarm  in the  event  of a  leak.  This  optical  sensing
technology  was sold to the  Bindicator  Company in January  1990 as part of the
liquid level  control  product  line.  In the sales  agreement,  the Company was
granted an  exclusive  royalty-free  license of the  technology  allowing  it to
manufacture  and market the  product  to UST  applications  for a period of five
years. In 1992, the Company began offering  groundwater  probes for use with the
TLM-830  and Liquid  330  systems to monitor  for  leaking  hydrocarbon  product
floating on the site's groundwater.
<PAGE>
         In 1990,  the Company  introduced  a product  aimed at the  underground
storage tank market, the TLM-800 tank level monitoring system.  Using ultrasonic
probe technology,  the system continuously measures product levels inside a UST,
providing an extensive range of automated inventory reports.

         AZI  introduced the TLM-830 in February  1992.  This  versatile  system
accommodates  varying  tank site  needs by  combining  the  TLM-800's  inventory
monitoring technology with the leak detection capabilities of the Liquid 330.

         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 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 uses the Tracer  Tight(TM) tracer testing system for
USTs,  which is  licensed  to Horizon by Tracer  Research  Corp.  ("Tracer")  of
Tucson,  Arizona.  The term of the  current  license  agreement  is five  years,
expiring in October 1998. The license is  nonexclusive  and neither  Horizon nor
other Tracer licensees have been assigned specific  protected  territories.  The
license  requires  that all test samples taken by Horizon be submitted to Tracer
for analysis at prescribed fees. Currently,  Horizon's business is substantially
dependent  on its  license  agreement  with  Tracer,  and  its  business  can be
materially  adversely  affected by various  circumstances  regarding the license
agreement,  including  termination  or  nonrenewal  of the license  agreement or
Tracer's  failure to upgrade its  technology  or adjust its pricing  should such
changes become necessary or desirable in light of competitive conditions.
<PAGE>
         SIRTIFY, a statistical inventory  reconciliation  package introduced in
1993, is a cost-effective tank management system that meets EPA requirements for
monthly monitoring of tanks and piping. Daily inventory information is collected
by  the  tank  owner  and  submitted   monthly  to  the  Company  for  analysis.
Comprehensive management and compliance reports are provided to the owner.

         In 1996,  Horizon  developed a program  that  provides the products and
services  required  by its tank  testing  customers  choosing  to  convert  to a
permanent method of leak detection. Offering ENCOMPASS as the compliance method,
Horizon  also  provides   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  has been  engaged  since  1990 in the  business  of
testing USTs for leakage using  EPA-recognized  testing  methods.  Under current
federal  regulations,  UST owners are required to monitor USTs on a permanent or
monthly  basis or,  alternatively,  to test  their  tanks on a  periodic  basis.
Various  methods  have  been  developed  for  testing  of USTs and most  must be
performed  on an  annual  basis  in  order  to  conform  to  current  regulatory
requirements.

         Recognizing  that  the  domestic  market  for  testing  USTs is  slowly
declining as UST owners choose to convert to permanent  monitoring  systems like
ENCOMPASS  before the  December  1998  deadline  mandated  by the EPA.  In 1996,
Horizon expanded its services and product offering as described above.

         Horizon's provides testing services in Arizona,  Utah, Idaho,  Montana,
Nevada,  California,  Washington and Oregon.  The markets and  applications  for
Horizon's  services  are the same as those  described  above with  regard to the
Company's ENCOMPASS and Soil Sentry product line.

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-
<PAGE>
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.

         In  December  1995,  the  Company   announced  that  it  had  completed
development of a proprietary  gold film  micro-sensor for the next generation of
the  Company's  Jerome line of toxic gas  monitors.  The new  micro-sensor  will
significantly  extend sensor life and  facilitate  the Company's  entry into new
markets in which continuous monitoring applications are required. The new Jerome
products are scheduled to be introduced in late 1997.

         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.
<PAGE>
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.

         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 is
scheduled to be released for sale to customers in the first quarter of 1997.

         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.
<PAGE>
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, 1996, warranty expense approximated 1.0% of net sales.
<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
affect 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.  At December  31,
1996,  backlog totaled  approximately  $320,000 compared to $730,000 at December
31, 1995.

         The  Company  markets  its  instruments  for  export  through  a direct
international  office in Singapore,  as well as through foreign  distributors in
Canada, Europe, the Middle East, the Far East, and Latin America.
<PAGE>
Industries Served - Customers
-----------------------------

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

         Two ENCOMPASS  customers  represent  approximately  14% of net sales in
1996.  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 approximately 17% of
total sales in 1996, with no sales to any geographic region 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 last through January 1999.

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.

         Horizon  -  Horizon  has a number of  competitors  in the tank  testing
business.   One  industry  leader  operates  a  nation-wide   tank  testing  and
multi-service UST business. Several other competitors operate regionally as does
Horizon.  There are many other local and  regional UST service  companies  which
provide tank testing services  utilizing the same method as Horizon.  Horizon is
potentially  subject  to  competition  from  other  licensees  of this and other
methods.
<PAGE>
Research and Development
------------------------

         Research and  development  expenses  increased  19% in 1996 compared to
1995. Expenditures for research and development for the years ended December 31,
1996,  1995 and 1994 were $720,133,  $605,627 and $374,538,  respectively.  This
represented  5.7% of sales in 1996, 4.6% in 1995 and 3.1% in 1994. The Company's
research  and  development   expenditures  for  1996  were  channeled  into  the
development of possible new products in all three product lines.

         In August  1988,  the Company  entered into a Research  Agreement  (the
"Research  Agreement") with Arizona State Research Institute  ("ASRI").  AZI and
ASRI jointly  performed work to improve  current  sensors and develop new sensor
technology.  The Research  Agreement  required  the Company to pay  expenditures
which were set forth each contract year and to guarantee  ASRI's equipment lease
payments  related to the research.  The Research  Agreement was terminated as of
December 31, 1990.  The Company made the lease payments  through  November 1993.
The research  performed  under the Research  Agreement is now being continued by
Company personnel.  AZI completed development of a new gold film micro-sensor in
December 1995.

         During the years ended  December 31, 1996,  1995 and 1994,  the Company
has not expensed any funds related to the Research Agreement.

         The  Company  also  intends to  develop  additional  environmental  and
electronic  instrumentation  products and services through internal research and
development,  and  acquisition (by purchase or license) of related product lines
or perhaps small instrument or service 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 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.

         See  "Horizon-Services,"  above, for information regarding an agreement
pursuant  to  which  the  Company  licenses  the  technology   utilized  in  its
tank-testing operation.
<PAGE>
Employees
---------

         As of  December  31,  1996,  the  Company  had a total of 97 full  time
employees and 6 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. The facility enabled the Company to consolidate all operations
from two formerly leased facilities and one owned facility.  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 has filed for an extension until April 18, 1997 to reply.

