<PAGE>
Chem International, Inc. 1997 Annual Report
<PAGE>
A Company Profile
<TABLE>
<CAPTION>
<S> <C>
Chem International, Inc. manufactures The Company's subsidiary, Manhattan
markets and sells vitamins, nutritional Drug Company, Inc. manufactures and
supplements and herbal products. The and sells its products for sale to
Company manufactures its products in distributors and multi-level marketers.
tablet and capsule form at its 100,000 The Company also operates a retail store
square foot manufacturing and mail order business under its own
facilities in Hillside, N.J. private label "Vitamin Factory".
</TABLE>
<PAGE>
To Our Shareholders
During our first year of operation as a public company, we have taken important
steps to poise the Company for future growth.
Our core business remains the manufacturing, marketing and sales of vitamins,
nutritional supplements and herbal products. While not the largest in the
industry, we have established an excellent reputation within our industry.
This past year, we set two strategic directions. One was to diversify our
customer base; the other was to increase the retail market segment of our
business. We are pleased to report that we have made significant progress on
both fronts.
We now have a broader customer base and have reduced our dependency on a single
customer who has developed its own manufacturing capacities. We have achieved
this goal by identifying other partners with potential to grow. For example, in
February, 1997, we announced that we signed a two-year, renewable distribution
agreement with Roche Vitamins, Inc. to service and supply Roche products to a
select segment of Roche's food, nutrition and cosmetic accounts.
Later in the year, we increased the retail market segment of our business by
adding our first proprietary product to our existing retail store and mail order
trade. We signed an exclusive agreement with The International Nutrition
Research Center, Inc. to market and distribute MAP, a new patented unique food
supplement in the sports nutrition field. We are supporting the new brand with
a strong integrated marketing program including print and radio advertising,
and public relations.
To support these business developments and increase profits, we are committed to
achieve greater manufacturing efficiencies and lower cost of materials. To that
effect, we have commenced an extensive renovation of our factory in July . It is
expected to be completed by year-end. In addition, we are establishing new
relationships with suppliers of raw material.
We are proud of our achievements this year, and look forward to building on our
strengths in the coming year.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
The following discussion should be read in conjunction with the historical
financial statements of the Company and notes thereto.
Results of Operations
Year ended June 30, 1997 Compared to the Year ended June 30, 1996
The Company's net [loss] for the year ended June 30, 1997 was $(654,304) as
compared to net income of $42,198 for the year ended June 30, 1996. This
decrease in net income of approximately $700,000 is primarily the result of a
$1,200,000 decrease in operating income resulting from a decrease in gross
profit of approximately $650,000 and an increase in selling and administrative
expenses of approximately $550,000 for the year ended June 30, 1997 as compared
to the year ended June 30, 1996. The decrease in gross profit is due to a higher
percentage of sales to lower margin customers and an increase in raw material
costs.
Cost of sales increased to $9,475,624 in 1997 as compared to $8,343,179 for
1996. Cost of sales increased as a percentage of sales to 85% as compared to 78%
for 1996. The increase in cost of sales is due to an increase in material costs.
The Company has begun to develop new raw material suppliers whereby the Company
can achieve a lower cost of materials.
Selling and administrative expenses for the year ended June 30, 1997 were
$2,546,972 versus $1,990,997 for the same period a year ago. The increase of
$555,975 was primarily attributable to an increase in officers' compensation of
approximately $225,000, an increase in office salaries of approximately $25,000,
a decrease in professional fees of approximately $38,000, a decrease in travel
and entertainment of approximately $21,000, an increase in consulting fees of
approximately $207,000, a decrease in office rent of approximately $22,000, an
increase in advertising and catalog costs of approximately $117,000 and an
increase in payroll tax expense of approximately $9,000.
Other income [expense] was $(4,588) for the year ended June 30, 1997 as compared
to $(127,823) for the same period a year ago. This increase of $123,235 is
attributable to a decrease in sales of fixed assets of $39,000, an increase of
$38,778 from a 50% owned partnership, a decrease in interest expense of $85,600
and an increase in interest and investment income of $37,857.
The Company began in July of 1997 a renovation of its blending department.
Management expects the renovation to be completed by October 15, 1997 and
expects to achieve greater manufacturing efficiencies as a result.
Sales for the years ended June 30, 1997 and 1996 were $11,126,860 and
$10,637,797, respectively, an increase of approximately $490,000 or 5%. For the
year ended June 30, 1997, the Company had sales to one customer, who accounted
for 48% of net sales in 1997 and 40% of net sales in 1996. The loss of this
customer would have an adverse affect on the Company's operations.
Retail and mail order sales for the year ended June 30, 1997 totaled $983,749 as
compared to $756,711 for the year ended June 30, 1996, an increase of $227,038
or 30%.
On February 17, 1997, the Company signed a distribution agreement with Roche
Vitamins, Inc. to service and supply Roche products to a select segment of
Roche's food, nutrition and cosmetic accounts. The agreement has an initial term
of two years and shall be renewable for additional terms of one year each. Sales
for the period from February 20, 1997 through June 30, 1997 under the agreement
totaled $308,259.
1
<PAGE>
Results of Operations [Continued]
Year ended June 30, 1997 Compared to the Year ended June 30, 1996 [Continued]
In 1997, the Company signed an exclusive agreement with International Nutrition
Research Center, Inc. ["INRC"] to market and distribute the Master Amino Acid
Pattern ["MAP"]. MAP is a new patented unique food supplement in the sports
nutrition field and is specifically recommended for professional and weekend
athletes who need to maximize protein synthesis. MAP is being marketed
exclusively by "The Vitamin Factory, Inc." a subsidiary of the Company through
mail order. MAP represents the first proprietary product developed for sale by
the Company.
On July 7, 1997, the Company was informed by one of its suppliers of a recall of
the supplier's raw material used in the manufacturing of tablets sold containing
the recalled raw material. On July 17, 1997, the Company issued a voluntary
recall to three customers affected by this and accordingly reduced its sales and
accounts receivable at June 30, 1997 by $127,000. The Company believes they have
recourse against the supplier for the full value of the tablets sold containing
the recalled raw material. In September, the Company instituted suit to recover
all damages.
Year ended June 30, 1996 ["Fiscal 1996"] Compared to the Year ended June 30,
1995 ["Fiscal 1995"]
Net sales for fiscal 1996 were $10,637,797, a decrease of $6,204,664, or 37%
from $16,842,461 for fiscal 1995. The decrease is directly related to a decrease
in sales to a major customer as well as a decrease in the total number of units
sold. Sales to such customer accounted for approximately 40% and approximately
76% of the Company's total sales in fiscal 1996 and fiscal 1995, respectively.
Retail and mail order sales were $756,711 for fiscal 1996, an increase of
$176,135 or 30% over fiscal 1995.
Cost of sales decreased to $8,343,179 for fiscal 1996 compared to $13,634,757
for fiscal 1995. Cost of sales decreased as a percentage of sales to 78% for
fiscal 1996 from 81% for fiscal 1995. The decrease as a percentage of product
sales was due to an increase in bottling and packaging services which carry a
lower cost percentage than bulk manufacturing. Additionally, retail and mail
order sales carry a lower cost percentage.
Selling and administrative expenses decreased 22% to $1,990,997 in fiscal 1996
as compared to $2,543,354 for fiscal 1995. The decrease of $552,357 is primarily
attributable to the following factors: (i) a decrease in advertising expenses of
$56,424, or 26%, to $159,447 for fiscal 1996 from $215,871 for fiscal 1995, due
to a decrease in magazine advertising; (ii) a decrease in professional fees of
$84,395, or 27%, to $225,916 for fiscal 1996 from $310,311 for fiscal 1995;
(iii) a decrease in officers' salaries of $329,162, or 61%, to $207,838 for
fiscal 1996 from $537,000 for fiscal 1995, as a result of a reduction in the
salary of a corporate officer; and (iv) a decrease in non-union pension and
profit-sharing plan expense of $59,675, or 125%, to a credit of $11,924 for
fiscal 1996 from a charge of $47,751 for fiscal 1995.
Other income/[expense] was $(127,823) for fiscal 1996 as compared to $686 for
fiscal 1996. This decrease of $128,509 is attributable to the following factors
(i) an increase in interest expense of $116,645 due to an $80,000 non-cash
charge for debt issuance costs related to the Bridge Units, a decrease in
imputed interest of $15,265 and an increase in line of credit borrowings; (ii) a
loss of $36,998 in fiscal 1996 from a 50%-owned partnership; (iii) an increase
in sales of fixed assets to $64,000 for fiscal 1996 from $11,452 for fiscal
1995; and (iv) a decrease in interest and investment income of $27,414.
2
<PAGE>
Liquidity and Capital Resources
At June 30, 1997, the Company's working capital was $4,032,402 an increase of
$1,687,544 over working capital at June 30, 1996. Cash and cash equivalents were
$1,010,256 at June 30, 1997 an increase of $245,191 from June 30, 1996. The
Company utilized $1,776,278 and $450,098 for operations for the years ended June
30, 1997 and 1996, respectively. The primary reasons for the increase in cash
utilized for operations are (a) an increase in inventories of approximately
$650,000 resulting from the new product, MAP, and an increased volume in the
mail order business and (b) the increase in accounts receivable of approximately
$400,000 resulting from an increase of approximately $1 million in sales for the
quarter ended June 30, 1997 versus the quarter ended June 30, 1996. The Company
utilized $660,004 and $300,874 in investing activities for the years ended June
30, 1997 and 1996, respectively. The Company generated $2,681,473 from financing
activities for the year ended June 30, 1997, primarily the net result of net
proceeds of approximately $3,400,000 from a public offering of common stock
offset by the payment of notes payable of approximately $1,200,000 The Company
utilized $354,710 from financing activities for the year ended June 30, 1996.
On February 3, 1997, the Company received a secured promissory note in the
amount of $250,000 with interest at 14% per annum. The note is due and payable
on November 3, 1997. Advance interest of $26,250 was payable out of the proceeds
of the loan and is taken into income over the period of the loan.
On October 29, 1996, the Company successfully completed a public offering
whereby the Company sold 632,500 units at $7.00 per unit, each unit consisting
of two shares of Common Stock and two Class A Redeemable Common Stock Purchase
Warrants. The net proceeds to the Company after deducting underwriting discounts
and commission of $575,575 and other expenses of the offering of $442,310 were
$3,357,170.
The Company has a $500,000 revolving line of credit agreement with a bank which
bears interest at .75% above the bank's prime lending rate and expires on
November 30, 1997. At June 30, 1997, there was no balance due under the line of
credit agreement. The Company has additionally secured a five year equipment
term loan with interest at 1.50% over the bank's prime lending rate. At June 30,
1997, the balance due under the equipment loan was $206,653.
The Company's total annual principal commitments at June 30, 1997 for the next
five years of $1,709,704 consists of obligations under operating leases for
facilities and a lease agreements for the rental of warehouse equipment, office
equipment and automobiles.
Effective July 1, 1996, the Company entered into employment agreements with each
of its five executive officers providing for aggregate compensation in the
amount of $580,000 for the fiscal year ending June 30, 1997. In 1998, the total
annual employment agreements will total $680,000. Such compensation amounts to
an approximate increase of $200,000 as compared to fiscal 1996.
On October 29, 1996, the date of the public offering, the Company repaid the
bridge lenders $300,000 plus accrued interest.
Management expects to renew the $500,000 line of credit which expires on
November 30, 1997. In the event that the Company requires additional working
capital the Company would have to either increase its line of credit or engage
in sales of its equity securities. There can be no assurance that any line of
credit increases or sales of equity securities can be accomplished on conditions
favorable to the Company.
3
<PAGE>
New Authoritative Pronouncements
The FASB has issued SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities." SFAS No. 125 is effective
for transfers and servicing of financial assets and extinguishment of
liabilities occurring after December 31, 1996. Earlier application is not
allowed. The provisions of SFAS No. 125 must be applied prospectively;
retroactive application is prohibited. Adoption on January 1, 1997 is not
expected to have a material impact on the Company. The FASB deferred some
provisions of SFAS No. 125, which are not expected to be relevant to the
Company.
The FASB issued Statement of Financial Accounting Standards ["SFAS"] No. 128,
"Earnings Per Share," and SFAS No. 129, "Disclosure of Information about Capital
Structure" in February 1997. SFAS No. 128 simplifies the earnings per share
["EPS"] calculations required by Accounting Principles Board ["APB"] Opinion No.