         The  Company  was  a  defendant  in  an  action   brought  by  Teledyne
Industries,  Inc.,  filed on March 24, 1992 in the United States District Court,
Northern District of Texas. The complaint alleged that the Company's Soil Sentry
product line  infringed  on a patent of which the  plaintiff  was the  exclusive
United States  licensee.  The suit was dismissed  with prejudice by order of the
court on April 12, 1995.

         On June 25, 1993, the State of Arizona  Department of Revenue issued an
assessment against a subsidiary of the Company, Horizon Engineering and Testing,
Inc. ("Horizon"), with respect to delinquent state sales tax payments alleged to
have been due in  connection  with  activities  of a  discontinued  construction
operation of a predecessor  corporation of Horizon. During 1996, Horizon reached
a settlement with the State of Arizona.

         Litigation  commenced in Superior Court,  Maricopa  County,  Arizona in
1996 with respect to certain  matters  arising in  connection  with a technology
development  agreement  and related  agreements  entered into by the Company and
Arizona  State  Research  Institute  ("ASRI") in 1988  related to the  Company's
Jerome  product line and providing the Company with certain  rights  thereunder.
Notwithstanding  such agreements,  ASRI exclusively licensed relevant technology
to Senova  Corporation  ("Senova") in February  1993.  The Company filed suit in
February 1996 against  Senova,  ASRI, the Arizona Board of Regents (the "Board")
and certain other defendants  requesting a declaratory  judgment  confirming the
Company's right to the contested technology
<PAGE>
and seeking  damages.  Senova also filed suit in January 1996 against ASRI,  the
Board, AZI and certain executive  officers of AZI seeking  declaratory  judgment
confirming the validity of its license  agreement with ASRI and seeking damages.
Certain  other  related  actions  also have been filed.  The  parties  reached a
settlement in June,  1996 under which the Company  would  receive  $1,000,000 in
cash 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.

The Company is not involved in any other legal proceedings,  the result of which
the Company believes could have a material adverse effect upon the Company.
<PAGE>
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 1996.

EXECUTIVE OFFICERS OF THE REGISTRANT

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

         Walfred  R.  Raisanen,  age 61, has been the  Chairman  of the board of
Directors since the Company's inception in January 1981. From 1981 until 1986 he
was the  President  and Treasurer of the Company.  Mr.  Raisanen was  re-elected
Treasurer in 1991 and also serves as Vice President of Research and Development.
Prior to his  position  with the  Company,  he was  President  and a Director of
Motorola Process Control, Inc. a predecessor to the Company.

         John P. Hudnall, age 46, came to the Company in 1985 as Chief Financial
Officer.  He became President and Chief Executive Officer in 1986 and a Director
in 1988. Mr. Hudnall's background spans 20 years in industry,  with positions in
production,  sales, finance and systems, including a position as Chief Financial
Officer for Inter-Tel, Inc., an independent telephone company.

         George G. Hays, age 41, joined the Company in 1997 as Vice President of
Finance, Chief Financial Officer, and Vice President of Manufacturing.  Prior to
his  position  with the  Company,  Mr.  Hays was  president  and founder of Hays
Financial Group, Inc., an investment banking firm, since 1986.

         Susan Berry,  age 48, 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.

         Michael Grant, age 47, became Vice President, Service in 1996. Prior to
that,  he was Vice  President of  Manufacturing  since 1993. He started with the
Company in 1988, first serving as National Service Manager,  then as Director of
Customer Service,  and, for the last five years, as Director of Operations.  Mr.
Grant has over 20 years of experience in manufacturing.

         Allen  Porter,  age 39, 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.

         Executive  officers are elected annually and serve at the discretion of
the Board of Directors.
<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
February 28, 1997,  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
                                            -----------------

                         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


                         1995               High         Low
                       --------             -----        ----


                    First Quarter           $1.19        $.69
                    Second Quarter           1.69         .75
                    Third Quarter            2.75        1.25
                    Fourth Quarter           2.25        1.81

         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 of Financial Condition and Results of Operations."
<PAGE>
SELECTED FINANCIAL DATA

         The  selected  financial  data for each of the five years in the period
ended December 31, 1996 have been derived from the Company's  audited  financial
statements,  and should be read in conjunction with the financial statements and
related notes thereto and other financial information appearing elsewhere herein
and in Item 6. The selected  financial  data is not required by Form 10- KSB and
is included herein as an unnumbered item.

INCOME STATEMENT DATA:
<TABLE>
<CAPTION>
                                                            Year Ended December 31, (1)
                                    --------------------------------------------------------------------------
                                        1996           1995            1994           1993           1992
                                    ------------    ------------   ------------    ------------   ------------
<S>                                 <C>             <C>            <C>             <C>            <C>
Net sales                           $ 12,639,943    $ 13,104,230   $ 12,105,818    $ 14,182,410   $ 10,862,419
Cost of goods sold                     5,556,172       5,644,945      5,859,033       6,624,607      4,534,819
Operating expenses                     6,690,522       6,588,757      7,789,962       6,706,167      5,601,140
                                    ------------    ------------   ------------    ------------   ------------
Operating income (loss)                  393,249         870,528     (1,543,177)        851,636        726,460
Interest Expense                         224,637         449,816        507,573         542,499        511,375
Other Income                              90,230
Settlement of Litigation                 997,096
Income tax (benefit) expense            (488,000)         11,000          2,000          35,000        180,458
Extraordinary item
   reduction of income tax
   expense from utilization of
   prior years' operating losses                                                                       172,922
 Cumulative effect of a change
    in accounting method                                                                113,500
                                    ------------    ------------   ------------    ------------   ------------
Net income (loss)                   $  1,743,938    $    532,585   ($ 1,938,200)   $    408,279   $    192,128
                                    ============    ============   ============    ============   ============

Net income (loss) per share         $        .25    $        .08   ($       .31)   $        .09   $        .07
Weighted average number of
    shares outstanding                 6,951,811       6,584,860      6,186,816       4,373,191      2,909,613
</TABLE>


BALANCE SHEET DATA:
<TABLE>
<CAPTION>
                                                       December 31, (1)
                            --------------------------------------------------------------------

                               1996          1995          1994           1993          1992
                            -----------   -----------   -----------   ------------   -----------
<S>                         <C>           <C>           <C>           <C>            <C>
Total assets                $11,024,164   $10,600.162   $11,966,710   $ 12,768,299   $11,369,361
Working capital             $ 3,950,096   $ 3,332,424   $ 2,318,979   $  4,439,421   $ 1,766,729
Long-term debt, excluding
   current portion          $   378,010   $ 1,663,112   $ 1,816,288   $  2,161,298   $ 1,961,515
Total liabilities           $ 2,592,458   $ 4,260,858   $ 6,228,112   $  5,092,459   $ 6,238,749
Shareholders' equity        $ 8,431,706   $ 6,339,304   $ 5,738,598   $  7,675,840   $ 5,130,612
</TABLE>
(1) Includes operations of Horizon acquired in September, 1992.
<PAGE>
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

         The statements contained herein 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,  and
positive responses to new developments,  constitute "forward-looking" statements
within the  meaning of the  Private  Securities  Litigation  Reform Act of 1995.
Management's   anticipation  is  based  upon  assumptions  regarding  levels  of
competition, research and development results, product introduction and delivery
schedules,  raw material markets, the markets in which the Company operates, and
stability of the regulatory  environment.  Any of these  assumptions could prove
inaccurate,  and therefore  there can be no assurance  that the  forward-looking
information will prove to be accurate.