15, and related interpretations, by replacing the presentation of primary EPS
with a presentation of basic EPS. SFAS No. 128 requires dual presentation of
basic and diluted EPS by entities with complex capital structures. Basic EPS
includes no dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution of securities that could
share in the earnings of an entity, similar to the fully diluted EPS of APB
Opinion No. 15. SFAS No. 128 is effective for financial statements issued for
periods ending after December 15, 1997, including interim periods; earlier
application is not permitted. When adopted, SFAS No. 128 will require
restatement of all prior-period EPS data presented; however, the Company has not
sufficiently analyzed SFAS No. 128 to determine what effect SFAS No. 128 will
have on its historically reported EPS amounts.
SFAS No. 129 does not change any previous disclosure requirements, but rather
consolidates existing disclosure requirements for ease of retrieval.
The FASB has issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130
is effective for fiscal years beginning after December 15, 1997. Earlier
application is permitted. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. SFAS No. 130 is not
expected to have a material impact on the Company.
The FASB has issued SFAS No. 131, "Disclosures About Segments of an Enterprise
and Related Information." SFAS No. 131 changes how operating segments are
reported in annual financial statements and requires the reporting of selected
information about operating segments in interim financial reports issued to
shareholders. SFAS No. 131 is effective for periods beginning after December 15,
1997, and comparative information for earlier years is to be restated. SFAS No.
131 need not be applied to interim financial statements in the initial year of
its application. SFAS No. 131 is not expected to have a material impact on the
Company.
Impact of Inflation
The Company does not believe that inflation has significantly affected its
results of operations.
4
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Stockholders and Board of Directors of
Chem International, Inc.
We have audited the accompanying consolidated balance sheet of
Chem International, Inc. and its subsidiaries as of June 30, 1997, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the consolidated financial
position of Chem International, Inc. and its subsidiaries as of June 30, 1997,
and the consolidated results of their operations and their cash flows for the
year then ended in conformity with generally accepted accounting principles.
MOORE STEPHENS, P. C.
Certified Public Accountants.
Cranford, New Jersey
September 10, 1997
6
<PAGE>
Independent Auditors' Report
To the Stockholders of
Chem International, Inc.
We have audited the accompanying consolidated statements of income,
stockholders' equity and cash flows of Chem International, Inc. and Subsidiaries
for the year ended June 30, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated results of
operations, changes in stockholders' equity and consolidated cash flows of Chem
International, Inc. and Subsidiaries for the year ended June 30, 1996, in
conformity with generally accepted accounting principles.
CORNICK, GARBER & SANDLER, LLP
CERTIFIED PUBLIC ACCOUNTANTS
New York, New York
September 4, 1996
7
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1997.
Assets:
Current Assets:
Cash and Cash Equivalents $ 1,010,256
Accounts Receivable - Net 2,464,708
Note Receivable 238,373
Inventories 2,086,366
Prepaid Expenses and Other Current Assets 291,389
Refundable Federal Income Taxes 240,000
---------------
Total Current Assets 6,331,092
---------------
Property and Equipment - Net 1,072,049
---------------
Other Assets:
Goodwill 293,872
Prepaid Pension Costs 340,291
Security Deposits and Other Assets 103,344
---------------
Total Other Assets 737,507
---------------
$ 8,140,648
===============
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
8
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1997.
Liabilities and Stockholders' Equity:
Current Liabilities:
Notes Payable $ 48,203
Accounts Payable 1,761,962
Federal and State Income Taxes Payable 41,416
Accrued Expenses and Other Current Liabilities 175,109
Accrued Expenses - Related Party 272,000
---------------
Total Current Liabilities 2,298,690
---------------
Non-Current Liabilities:
Notes Payable 234,171
Notes Payable - Related Party 276,444
---------------
Total Non-Current Liabilities 510,615
---------------
Commitments and Contingencies [14] --
---------------
Stockholders' Equity:
Preferred Stock - Authorized 1,000,000 Shares,
$.002 Par Value, No Shares Issued --
Common Stock - Authorized 25,000,000 Shares,
$.002 Par Value, 4,335,000 Shares Issued and Outstanding 8,670
Additional Paid-in Capital 4,196,072
Retained Earnings 1,126,601
---------------
Total Stockholders' Equity 5,331,343
---------------
Total Liabilities and Stockholders' Equity $ 8,140,648
===============
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
9
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended
June 30,
1997 1996
---- ----
Sales $ 11,126,860 $ 10,637,797
Cost of Sales 9,475,624 8,343,179
------------ ------------
Gross Profit 1,651,236 2,294,618
Selling and Administrative Expenses 2,546,972 1,990,997
------------ ------------
Operating [Loss] Income (895,736) 303,621
------------ ------------
Other Income [Expense]:
Gain on Sale of Fixed Assets 25,000 64,000
Interest Expense (85,696) (171,296)
Interest Expense - Related Party (14,099) (14,099)
Interest and Investment Income 68,427 30,570
Income [Loss] on Investment in Partnership 1,780 (36,998)
----------- ------------
Other Income [Expense] - Net (4,588) (127,823)
----------- ------------
[Loss] Income Before Income Taxes (900,324) 175,798
Federal and State Income Tax [Benefit] Expense (246,020) 133,600
----------- ------------
Net [Loss] Income $ (654,304) $ 42,198
=========== ============
Net [Loss] Income Per Share $ (.16) $ .01
=========== ============
Average Common Shares Outstanding 4,007,877 3,081,000
=========== ============
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
10
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED JUNE 30,
1997 AND 1996.
<TABLE>
<CAPTION>
Additional Total
Common Stock Preferred Paid-in Retained Stockholders'
Shares Par Value Stock Capital Earnings Equity
------ --------- ----- ------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance - July 1, 1995 1,000,000 $ 2,000 $ 473 $ 593,859 $ 1,658,707 $ 2,255,039
Contribution of Stock of
Bioscience Technologies, Inc. -- -- -- 2,977 -- 2,977
Conversion of Class B Preferred
Stock 2,000,000 4,000 (160) 12,160 -- 16,000
Redemption of Class A Preferred
Stock -- -- (313) (156,160) -- (156,473)
Sale of Common Stock in Private
Placement 70,000 140 -- 155,141 -- 155,281
Issuance of Bridge Units 300,000 600 -- 1,199,400 -- 1,200,000
Reversal of Liabilities Assumed on
Reverse Acquisition -- -- -- 61,656 -- 61,656
Imputed Interest on Note Payable -
Related Party -- -- -- 14,099 -- 14,099
Net Income -- -- -- -- 42,198 42,198
--------- --------- --------- --------- ------------ ------------
Balance - June 30, 1996 3,370,000 6,740 -- 1,883,132 1,700,905 3,590,777
Reversal of Issuance of
Bridge Units (300,000) (600) -- (1,199,400) 80,000 (1,120,000)
Imputed Interest on Note
Payable - Related Party -- -- -- 14,099 -- 14,099
Issuance of Stock Options -- -- -- 143,601 -- 143,601
Net Proceeds from Public
Offering 1,265,000 2,530 -- 3,354,640 -- 3,357,170
Net [Loss] -- -- -- -- (654,304) (654,304)
------------ ------------ ------------ ---------- ------------ ------------
Balance - June 30, 1997 4,335,000 $ 8,670 $ -- $4,196,072 $ 1,126,601 $ 5,331,343
============ ============ ============ ========== ============ ============
</TABLE>
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
11
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended
June 30,
1 9 9 7 1 9 9 6
------- -------
<S> <C> <C>
Operating Activities:
Net [Loss] Income $ (654,304) $ 42,198
--------------- ---------------
Adjustments to Reconcile Net [Loss] Income to Net Cash
[Used for] Operating Activities:
Depreciation and Amortization 310,395 338,838
Lease Termination Items (108,753) --
Noncurrent Rent Charge -- 35,595
Deferred Income Taxes 27,000 (82,955)
Imputed Interest on Note Payable - Related Party 14,099 14,099
[Gain] Loss on Investment in Partnership (1,780) 36,998
Interest Income on Note Receivable (14,623) --
Bad Debt Expense 23,779 13,262
[Gain] on Sale of Property and Equipment (25,000) (64,000)
Consulting Expense - Stock Options 143,601 --
Changes in Assets and Liabilities:
[Increase] Decrease in:
Accounts Receivable (291,987) (838,599)
Inventories (653,134) (505,271)
Prepaid Expenses and Other Current Assets (241,332) (39,557)
Prepaid Pension Costs (45,957) (45,110)
Security Deposits and Other Assets (12,991) --
Increase [Decrease] in:
Accounts Payable (115,228) 536,580
Federal and State Income Taxes Payable (127,549) (24,032)
Accrued Expenses and Other Liabilities (2,514) 131,856
--------------- ---------------
Total Adjustments (1,121,974) (492,296)
--------------- ---------------
Net Cash - Operating Activities - Forward (1,776,278) (450,098)
--------------- ---------------
Investing Activities:
Investment in Partnership (5,000) --
Issuance of Note Receivable (223,750) --
Repayment of Loan from Related Company 16,849 --
Repayment of Note Payable - Stock Retirement (156,473) --
Purchase of Property and Equipment (316,499) (328,920)
Proceeds from Sale of Property and Equipment 25,000 64,000
Loans to Stockholders (92) (54,977)
Repayment of Loans by Stockholders -- 51,019
Repayment of Note Receivable 3,183 --
Repayment of Loan by Affiliated Company -- 12,837
Loan to Related Company (3,222) (16,127)
Investment in Split Dollar Life Insurance -- (28,706)
--------------- ---------------
Net Cash - Investing Activities - Forward $ (660,004) $ (300,874)
</TABLE>
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
12
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended
June 30,
1 9 9 7 1 9 9 6
------- -------
<S> <C> <C>
Net Cash - Operating Activities - Forwarded $ (1,776,278) $ (450,098)
--------------- ---------------
Net Cash - Investing Activities - Forwarded (660,004) (300,874)
--------------- ---------------
Financing Activities:
Proceeds from Public Offering 3,426,344 --
Net Proceeds from Bridge Note Financing -- 290,994
Proceeds from Notes Payable 412,744 394,156
Repayment of Notes Payable (1,157,615) (1,141,967)
Net Proceeds from Sale of Common Stock in Private Placement -- 155,281
Deferred Offering Costs -- (69,174)
Proceeds from Conversion of Class B Preferred Stock -- 16,000
--------------- ---------------
Net Cash - Financing Activities 2,681,473 (354,710)
--------------- ---------------
Net Increase [Decrease] in Cash and Cash Equivalents 245,191 (1,105,682)
Cash and Cash Equivalents - Beginning of Years 765,065 1,870,747
--------------- ---------------
Cash and Cash Equivalents - End of Years $ 1,010,256 $ 765,065
=============== ===============
Supplemental Disclosures of Cash Flow Information:
Cash paid during the years for:
Interest $ 59,000 $ 83,000
Income Taxes $ 168,000 $ 242,000
</TABLE>
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
The Company incurred offering costs of $69,174 as of June 30, 1996. These
costs were offset against the net proceeds of the public offering as reflected
in the consolidated statements of stockholders' equity for the year ended June
30, 1997.
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
13
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
[1] Business
Chem International, Inc. [the "Company"] is engaged primarily in the
manufacturing, marketing and sales of vitamins, nutritional supplements and
herbal products. Its customers are located primarily throughout the United
States.
[2] Summary of Significant Accounting Policies
Principles of Consolidation - The accompanying consolidated financial statements
include the accounts of the Company and its subsidiaries all of which are
wholly-owned. Intercompany transactions and balances have been eliminated in
consolidation.
Cash and Cash Equivalents - Cash equivalents are comprised of certain highly
liquid investments with a maturity of three months or less when purchased.
Inventories - The inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out method.
Depreciation - The Company follows the general policy of depreciating the cost
of property and equipment over the following estimated useful lives:
Machinery and Equipment 7 Years
Transportation Equipment 5 Years
Leasehold Improvements See Below
Effective July 1, 1995, the Company revised its estimate of the useful lives of
its leasehold improvements from 31 years to 15 years from date of acquisition.
This change in estimate increased depreciation expense by approximately $26,000
and decreased net income by approximately $16,000 for the year ended June 30,
1996.
Machinery and equipment are depreciated using accelerated methods while
leasehold improvements are amortized on a straight-line basis. Depreciation
expense was $298,408 and $326,851 for the years ended June 30, 1997 and 1996,
respectively.