Results of Operations:

         The  following  tables set forth  items in the  Company's  Consolidated
Statements  of  Operations  as a percent of total net sales for the years  ended
December 31, 1996, 1995 and 1994:
<TABLE>
<CAPTION>
                                                   Percent of net sales      Percentage change
                                                  Year ended December 31,    over prior periods

                                                                             1996 vs.  1995 vs.
                                                 1996      1995      1994      1995     1994
                                                ------    ------    ------    ------    ----
<S>                                             <C>       <C>       <C>           <C>     <C>
Net sales                                       100.0%    100.0%    100.0%       -4%      8%
Cost of goods sold                               44.0%     43.1%     48.4%       -2%     -4%
                                                ------    ------    ------    ------    ----
            Gross margin                         56.0%     56.9%     51.6%       -5%     19%
                                                ------    ------    ------    ------    ----
Expenses
   Marketing                                     24.5%     23.8%     29.4%       -1%     -12%
   General and administrative                    17.3%     17.3%     20.0%       -3%     -6%
   Research and development                       5.7%      4.6%      3.1%       19%     62%
   Amortization and depreciation                  5.4%      4.6%      4.8%       15%      3%
   Restructuring costs                            0.0%      0.0%      7.1%        0%   -100%
                                                ------    ------    ------    ------    ----
             Total expenses                      52.9%     50.3%     64.3%        2%    -15%
                                                ------    ------    ------    ------    ----
Operating income (loss)                           3.1%      6.6%    -12.7%      -55%    156%
                                                ------    ------    ------    ------    ----
Other revenue (expense)
   Interest income                                0.2%       .2%      0.1%        0%    136%
   Interest expense                              -1.8%     -3.4%     -4.2%      -50%    -11%
   Other                                          8.4%       .8%      0.9%      956%     -4%
                                                ------    ------    ------    ------    ----
             Total other revenue (expense)        6.8%     -2.5%     -3.2%     -364%    -17%
                                                ------    ------    ------    ------    ----


Income (loss) before income taxes                 9.9%      4.1%    -16.0%      131%    128%
Income tax (benefit) expense                     -3.9%       .1%      0.0%    -4536%    450%
                                                ------    ------    ------    ------    ----
Net income (loss)                                13.8%      4.1%    -16.0%      227%    127%
                                                ======    ======    ======    ======    ====
</TABLE>

Fiscal 1996 vs. Fiscal 1995
---------------------------
         Net income  increased 227% to $1,743,938 in 1996 from $532,585 in 1995.
The  increase in net income  resulted in part from  $997,096 of other income the
Company  recognized during 1996 related to a settlement the Company reached with
a state organization involving a
<PAGE>
technology  contract.  Net income also  increased  as a result of a $488,000 tax
benefit  recognized in 1996 from  reducing the Company's  deferred tax valuation
allowance and recognizing a deferred tax asset.

         Net sales decreased 4% to $12,639,943 in 1996 from $13,104,230 in 1995.
Sales  decreased  primarily in tank testing  services and in Computrac  moisture
analyzers.  These sales  decreases were offset to a large extent by increases in
sales of the ENCOMPASS fuel management and compliance systems, ENCOMPASS related
installations.

         Cost of goods sold was 44% of sales in 1996 compared to 43% of sales in
1995.  Gross margin  decreased  primarily due to lower  utilization  of the tank
testing field  technicians.  Gross margin also  decreased as a result of a lower
mix of sales of the Computrac moisture analyzer sales.

         Overall  expenses in 1996  increased  $101,765  or 2% above  1995.  The
increase  was  primarily  the result of the  $114,506  increase in research  and
development expenses.

         Marketing  expenses  decreased  $24,970 or 1% in 1996 compared to 1995.
The  decrease in marketing  expenses  was  primarily a result of the decrease in
tank testing sales personnel.

         General and administrative  expenses  decreased $78,169,  or 3% in 1996
compared to 1995. General and administrative  expenses decreased  primarily as a
result of decreased  administrative  personnel  and expenses in the tank testing
operations.  Some of this tank testing  personnel have been reassigned to manage
the installation of ENCOMPASS systems.

         Research and development  expenses increased  $114,506,  or 19% in 1996
compared  to 1995.  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.

         Amortization and depreciation  expenses  increased  $90,398,  or 15% in
1996  compared to 1995 due to the  purchase  of  additional  capital  equipment,
including computer equipment.

         Interest expense  decreased  $225,179,  or 50% in 1996 compared to 1995
due to a decrease in the average outstanding debt.

Fiscal 1995 vs. Fiscal 1994
---------------------------
         The Company  reported net income of $532,585 in 1995  compared to a net
loss of  $1,938,200  in 1994,  an increase of 127%.  The  increase in net income
compared to 1994 resulted in part from the Company developing and implementing a
formal  plan in the  third  quarter  of 1994 to  restructure  the  Environmental
Technology  Group (ETG).  The total one-time  restructuring  costs for 1994 were
$863,837.

         Net  sales  for the  year  ended  December  31,  1995  increased  8% to
$13,104,230  compared to  $12,105,818  in 1994.  The increase in sales  resulted
primarily from increases in sales of the
<PAGE>
ENCOMPASS   fuel   management   and  compliance   systems,   ENCOMPASS   related
installations and Computrac moisture analyzers.  These sales increases more than
offset a decrease in tank testing sales. Tank testing sales decreased  primarily
as a result of the  reorganization  in 1994 to redirect the sales focus from the
Eastern U.S. back to the Western U.S. and a small decline in the domestic market
for testing UST's.

         Cost of goods sold was 43% of sales in 1995 compared to 48% of sales in
1994.  Gross margin  increased  primarily due to higher  utilization of the tank
testing field  technicians.  Lower tank testing sales for 1995 was  accomplished
with significantly  fewer technicians and much higher  productivity  compared to
1994. Gross margin also improved in 1995 as a result of a higher mix of sales of
the ENCOMPASS systems in the ENCOMPASS and Soil Sentry product line.