Consulting Agreement - On October 29, 1996, the Company entered into a two year
consulting agreement for $88,550 with the underwriter of the Company's public
offering, which is being taken into expense over the term of the agreement. The
balance recorded at June 30, 1997 is approximately $59,000 and is included in
prepaid expenses and other assets.
Goodwill - Goodwill, representing the excess of cost over the fair value of the
net assets acquired of the Company's principal operating business subsidiary at
its date of its acquisition in 1981, is being amortized over 40 years on the
straight-line method. The Company carries its goodwill at its amortized cost,
subject to periodic review for impairment.
Amortization expense was $11,987 for each of the years ended June 30, 1997 and
1996.
Estimates - The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Earnings [Loss] Per Share - Earnings [loss] per common share are computed based
upon the weighted average number of common and common stock equivalents shares
outstanding during the periods presented after giving retroactive effect to the
1-for-4 reverse stock split in July 1996. Common stock equivalents are included
when dilutive.
14
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #2
[2] Summary of Significant Accounting Policies [Continued]
Revenue Recognition - The Company generally recognizes revenue upon shipment of
the product.
Impairment - Certain long-term assets of the Company including goodwill are
reviewed at least annually as to whether their carrying value has become
impaired, pursuant to guidance established in Statement of Financial Accounting
Standards ["SFAS"] No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of." Management considers assets to be
impaired if the carrying value exceeds the future projected cash flows from
related operations [undiscounted and without interest charges]. If impairment is
deemed to exist, the assets will be written down to fair value or projected
discounted cash flows from related operations. Management also re-evaluates the
periods of amortization to determine whether subsequent events and circumstances
warrant revised estimates of useful lives. As of June 30, 1997, management
expects these assets to be fully recoverable.
Stock Options Issued to Employees - The Company adopted the fair value method of
SFAS No. 123, "Accounting for Stock-Based Compensation," on July 1, 1996 for
financial note disclosure purposes and will continue to apply the intrinsic
value method of Accounting Principles Board ["APB"] Opinion No. 25, "Accounting
for Stock Issued to Employees," for financial reporting purposes.
Advertising - Costs incurred for producing and communicating advertising are
expensed when incurred. Advertising expense was $235,636 and $159,447 for the
years ended June 30, 1997 and 1996, respectively.
[3] Investment in and Advances to Partnership
The Company was a 50% partner in Swedish Herbal Institute - Chem Associates [the
"Partnership"]. In addition to its $1,000 capital investment, the Company had
advanced approximately $70,000 in exchange for a series of promissory notes. As
of June 30, 1996, the Partnership was insolvent and the Company recorded a loss
on its investment and a charge for approximately 50% of its note receivable for
the year ended June 30, 1996. The balance was assumed by the other 50% partner.
At June 30, 1997, the balance of this note is $32,317 and is included in other
assets.
[4] Investment in Manhattan Health Products, L.L.C.
The Company is a 50% partner in Manhattan Health Products, L.L.C. In June 1997,
the Company's capital investment was recorded at $5,000 and is included in other
assets.
[5] Inventories
Inventories consist of the following at June 30, 1997:
Raw Materials $ 892,022
Work-in-Process 450,970
Finished Goods 743,374
---------------
Total $ 2,086,366
----- ===============
15
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #3
[6] Property and Equipment
Property and equipment comprise the following at June 30, 1997:
Leasehold Improvements $ 826,209
Machinery and Equipment 1,861,913
Transportation Equipment 36,652
---------------
Total 2,724,774
Less: Accumulated Depreciation and Amortization 1,652,725
Total $ 1,072,049
----- ===============
[7] Note Receivable
On February 3, 1997, the Company received a secured promissory note in the
amount of $250,000 with interest at 14% per annum. The note is due and payable
on November 3, 1997. Prepaid interest of $26,250 was received and will be
amortized over the period of the loan.
[8] Notes Payable
Notes payable are summarized as follows at June 30, 1997:
<TABLE>
<CAPTION>
Related Party
Notes Payable Note Payable Total
------------- ------------- -----
<S> <C> <C> <C>
Notes Payable:
Bio Merieux Vitek, Inc. (a) $ 75,721 $ -- $ 75,721
Gerob Realty Partnership [See Note 14](b) -- 276,444 276,444
Summit Bank:
Revolving Line-of-Credit (c) -- -- --
Equipment Term Loan (d) 206,653 -- 206,653
---------------- --------------- --------------
Totals 282,374 276,444 558,818
Less: Current Portion 48,203 -- 48,203
---------------- --------------- --------------
Noncurrent Portion $ 234,171 $ 276,444 $ 510,615
------------------ ================ =============== ==============
</TABLE>
(a) Five year 10% equipment note dated April 1, 1997 providing for monthly
payments of $1,698 for principal and interest. The note is collateralized
by laboratory equipment.
(b) Noninterest bearing note due September 10, 1997. For financial reporting
purposes, interest has been imputed at 8.5% a year with the net of tax
effect being credited to additional paid-in capital. [See Notes 17 and
19A].
(c) Under the terms of a revolving line of credit which expires on November 30,
1997, the Company may borrow up to $500,000 at 3/4% above the bank's prime
rate. The loan is collateralized by accounts receivable, inventory and
machinery and equipment. The loan has been guaranteed by the Company's
president and principal stockholder. At June 30, 1997, there were no
borrowings under the line of credit.
16
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #4
[8] Notes Payable [Continued]
(d) Under the terms of an equipment term loan, due November 30, 2001, the
Company may borrow up to $350,000 at 1-1/2% above the bank's prime rate.
The term loan provides for monthly payments of $4,698 for principal and
interest. At June 30, 1997, the interest rate was 9.75%. The loan is
collateralized by machinery and equipment. The loan has been guaranteed by
the Company's president and principal stockholder.
The loan agreement with Summit Bank contains certain financial covenants
relating to the maintenance of specified liquidity, debt to equity and debt
coverage ratios and requires that the Company's president and principal
stockholder maintain a minimum stock ownership percentage of the Company. At
June 30, 1997, the Company was in compliance with all bank covenants.