         Overall  expenses in 1995  decreased  $1,201,205 or 15% below 1994. The
decrease was primarily  the result of the $863,837  decrease in costs related to
ETG  restructuring  in the third  quarter  of 1994  which was zero in 1995.  The
restructuring  costs were related to formally  restructuring  the  Environmental
Technology  Group (ETG) and consisted  primarily of the write down of inventory,
patents and related severance expenses. Total expenses also decreased a total of
$587,277 in marketing and general and  administrative  expense  primarily in the
restructured tank testing operations.

         Marketing  expenses decreased $440,228 or 12% in 1995 compared to 1994.
The  decrease in marketing  expenses  was  primarily a result of the decrease in
tank  testing  sales  personnel in the Eastern  United  States which the Company
anticipates will be permanent.

         General and administrative  expenses decreased $147,049,  or 6% in 1995
compared to 1994. General and administrative  expenses decreased  primarily as a
result of decreased  administrative  personnel  and expenses in the tank testing
operations.  Some of this tank testing  personnel have been reassigned to manage
the installation of ENCOMPASS systems.

         Research and development  expenses increased  $231,089,  or 62% in 1995
compared  to 1994.  The  increase  in  research  and  development  expenses  was
primarily the result of capitalizing  some final stage development costs for the
ENCOMPASS  product in 1994. There were no similar final stage  development costs
in 1995.

         Amortization and depreciation expenses increased $18,820, or 3% in 1995
compared to 1994.

         Interest expense decreased $57,757, or 11% in 1995 compared to 1994 due
to a decrease in the average outstanding debt.


Liquidity and Capital Resources:
--------------------------------

         Working  capital  increased  19% to  $3,947,282  at  December  31, 1996
compared to $3,332,424 at December 31, 1995. The current ratio increased to 2.78
in 1996 from 2.28 in
<PAGE>
1995. The increase in working capital and the current ratio was primarily due to
increased cash flow from operations.

         At  December  31,  1996 as compared  to  December  31,  1995,  accounts
receivable  decreased $454,361,  primarily as a result of improvements in credit
and collection policies and procedures. Inventory at December 31, 1996 increased
$256,212  compared to December  31,  1995,  primarily  as a result of  increased
inventory for two new products  scheduled for  introduction in the first quarter
of 1997.

         Cash and cash equivalents  increased  $111,549 in 1996, to end the year
at $597,931.  Cash provided by operating  activities was $1,231,095 in 1996. The
sources  of cash for  operating  activities  was  primarily  a result of the net
income plus non-cash charges  (depreciation  and amortization) and the decreases
in accounts  receivable offset partly by increases in the settlement  receivable
and deferred tax asset. Cash used by investing  activities was $129,457 in 1996.
Cash used by financing activities was $990,089 in 1996, which was primarily used
to reduce  borrowing  under the bank  lines of credit  and to make  payments  on
long-term debt and capital leases.

         The Company currently has two lines of credit available through Silicon
Valley Bank ("the Bank"), collateralized by accounts receivable,  inventory, and
property,  plant and equipment which provide for an aggregate maximum commitment
of $2,500,000  through March 15, 1997. At December 31, 1996,  the Company had $0
outstanding  under its domestic line of credit for $1,500,000.  Borrowings under
this line of credit are at the Bank's prime rate of interest plus 1.5% (9.75% at
December 31,  1996.) The second line of credit is an  international  credit line
and is 90%  guaranteed  by the  Export-Import  Bank  of the  United  States.  At
December 31, 1996, the Company had $0 outstanding under its  international  line
of credit for $1,000,000. Borrowings under this line of credit are at the Bank's
prime rate of interest  plus 1.0% (9.25% at December 31,  1996).  Subsequent  to
December 31, 1996,  the lines of credit were renewed  through March 15, 1998 for
an  aggregate  commitment  of  $2,500,000.  The  domestic  line was  renewed for
$1,500,000 at an interest rate of prime plus .75%.  The  international  line was
renewed for  $1,000,000 at an interest of rate of prime plus .75%.  The lines of
credit  contain  certain  covenants,  including  minimum  net income  levels and
certain financial ratios.  The Company was in compliance with all Bank covenants
at December 31, 1996.

         On April 14,  1995,  the Company  entered into an a  Subordinated  Loan
Agreement with Classic Syndicate, Inc. ("Classic"). Pursuant to the Subordinated
Loan  Agreement,  Classic holds a 10% Note in the  principal  amount of $375,000
with a maturity  date of April 30, 1997.  The funds were to be used  exclusively
for the April 30, 1995 principal payment to Bridge. Semiannual interest payments
were made on April 30, 1996 and October 31, 1996.

         On November 17, 1995,  the Company  entered into a Loan  Agreement with
the Bank. Pursuant to the Loan Agreement, the Bank holds a note in the principal
amount of $395,353 at an interest  rate of prime plus 2% (10.25% at December 31,
1996) 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.
<PAGE>
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.
<PAGE>
ITEM 7.   FINANCIAL STATEMENTS



                                                     I N D E X



                                                                        Page No.


Independent Auditors' Report .......................................       23

Consolidated Balance Sheets ........................................       24

Consolidated Statements of Operations ..............................       25

Consolidated Statements of Shareholders' Equity ....................       26

Consolidated Statements of Cash Flows ..............................       27

Notes to Consolidated Financial Statements .........................       29
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
                 -----------------------------------------------

             1996 Consolidated Financial Statements and Independent
                                Auditors' Report
<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, 1996 and 1995, and
the related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended  December 31, 1996.  These
financial  statements are the  responsibility of the Company's  management.  Our
responsibility is to express an opinion on the 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,  1996  and  1995  and the  results  of  their
operations  and their cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.


/s/  Deloitte & Touche LLP

DELOITTE & TOUCHE LLP

Phoenix, Arizona
March 7, 1997
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
                 -----------------------------------------------

                           CONSOLIDATED BALANCE SHEETS
                           ---------------------------
<TABLE>
<CAPTION>
                                                                        December 31,
                                                                        ------------
                                                                     1996          1995
                                                                 -----------   -----------
<S>                                                              <C>           <C>
                         ASSETS
                      -----------

CURRENT ASSETS:
             Cash and cash equivalents                           $   597,931   $   486,382
             Receivables, less allowance for doubtful
                          accounts of $165,000 and $191,000        2,917,476     3,371,837
             Inventories:
                          Components                               1,369,007     1,148,508
                          Finished Goods                             680,975       645,262
                                                                 -----------   -----------
                                                                   2,049,982     1,793,770
             Current portion of notes receivable related party        45,501        55,501
             Prepaid expenses and other current assets               550,840       222,680
                                                                 -----------   -----------
                                      Total current assets         6,161,730     5,930,170

PROPERTY, PLANT AND EQUIPMENT, net                                   846,458     1,083,199
GOODWILL, net of accumulated amortization
             of $2,121,266 and $1,874,912                          2,209,650     2,455,924
COVENANT NOT TO COMPETE, net of accumulated
             amortization of $247,917 and $189,583                   102,084       160,417
DEFERRED TAX ASSET                                                   641,437       113,500
OTHER ASSETS                                                       1,062,805       856,952
                                                                 -----------   -----------
TOTAL                                                            $11,024,164   $10,600,162
                                                                 ===========   ===========

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

CURRENT LIABILITIES:
             Lines of credit                                     $         0   $   250,000
             Accounts payable                                        771,679       863,386
             Accrued salaries and commissions                        251,273       374,838
             Accrued interest                                         27,652        14,713
             Other accrued expenses                                  369,576       481,585
             Current portion of long-term debt and
                          capital lease obligations                  794,268       613,224
                                                                 -----------   -----------
                                      Total current liabilites     2,214,448     2,597,746

LONG-TERM DEBT AND CAPITAL LEASE
             OBLIGATIONS - less current portion                      378,010     1,663,112

COMMITMENTS AND CONTINGENCIES (Note J)

SHAREHOLDERS' EQUITY:
             Common Stock, $.01 par value:
                  Authorized, 10,000,000 shares;
                  Issued, 6,677,680 and 6,352,563 shares              66,777        63,526
             Preferred Stock, $.01 par value
                  Authorized, 1,000,000 shares
             Additional paid-in capital                            9,706,163     9,360,950
             Deficit                                              (1,118,783)   (2,862,721)
                                                                 -----------   -----------
                                                                   8,654,157     6,561,755
             Less treasury stock, 86,165 shares at cost             (222,451)     (222,451)
                                                                 -----------   -----------
                          Total shareholders' equity               8,431,706     6,339,304
                                                                 -----------   -----------
TOTAL                                                            $11,024,164   $10,600,162
                                                                 ===========   ===========
</TABLE>
                 See Notes to Consolidated Financial Statements
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
                 -----------------------------------------------

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      -------------------------------------
<TABLE>
<CAPTION>
                                                      Year Ended December 31,
                                             --------------------------------------------
                                                 1996            1995            1994
                                             ------------    ------------    ------------
<S>                                          <C>             <C>             <C>
NET SALES                                    $ 12,639,943    $ 13,104,230    $ 12,105,818

COST OF GOODS SOLD                              5,556,172       5,644,945       5,859,033
                                             ------------    ------------    ------------

              Gross margin                      7,083,771       7,459,285       6,246,785
                                             ------------    ------------    ------------

EXPENSES
     Marketing                                  3,091,134       3,116,104       3,556,332
     General & administrative                   2,190,472       2,268,641       2,415,690
     Research & development                       720,133         605,627         374,538
     Amortization & depreciation                  688,783         598,385         579,565
     Restructuring costs                                0               0         863,837
                                             ------------    ------------    ------------

              Total Expenses                    6,690,522       6,588,757       7,789,962
                                             ------------    ------------    ------------

OPERATING INCOME (LOSS)                           393,249         870,528      (1,543,177)
                                             ------------    ------------    ------------

OTHER REVENUE (EXPENSE)
     Interest income                               22,124          22,039           9,320
     Interest expense                            (224,637)       (449,816)       (507,573)
     Settlement of litigation (Note J)            997,096
     Other                                         68,106         100,834         105,230
                                             ------------    ------------    ------------

              Total other income (expense)        862,689        (326,943)       (393,023)
                                             ------------    ------------    ------------

INCOME (LOSS) BEFORE INCOME TAXES               1,255,938         543,585      (1,936,200)

INCOME TAXES (BENEFIT)                           (488,000)         11,000           2,000
                                             ------------    ------------    ------------

NET INCOME (LOSS)                            $  1,743,938    $    532,585    ($ 1,938,200)
                                             ============    ============    ============


NET INCOME (LOSS) PER SHARE                  $       0.25    $       0.08    ($      0.31)
                                             ============    ============    ============

WEIGHTED AVERAGE NUMBER OF COMMON SHARES
     AND COMMON STOCK EQUIVALENTS               6,951,811       6,584,860       6,186,816
                                             ============    ============    ============
</TABLE>
                 See Notes to Consolidated Financial Statements
<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, 1994             6,152,616    $    61,526    $ 9,293,871   ($1,457,106)   ($  222,451)   $ 7,675,840

  Issuance of stock pursuant to:
    Stock purchase plan                 38,702            387         43,838                                      44,225
    Stock private placement fees                                     (43,309)                                    (43,309)
    Exercise of warrants                 4,166             42                                                         42
  Net loss                                                                      (1,938,200)                   (1,938,200)
                                   -----------    -----------    -----------   -----------    -----------    -----------

BALANCE, DECEMBER 31, 1994           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
                                   ===========    ===========    ===========   ===========    ===========    ===========
</TABLE>
                 See Notes to Consolidated Financial Statements
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
                 -----------------------------------------------

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                      -------------------------------------
<TABLE>
<CAPTION>
                                                          Year ended December 31,
                                                   -----------------------------------------
                                                      1996           1995           1994
                                                   -----------    -----------    -----------
<S>                                                <C>            <C>            <C>
OPERATING ACTIVITIES:
  Net income (loss)                                $ 1,743,938    $   532,585    ($1,938,200)

  Adjustments to reconcile net income to net cash
  provided  (used) by operating
    activities:
    Depreciation and amortization                      804,495        779,577        812,501
    Gain on sale or abandonment of property,
      plant and equipment                              (34,570)       (62,294)       (93,552)
    Provision for losses on receivables                (25,289)         4,257         10,882
    Restructuring charges                                                            747,995
    Provision for inventory obsolesence                                               89,965

  Change in operating assets and liabilities:
    Decrease in receivables                            479,650        486,164        177,576
    (Increase) decrease in inventories                (256,212)       296,388       (389,816)
    Decrease in other current assets                    46,257         11,639        129,779
    (Increase) in settlement receivable               (364,419)
    (Increase) in deferred tax asset                  (527,937)
    (Increase) decrease in other assets               (320,476)        21,011       (302,051)
    (Decrease) increase in accounts payable            (91,707)        47,025        (73,205)
    (Decrease) increase in accrued expenses           (222,635)       125,389        (20,939)
                                                   -----------    -----------    -----------

NET CASH PROVIDED (USED) BY
  OPERATING ACTIVITIES                               1,231,095      2,241,741       (849,065)
                                                   -----------    -----------    -----------

INVESTING ACTIVITIES:
  Purchases of property, plant and
    and equipment and other assets                    (207,354)      (106,523)       (64,639)
  Proceeds from sale of property, plant and
    and equipment and other assets                      77,897         80,553        136,264
                                                   -----------    -----------    -----------