The following are maturities of long-term debt for each of the next five years:
<TABLE>
<CAPTION>
Related Party
Notes Payable Note Payable Total
------------- ------------- -----
<S> <C> <C> <C>
June 30,
- --------
1998 $ 48,203 $ -- $ 48,203
1999 50,501 -- 50,501
2000 52,028 -- 52,028
2001 53,710 -- 53,710
2002 52,166 -- 52,166
Thereafter 25,766 276,444 302,210
---------------- --------------- --------------
Totals $ 282,374 $ 276,444 $ 558,818
------ ================ =============== ==============
</TABLE>
[9] Income Taxes
Provision for income taxes consists of the following:
Years Ended
June 30,
------------------------
1 9 9 7 1 9 9 6
------- -------
Currently Payable:
Federal $ (277,276) $ 162,000
State 4,256 54,555
--------------- ----------------
(273,020) 216,555
--------------- ----------------
Deferred:
Federal 22,950 (70,112)
State 4,050 (12,843)
--------------- ----------------
27,000 (82,955)
--------------- ----------------
Totals $ (246,020) $ 133,600
------ =============== ================
17
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #5
[9] Income Taxes [Continued]
Reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate is as follows:
Years Ended
June 30,
------------------
1997 1996
---- ----
U.S. Statutory Rate (34)% 34%
State Taxes on Income - Net of Federal Benefit (6) 6
Nondeductible Items:
Travel and Entertainment 4 11
Amortization of Deferred Bridge Loan Finance Costs -- 18
Amortization of Goodwill 2 3
Other - Net 1 4
Consulting Fees 6 --
---- ---
Effective Income Tax Rate (27)% 76%
------------------------- ===== ====
Deferred income taxes arise from temporary differences resulting from income and
expense reported for financial accounting and tax purposes in different periods.
The significant components of deferred tax assets and [liabilities] relate to
the following at June 30, 1997:
Inventory Cost $ 24,000
Other 6,000
Nondeductible Expense 109,000
Pension Benefit Obligation (136,000)
Depreciation Expense 14,000
---------------
Subtotal 17,000
Valuation Allowance 0
Total Net Deferred Tax Assets $ 17,000
----------------------------- ===============
The Company believes that net deferred tax assets, which are included in other
current assets, are more likely than not to be realized because all deductible
temporary differences will be utilized as charges against reversals of future
taxable temporary differences.
The Company and its subsidiaries file a consolidated federal income tax return.
[10] Pension Plans
The Company sponsors a noncontributory defined benefit pension plan covering all
nonunion employees meeting age and service requirements. Contributions to the
plan, which are made solely by the Company, are determined by an outside
actuarial firm. The Company made no contributions for 1997 or 1996,
respectively.
The defined benefit pension plan calls for benefits to be paid to eligible
employees at retirement based primarily upon years of service with the Company
and the average monthly compensation. Contributions to the plan reflect benefits
attributed to employees' services to date, as well as services expected to be
earned in the future. Plan assets consist primarily of marketable securities.
18
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #6
[10] Pension Plans [Continued]
Pension expense includes the following components:
<TABLE>
<CAPTION>
Years Ended
June 30,
------------------------
1 9 9 7 1 9 9 6
------- -------
<S> <C> <C>
Service Cost of the Current Period $ 27,920 $ 25,992
Interest Cost on the Projected Benefit Obligation 36,541 33,706
Actual Gain on Assets Held in the Plan (81,318) (75,708)
Net Amortization of Transition Liability and Net Gain (29,100) (29,100)
--------------- ----------------
Pension Expense [Credit] $ (45,957) $ (45,110)
------------------------ =============== ================
</TABLE>
The following sets forth the funded status of the plan and the amounts shown in
the accompanying balance sheet:
<TABLE>
<CAPTION>
1 9 9 7 1 9 9 6
------- -------
<S> <C> <C>
Actuarial Present Value of Benefit Obligations:
Vested Benefits $ (567,601) $ (491,317)
Nonvested Benefits -- (17,172)
-------------- --------------
Accumulated Benefit Obligation (567,601) (508,489)
Effect of Anticipated Future Compensation Levels and Other Events (31,187) (40,398)
-------------- --------------
Projected Benefit Obligation (598,788) (548,887)
Fair Value of Assets Held in the Plan 1,138,348 1,016,480
-------------- --------------
Excess of Plan Assets Over Projected Benefit Obligation 539,560 467,593
Unrecognized Transition Obligation 80,500 92,001
Unrecognized Net Gain from Past Experience Different than Assumed (279,769) (265,260)
-------------- --------------
Prepaid Pension Cost Included in the Balance Sheet $ 340,291 $ 294,334
-------------------------------------------------- ============== ==============
</TABLE>
The weighted average discount rate used to measure the projected benefit
obligation is 7% for 1997 and 7% for 1996, the rate of increase in future
compensation levels is 2% for 1997 and 2% for 1996 and the expected long-term
rate of return on assets is 7% for 1997 and 7% in 1996. The Company uses the
straight-line method of amortization of unrecognized gains and losses.
Additionally, the Company participates in a union sponsored multi-employer
defined contribution plan covering all union employees. Information relating to
accumulated benefits obligations and plan assets is not available. Under ERISA,
an employer, upon withdrawal from a multi-employer plan, is required to fund its
proportionate share of the plan's unfunded vested benefits at the point of
withdrawal. The Company has no intention of withdrawing from the plan. The
Company is required to fund the plan on the first of each month for the
preceding month's obligation. Total contributions were $48,960 and $46,320 for
the years ended June 30, 1997 and 1996, respectively.
[11] Profit-Sharing Plan
The Company maintains a profit-sharing plan which qualifies under Section 401(k)
of the Internal Revenue Code, covering all nonunion employees meeting age and
service requirements. Contributions are determined by matching a percentage of
employee contributions. The total expense for the years ended June 30, 1997 and
1996 was $32,596 and $33,186, respectively.
19
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #7
[12] Significant Risks and Uncertainties
[A] Concentrations of Credit Risk - Cash - The Company maintains balances at
several financial institutions. Accounts at each institution are insured by the
Federal Deposit Insurance Corporation up to $100,000. At June 30, 1997, the
Company's uninsured cash balances totaled approximately $907,000. The Company
does not require collateral in relation to cash credit risk.
[B] Concentrations of Credit Risk - Receivables - The Company routinely assesses
the financial strength of its customers and, based upon factors surrounding the
credit risk of its customers, establishes an allowance for uncollectible
accounts and, as a consequence, believes that its accounts receivable credit
risk exposure beyond such allowances is limited. The Company does not require
collateral in relation to its trade accounts receivable credit risk. The amount
of the allowance for uncollectible accounts at June 30, 1997 is $15,750.