NET CASH (USED) PROVIDED BY
  INVESTING ACTIVITIES                                (129,457)       (25,970)        71,625
                                                   -----------    -----------    -----------
</TABLE>
                                    Continued
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
                 -----------------------------------------------

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                      -------------------------------------
                                   (Continued)
<TABLE>
<CAPTION>
                                                            Year ended December 31,
                                                   -----------------------------------------
                                                      1996           1995           1994
                                                   -----------    -----------    -----------
<S>                                                 <C>            <C>              <C>
FINANCING ACTIVITIES:
  Borrowings of long-term debt                                      1,625,000
  Payments of long-term debt and capital leases     (1,104,058)    (2,441,192)      (156,201)
  Net (payments) borrowings under bank
    lines of credit                                   (250,000)    (1,375,000)       825,000
  Proceeds received on notes receivable                 15,506          5,703            902
  Stock issued for warrants                             79,114         29,850             42
  Sale of common stock, net proceeds                                                 (43,309)
  Issuance of common stock for earnout agreement       202,585
  Issuance of common stock pursuant
    to stock purchase plan                              66,764         38,271         44,225
                                                   -----------    -----------    -----------

NET CASH (USED) PROVIDED BY
  FINANCING ACTIVITIES                                (990,089)    (2,117,368)       670,659
                                                   -----------    -----------    -----------

NET INCREASE (DECREASE) IN CASH
  AND CASH EQUIVALENTS                                 111,549         98,403       (106,781)

CASH AND CASH EQUIVALENTS,
  beginning of year                                    486,382        387,979        494,760
                                                   -----------    -----------    -----------

CASH AND CASH EQUIVALENTS
  end of year                                      $   597,931    $   486,382    $   387,979
                                                   ===========    ===========    ===========


SUPPLEMENTAL CASH FLOW INFORMATION:
  Transfer of inventories to property, plant and
    equipment to be used as demonstration units    $    57,057    $   100,589    $   115,239
  Property, plant and equipment acquired through
    capital lease obligations                                          51,524        550,998
  Note receivable acquired for asset sale                                            170,000
  Note payable due for asset sale                                                     10,000
  Interest paid                                        126,172        502,759        477,039
  Income taxes paid                                      5,025          4,669          9,270
</TABLE>
                 See Notes to Consolidated Financial Statements
<PAGE>
                 ARIZONA INSTRUMENT CORPORATION AND SUBSIDIARIES
                 -----------------------------------------------

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

                       THREE YEARS ENDED DECEMBER 31, 1996
                       -----------------------------------



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 (UST's) and
the Jerome  line of toxic gas  detection  instruments  primarily  used to detect
mercury and hydrogen sulfide. The Company also provides tank testing and related
services  for the  underground  storage tank  market.  The Company  sells in the
United States and also international markets.

Sales of  instruments  are  recognized  once  the  shipment  is  made.  Sales of
underground  storage tank (UST) services are recognized  based on the percentage
of completion.

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
useful  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.  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.
<PAGE>
Covenant not to compete resulted as part of the Horizon  acquisition in 1992 and
is being amortized on a straight line basis.

Debt issue costs are  amortized  using the interest  method over the term of the
related debt.

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 1996 financial statements.

Income (Loss) per share is computed using the weighted  average number of common
shares  outstanding  during each year after giving  effect to stock  options and
warrants considered to be dilutive common stock equivalents.

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.

 B.     PROPERTY, PLANT AND EQUIPMENT
        -----------------------------

Property, plant and equipment at December 31 consists of the following:


                                                         1996           1995
                                                     -----------    -----------

                 Leasehold improvements              $   157,604    $   154,807
                 Furniture, fixtures and equipment     3,936,984      3,887,422
                 Automobiles                              99,359        123,111
                                                     -----------    -----------
                                                       4,193,947      4,165,340
                 Less accumulated depreciation
                    and amortization                  (3,347,489)    (3,082,141)
                                                     -----------    -----------
                                                     $   846,458    $ 1,083,199
                                                     ===========    ===========




C.     BANK LINES OF CREDIT
       --------------------

At December 31,  1996,  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
<PAGE>
$2,500,000  through  March 15, 1997.  At December  31, 1996,  the Company had $0
outstanding  under  its  domestic  line of credit at the  bank's  prime  rate of
interest  plus 1.5%  (9.75% at  December  31,  1996).  The  Company  also had $0
outstanding  under  the  international  line of  credit at  December  31,  1996.
Borrowings  under this line of credit are at the bank's  prime rate of  interest
plus 1.0% (9.25% at December 31,  1996).  Subsequent  to December 31, 1996,  the
lines of credit were renewed through March 15, 1998 for an aggregate  commitment
of $2,500,000.  The domestic line was renewed for $1,500,000 at an interest rate
of prime plus .75% and the  international  line was renewed for $1,000,000 at an
interest rate of prime plus .75%. The lines of credit contain certain covenants,
including minimum net income levels and certain  financial  ratios.  The Company
was in compliance with all bank covenants at December 31, 1996.

D.      LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
        --------------------------------------------

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


                                                            1996         1995
                                                         ----------   ----------

             Capital lease obligations (Note J)          $  398,557   $  670,170
             Notes payable                                  375,000      375,000
             Notes payable to Bank                          398,721    1,231,166
                                                         ----------   ----------

          Total Debt and Capital Leases                   1,172,278    2,276,336
             Less current position                          794,268      613,224
                                                         ----------   ----------

          Long-Term Portion of Debt and Capital Leases   $  378,010   $1,663,112
                                                         ==========   ==========



On April 14, 1995, the Company entered into an agreement with Classic Syndicate,
Inc ("Classic").  Pursuant to the Subordinated  Loan Agreement,  Classic holds a
10% Note in the  principal  amount of $375,000 with a maturity date of April 30,
1997.  The funds were to be used  exclusively  for the April 30, 1995  principal
payment to Bridge. Semi-annual interest payments are to be made.

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 $395,353 at an interest  rate of prime plus 2% (10.25% at December 31,
1996)  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
<PAGE>
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, 1996 the Company was in
agreement with all covenants of this agreement.

Long-term debt and capital lease obligations at December 31, 1996 are payable as
follows:


                               1997   $  794,268
                               1998      285,079
                               1999       81,104
                               2000       11,827
                               ----   ----------
                                      $1,172,278
                                      ==========



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 July 1983,  the Company  adopted an  Incentive  Stock  Option  Plan  ("ISOP")
pursuant to which the Company could, for a period of 10 years,  grant options to
purchase up to 100,000 shares of the Company's Common Stock. ISOP options may be
granted to employees of the Company or any subsidiary. The exercise price of all
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 10 years from the
date of grant. In 1984,  non-qualified  stock options were granted to an officer
and a former  director.  The exercise  price of the options is equal to the fair
market value of the Company's Common Stock on the date of grant.

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 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.
<PAGE>
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, 1994      395,645    $   2.53
                  Granted                        57,719        2.20
                  Canceled                      (75,480)       3.00
                                               --------    --------
               Outstanding December 31, 1994    377,884        2.39
                  Granted                       678,903         .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)        .92
                  Exercised                     (53,342)        .96
                                               --------    --------

               Outstanding December 31, 1996    792,711    $   1.29
                                               ========    ========

At December 31, 1996,  141,544 options were  exercisable.  At December 31, 1995,
52,500 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.
<PAGE>
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,  1996,  1995 and 1994 a total of 40,637,
46,476 and 38,702 shares of common stock have been  purchased at average  prices
of $1.42,  $.82 and $1.14 per share,  respectively.  As of December  31, 1996, a
total of 181,263 shares were available under this plan.

The  estimated  fair value of options  granted  during 1996 was $1.15 per share,
while the  estimated  fair value of options  granted  during  1995 was $0.42 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, 1996 and December 31,
1995 would have been reduced to the pro forma amounts indicated below:

                                                        1996            1995
                                                    -------------   -----------
Net income to common shareholders
                  As reported                       $   1,743,938   $   532,585
                  Pro forma                         $   1,671,943   $   485,340

Net income per common and common equivalent share
                  As reported                       $        0.25   $      0.08
                  Pro forma                         $        0.24   $      0.07

The fair values of options  granted under the Company's fixed stock option plans
during 1995 and 1996 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.

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.
<PAGE>
G.      INCOME TAXES
        ------------

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


                                          1996         1995        1994
                                     ---------    ---------   ---------
         Federal:
            Current                  $  20,500    $   2,250   $       0
            Deferred                  (493,000)
         State:
            Current                      9,500        8,750       2,000
             Deferred                  (25,000)
                                     ---------    ---------   ---------
                                     $(488,000)   $  11,000   $   2,000
                                     =========    =========   =========


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:




                                     1996         1995        1994
                                  ---------    ---------   ---------
Provision (benefit) computed at
   federal statutory rates        $ 427,000    $ 185,000   ($658,988)
State taxes                         (15,500)       9,000       2,000
Goodwill                             63,500       63,000      63,500
Other                               (19,000)      66,000      12,600
Change in valuation allowance      (944,000)    (312,000)    582,888
                                  ---------    ---------   ---------

                                  ($488,000)   $  11,000   $   2,000
                                  =========    =========   =========



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:
<PAGE>
                                                          1996          1995
                                                       ----------    ----------
Deferred tax assets:
Current
   Reserves not currently deductible                   $  216,000    $  114,000
   Operating loss carryforwards                           123,000
Long Term                                                                70,000
   Other intangibles                                                    398,000
   Operating loss carryforwards                                         324,000
   Tax credit carryforwards                               380,000
   Difference between book and tax basis of property        4,000       151,500
                                                       ----------    ----------
Total deferred tax assets                                 723,000     1,057,500

Deferred tax liabilities:
Long Term
 Other intangibles                                        (43,000)
 Other                                                    (39,500)
                                                       ----------    ----------
Total deferred tax liabilities                            (82,500)

Valuation allowance                                                    (944,000)
                                                       ----------    ----------
Net deferred tax asset                                 $  640,500    $  113,500
                                                       ==========    ==========




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,  1996,  the Company had net  operating  loss  carryforwards  of
approximately  $361,000  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.  No  contributions  have been made in any of the three years ended
December 31, 1996.

I.      SALES
        -----

Export  sales,   primarily  to  Canada,  Korea  and  Sweden  were  approximately
$2,191,000,  $1,950,000  and  $2,220,000  for the years ended December 31, 1996,
1995 and 1994, respectively.

The Company has a  concentration  of sales from a product to two customers  that
makes up approximately 14% of net sales. The potential for a negative  financial
impact could  result from a partial or total loss of the  business  relationship
with these customers.  Management  believes that the  relationships  between the
Company  and these  customers  were good at December  31,  1996.  Management  is
actively seeking to
<PAGE>
diversify  sales  of this  new  product  to a number  of  other  customers,  and
anticipate  that  additional  customers  will be added  during  the next  twelve
months.

J.      COMMITMENTS AND CONTINGENCIES
        -----------------------------

Leases
------

Certain  office  facilities  and  equipment are held under capital and operating
leases. These leases expire in periods through 2003 and include renewal options.
Capital  leases  included  in  Property  and  Equipment  total   $1,281,374  and
$1,361,193  (net of  accumulated  amortization  of $945,105 and  $765,429) as of
December 31, 1996 and 1995, respectively.

At December 31, 1996,  future  minimum lease  payments  under such leases having
non- cancelable terms in excess of one year are summarized as follows:


                                             Capital lease      Operating leases
                                         --------------------   ----------------

1997                                     $            287,750   $        335,731
1998                                                  134,140            333,422
1999                                                   17,316            338,991
2000                                                   12,987            328,182
2001                                                        0            317,604
Thereafter                                                  0            873,411
                                         --------------------   ----------------

Total minimum lease payments                          452,193   $      2,527,341
                                                                ================
Less amount representing interest                      53,636
Net present value of future minimum      --------------------

   Lease payments                        $            398,557
                                         ====================


Rent  expense for  operating  leases was  approximately  $325,000,  $360,000 and
$335,000 for the years ended December 31, 1996, 1995 and 1994, 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  $33,764,
$33,764  and  $35,801  for the years ended  December  31,  1996,  1995 and 1994,
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 will be completed on December 31, 1997.


Litigation
----------
<PAGE>
Litigation had been 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 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.

Subsequent to December 31, 1996, the Company became 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 this claim cannot
be determined at this time,  management of the Company does not believe that the
ultimate  disposition of this claim will have a material effect on the financial
position or result of operations of the Company.

K.      RESTRUCTURING COSTS
        -------------------

During the third quarter of 1994 the Company  developed and implemented a formal
plan to  restructure  the  Environmental  Technology  Group  (ETG).  Because  of
competitive  market  conditions  in the  Eastern  US, the  Company  had not been
successful in profitably developing tank testing in these territories. Also, the
Company  changed focus in the Soil Sentry product line by reducing the number of
products offered and focusing on newer, more profitable  products.  The plan for
restructuring   involved  closing  down  the  tank  testing  sales  and  service
operations in the Eastern US, writing off certain Soil Sentry  inventory and the
related patent and reducing related corporate staffing expenses by approximately
10%. The total restructuring costs for 1994 were $863,837 which consisted of the
following:

                 Write down of inventory              $405,373
                 Write down of patent                  342,622
                                                      --------

                 Total non-cash restructuring costs    747,995
                 Total cash severance costs            115,842
                                                      --------

                 Total restructuring costs            $863,837
                                                      ========


The   restructuring   was  completed  in  1994  and  there  were  no  additional
restructuring related expenses in 1995 or 1996.