[13] Major Customer
For the years ended June 30, 1997 and 1996, approximately 48% and 40% of
revenues were derived from one customer. The loss of this customer would have an
adverse affect on the Company's operations. In addition, for the years ended
June 30, 1997 and 1996, an aggregate of approximately 19% and 25%, respectively,
of revenues were derived from two other customers; no other customers accounted
for more than 10% of consolidated sales for the years ended June 30, 1997 and
1996. Accounts receivable from these customers comprised approximately 51% and
58% of total accounts receivable at June 30, 1997 and 1996, respectively.
[14] Commitments and Contingencies
[A] Leases
Related Party Leases - Certain manufacturing and office facilities are leased
from Gerob Realty Partnership ["Gerob"] whose partners are stockholders of the
Company. The lease, which expires on December 31, 1997, provides for a minimum
annual rental of $60,000 plus payment of all real estate taxes. Rent and real
estate tax expense for the years ended June 30, 1997 and 1996 on this lease was
approximately $143,000 and $172,000, respectively. Unpaid rent of $272,000 due
to Gerob at June 30, 1997 has been separately disclosed as accrued expenses on
the consolidated balance sheet.
The Company's original lease agreement with a non-related party for warehouse
and office facilities was terminated on January 10, 1997 when the landlord sold
the premises. At the time of sale the rentals under the lease were recorded for
financial accounting purposes on a straight-line basis. At December 31, 1996,
accrued future rentals of $105,613, which give effect to both future scheduled
increases and certain concessions at the lease inception had been recorded as a
non-current liability. Because of the termination of the lease the balance of
accrued future rentals of $105,613 has been allocated to rent expense in the six
month period ended June 30, 1997. The Company subleased a portion of its
premises on a month-to-month basis through January 10, 1997 for approximately
$25,000 a month.
Other warehouse and office facilities are leased from Vitamin Realty Associates,
L.L.C., a limited liability company, which is 90% owned by the Company's
president and principal stockholder and certain family members and 10% owned by
the Company's chief financial officer. The lease was effective on January 10,
1997 and provides for minimum annual rental of $346,000 through January 10, 2002
plus increases in real estate taxes and building operating expenses. At its
option, the Company has the right to renew the lease for an additional five year
period.
Other Lease Commitments - The Company leases warehouse equipment for a five year
period providing for an annual rental of $15,847 and office equipment for a five
year period providing for an annual rental of $8,365.
20
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #8
[14] Commitments and Contingencies [Continued]
[A] Leases [Continued]
Other Lease Commitments [Continued] - The Company leases automobiles under
non-cancelable operating lease agreements which expire through 2000.
The minimum rental commitment for long-term non-cancelable leases is as follows:
<TABLE>
<CAPTION>
Related Party
Lease Lease
Commitment Commitment Total
---------- ---------- -----
<S> <C> <C> <C>
Year Ending
June 30,
1998 $ 37,077 $ 346,000 $ 383,077
1999 32,384 346,000 378,384
2000 31,703 346,000 377,703
2001 24,212 346,000 370,212
2002 17,719 182,609 200,328
Thereafter -- -- --
---------------- --------------- --------------
Total $ 143,095 $ 1,566,609 $ 1,709,704
----- ================ =============== ==============
</TABLE>
Total rent expense, including real estate taxes and maintenance charges, was
approximately $285,000 and $526,000 for the years ended June 30, 1997 and 1996,
respectively. Rent expense is stated net of sublease income of approximately
$160,000 and $200,000 for the years ended June 30, 1997 and 1996, respectively.
[B] Employment Agreements - Effective July 1, 1996, the Company entered into
three year employment agreements with its president and four other officers
which provide for aggregate annual salaries of $580,000 for the year ending June
30, 1997 and $680,000 for the year ending June 30, 1998. These agreements are
subject to annual increases equal to at least the increase in the consumer price
index for the Northeastern United States. An agreement with one of the officers
also provided for a $100,000 signing bonus, which was expensed during the year
ended June 30, 1997.
[C] Litigation - Numerous unrelated manufacturers, distributors, suppliers,
importers and retailers of manufactured L-tryptophan are or were defendants in
lawsuits seeking compensation and punitive damages for alleged personal injury
from ingestion of products containing manufactured L-tryptophan. A number of
these suits have been settled or discontinued. Additional suits may be filed.
Prior to a request from the FDA in November 1989 for a national, industry-wide
recall, the Company halted sales and distribution and also ordered a recall of
L-tryptophan products. Subsequently, the FDA indicated that there is a strong
link between the ingestion of the allegedly contaminated L-tryptophan and a
blood disorder. There has been no indication that the blood disorder was caused
by any formulation or manufacturing fault of the Company or any of the other
firms that manufactured tablets and/or capsules containing L-tryptophan.
The Company and certain companies in the vitamin industry, including
distributors, wholesalers and retailers, have entered into an Indemnification
Agreement with Showa Denko America, Inc. ["SDA"], which appears to have been the
supplier of all of the alleged contaminated L-tryptophan products. SDA has
assumed the defense of all claims against the Company arising out of the
ingestion of L-tryptophan products and has agreed to pay the legal fees and
expenses in that defense. SDA's parent company has agreed to guarantee SDA's
obligation therein. SDA has posted a revolving irrevocable letter of credit, in
the amount of $20,000,000, to be used for the benefit of the Company and other
indemnified parties.
21
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #9
[14] Commitments and Contingencies [Continued]
[C] Litigation [Continued] - Manhattan Drug has product liability insurance,
which the Company believes provides coverage for all of its L-tryptophan
products subject to these claims, including legal defense costs. Based upon the
aforementioned indemnification arrangements, the Company's product liability
insurance and the product liability insurance of its suppliers, the Company does
not believe the outcome of these actions will have a material adverse effect on
the Company, and, accordingly, no provision has been made for any loss that may
be incurred by the Company as a result of these actions.
[15] Related Party Transactions
During the year ended June 30, 1997, the Company entered into a consulting
agreement with the brother of the Company's president on a month to month basis
for $1,000 per month for the year ended June 30, 1997. The total consulting
expense recorded per this verbal agreement by the Company was $11,000.