L.     RELATED PARTY TRANSACTIONS
       --------------------------

During  September  1993, the Company loaned $45,000 to one of its officers.  The
loan is  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
<PAGE>
$35,000.  The note bears interest at 10% per annum and the remaining  balance is
due December,  1997. During April 1994, the Company loaned approximately $10,000
to another officer. The note bears interest at 10% and is due December, 1997.
<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, 1996 and 1995.

Consolidated  statements of operations - Years ended December 31, 1996, 1995 and
1994

Consolidated statements of shareholders' equity - Years ended December 31, 1996,
1995 and 1994

Consolidated  statements of cash flows - Years ended December 31, 1996, 1995 and
1994

Notes to consolidated financial statements








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

3.1 Certificate of Incorporation of Registrant as amended through June 30, 1994:
<PAGE>
         Incorporated by reference from Form 10-Q filed in August 1994.

3.2      By-laws of Registrant as amended through June 30, 1994: Incorporated by
         reference from Form 10-Q filed in August 1994.

10.1     United States Patent No. 4,165,633 issued August 28, 1979: Incorporated
         by reference from Form S-18 filed on July 27, 1983.

10.2*    1983  Incentive  Stock  Option  Plan  of  Registrant:  Incorporated  by
         reference from Form S-18 filed on July 17, 1983.

10.3*    1985 Stock Option Plan:  Incorporated  by reference from Form 10K filed
         in March 1986.

10.4*    1991 Stock Option Plan:  Incorporated  by reference from Form 10K filed
         in March 1992.

10.5     Amended and  restated  Silicon  Valley Bank,  Export-Import  Guaranteed
         Business Loan Agreement,  February 1993. Incorporated by reference from
         Form 10-KSB filed in March 1993.

10.6     Loan  Modification  Agreement  with Silicon Valley Bank dated March 15,
         1994 to renew the lines of credit through March 15, 1995.  Incorporated
         by reference from Form 10-QSB filed in March 1994.

10.7     Amended  and  restated  Silicon  Valley Bank  Domestic  and Export Loan
         Agreements, dated March 15, 1995 through March 15, 1996.

10.8     Warrant  Purchase  Agreement  dated as of  December  15,  1991  between
         Arizona Instrument Corporation and Silicon Valley Bank: Incorporated by
         reference from Form 10K filed in March 1992.

10.9*    Employment   Agreement   dated   September  30,  1992  between  Horizon
         Acquisition Co. and Quinn Johnson.  Incorporated by reference from Form
         8-K dated September 30, 1992.

10.10    Noncompete   Agreement   dated   September  30,  1992  between  Horizon
         Acquisition Co. and Quinn Johnson.  Incorporated by reference from Form
         8-K dated September 30, 1992.

10.11*   Employment Agreement between Walfred R. Raisanen and Arizona Instrument
         Corporation dated November 5, 1992. Incorporated by reference from Form
         ESB filed in March 1993.

10.12*   Employment Agreement between the Company and John P. Hudnall dated
<PAGE>
         June 3, 1993.  Incorporated  by reference from Form 10-QSB filed August
         1993.

10.13    Lease Agreement between the Company and Wood Street Limited Partnership
         dated  September 1, 1993.  Incorporated  by reference  from Form 10-QSB
         filed August 1993.

10.14    Amended and Restated License  Agreement  between the Company and Tracer
         Research Corporation dated October 27, 1993.  Incorporated by reference
         from Form 10-QSB filed November 1993.

10.15    Warrant  Agreement between the Company and Cruttenden & Co., Inc. dated
         November 30, 1993. Incorporated by reference from Report on Form 10-QSB
         dated November 30, 1993.

10.16    Amendment No. 7 to the Purchase  Agreement  between Arizona  Instrument
         Corporation and Bridge Capital Investors II, dated July 1, 1994.

10.17    Amendment No. 8 to the Purchase  Agreement  between Arizona  Instrument
         Corporation and Bridge Capital Investors II, dated March 30, 1995.

10.18    Promissory  Note between  Arizona  Instrument  Corporation  and Classic
         Syndicate, Inc., dated April 15, 1996.

10.19    Loan Modification  Agreement between Arizona Instrument Corporation and
         Silicon Valley Bank related to a new Promissory Note, dated November 7,
         1995.

10.20    Promissory  Note between  Arizona  Instrument  Corporation  and Silicon
         Valley Bank, dated November 7, 1995.

10.21    Agreement  between  Arizona  Instrument  Corporation and Bridge Capital
         Investors II,  regarding  the terms for  prepayment of the Bridge Note,
         dated November 27, 1995.

22.1     Subsidiaries:  Quintel  International,  Inc.,  incorporated  under  the
         Companies Act of 1982 of Barbados, W.I.; Computrac International, Inc.,
         an Arizona  Corporation,  Horizon  Engineering  and  Testing  Inc.,  an
         Arizona  Corporation,   each  of  which  is  wholly  owned  by  Arizona
         Instrument Corporation.

24.1     Accountants' Consent (filed herewith).

27       Financial Data Schedule (filed herewith).

(b)      There were no reports on Form 8-K for the year ended December 31, 1996

         * Management Contract or compensatory plan or arrangement.
<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 28, 1997                   By:   /s/ John P. Hudnall
     ----------------                      --------------------------------
                                              John P. Hudnall, 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/ Walfred R. Raisanen            Chairman of the Board of                March 28, 1997
-----------------------                                                    --------------
Walfred R. Raisanen                Directors

/s/ John P. Hudnall                President and Director (Princi-         March 28, 1997
-----------------------                                                    --------------
John P. Hudnall                    pal Executive Officer)

/s/ George G. Hays                 Chief Financial Officer                 March 28, 1997
-----------------------                                                    --------------
George G. Hays                     (Principal Financial and
                                   Accounting Officer)

/s/ Quinn Johnson                  Director                                March 28, 1997
-----------------------                                                    --------------
Quinn Johnson

/s/ Richard Long                   Director                                March 28, 1997
-----------------------                                                    --------------
Richard Long

/s/ S. Thomas Emerson              Director                                March 28, 1997
-----------------------                                                    --------------
S. Thomas Emerson

/s/ Patricia Onderdonk             Director                                March 28, 1997
-----------------------                                                    --------------
Patricia Onderdonk

/s/ Stanley H. Weiss               Director                                March 28, 1997
-----------------------                                                    --------------
Stanley H. Weiss

/s/ Steven Zylstra                 Director                                March 28, 1997
-----------------------                                                    --------------
Steven Zylstra
</TABLE>