[16] Fair Value of Financial Instruments
Generally accepted accounting principles require disclosing the fair value of
financial instruments to the extent practicable for financial instruments which
are recognized or unrecognized in the balance sheet. The fair value of the
financial instruments disclosed herein is not necessarily representative of the
amount that could be realized or settled, nor does the fair value amount
consider the tax consequences of realization or settlement.
In assessing the fair value of financial instruments, the Company uses a variety
of methods and assumptions, which are based on estimates of market conditions
and risks existing at the time. For certain instruments, including cash and cash
equivalents, accounts receivable, notes receivable, accounts payable, and
accrued expenses, it was estimated that the carrying amount approximated fair
value because of the short maturities of these instruments. Short-term debt and
long-term debt including long-term debt to a related party is based on current
rates at which the Company could borrow funds with similar remaining maturities
and approximates fair value.
[17] Equity Transactions
[A] Capital Stock - Effective December 27, 1994, the Company and Frog
Industries, Ltd. ["Frog"], an inactive corporation, executed a plan of Merger
whereby the Company was merged into Frog [the "Merger"]. Each share of the
Company's then outstanding voting common stock was exchanged for 30,357 shares
of Frog's voting common stock. Each issued share of the Company's then
outstanding preferred stock was converted into one share of non-voting Class A
preferred stock and .51127 shares of non-voting Class B convertible preferred
stock of Frog, resulting in 156,473 shares of outstanding Class A preferred
stock and 80,000 shares of outstanding Class B preferred stock, with a par value
of $313 and $160, respectively. Simultaneously with the Merger, Frog changed its
name to Chem International, Inc.
For accounting purposes, the transaction has been treated as an acquisition of
Frog by the Company. As of the date of the Merger, Frog was inactive, had no
assets and had recorded liabilities of $61,656 for possible income and other tax
liabilities and for certain unstated judgments. Since the Company attributed no
value to its shares issued or recorded any "goodwill" in the acquisition, it
recorded the $61,656 excess of liabilities assumed over assets acquired as a
direct charge to additional paid-in capital. As a result of the Company's
subsequent reincorporation in Delaware in February 1996, it eliminated all
delinquent tax filings. Also, management now believes that the likelihood of any
prior outstanding claims or judgments being asserted against Frog is remote.
Accordingly, the previously recorded liabilities have been reversed and credited
to additional paid-in capital at June 30, 1996.
22
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #10
[17] Equity Transactions [Continued]
[A] Capital Stock - The Class A preferred stock was entitled to receive
dividends, as and when declared, up to a total of $1,853,527 [the "Aggregate
Class A Preferred Stock Dividend Preference"] and in no event, so long as any
shares of Class A preferred stock were outstanding, could any dividends be paid
on any shares of common stock or Class B preferred stock be purchased by the
Company unless all dividends were paid on the Class A preferred stock.
In February 1996, the 80,000 shares of Class B preferred stock were converted
into 2,000,000 shares of common stock. The preferred stockholders also paid the
Company $16,000, equal to the then par value of the common shares issued.
In June 1996, the aggregate Class A Preferred Stock Dividend Preference was
waived, when the 156,473 outstanding shares of Class A preferred stock were
redeemed for $1 a share and retired.
In February 1996, the Company [a New York corporation] was merged into its
wholly-owned subsidiary, Chem International, Inc. [a Delaware corporation],
pursuant to Section 253 of the Delaware Corporation Law for the sole purpose of
changing its domicile. As a result thereof and after giving effect to
restatements to the Company's certificate of incorporation subsequent to the
conversions and retirement of the previously outstanding Class A and Class B
preferred stock, the authorized capitalization of the Company is as follows:
Preferred Stock: Authorized 1,000,000 shares $.002 par value
Common Stock: Authorized 25,000,000 shares $.002 par value
The Board of Directors of the Company has the right to determine the
designations, rights, preferences and privileges of the holders of one or more
series of preferred stock which might be issued.
In May 1996, the Company sold, in a private placement, 70,000 shares of common
stock for $175,000. In June 1996, the Company also issued the equivalent of
300,000 Bridge Units [each consisting of one share of common stock and one
warrant to purchase a share of common stock at $5.50 a share for four years
following the offering] in connection with the sale of $300,000 of 7% promissory
notes to four investors. The Bridge Units were valued at $4 each, a total of
$1,200,000, which was being charged to operations over the term of the Bridge
Notes. On October 16, 1996, the Bridge Lenders waived their rights to the bridge
units and agreed to the cancellation of the underlying securities. Accordingly,
the Company has eliminated the amount previously recorded for the bridge units
and the related bridge loan finance costs of $80,000.
In July 1996, the Company affected a 1 for 4 reverse common stock split. The
foregoing amounts for common stock and the attached financial statements give
retroactive effect to the reverse stock split.
On October 29, 1996, the Company received net proceeds of approximately
$3,400,000 from the sale of 632,500 units at $7.00 per unit in a public
offering. Each unit consisted of two shares of Common Stock and two Class A
Redeemable Common Stock Purchase Warrants.
[B] Additional Paid-in Capital - On August 31, 1995, two shareholders, who are
members of the principal shareholder's family, contributed 100% of the issued
and outstanding shares of stock of Bioscience Technologies, Inc. to the Company.
The net book value of Bioscience Technologies, Inc. was credited to additional
paid-in capital. Its operations for the year ended June 30, 1995 and for the two
months ended August 31, 1995 were immaterial in relation to those of the
Company.
At June 30, 1996, previously recorded liabilities of $61,646 were credited to
additional paid-in capital concerning the reverse acquisition of Frog by the
Company [See Note 17A].
23
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #11
[17] Equity Transactions [Continued]
[B] Additional Paid-in Capital [Continued] - For financial accounting purposes,
interest of 8.5% a year is being imputed on a related party non-interest bearing
note [See Note 8(b)].
[C] Stock Option Plan - The Company has adopted a stock option plan for the
granting of options to employees, officers, directors and consultants of the
Company to purchase up to 1,000,000 shares of common stock, at the discretion of
the Board of Directors. Stock option grants are limited to a total of 500,000
shares for "incentive stock options" and 500,000 shares for "non-statutory
options" and, may not be priced less than the fair market value of the Company's
common stock at the date of grant. Options granted are generally for ten year
periods, except that options granted to a 10% stockholder [as defined] are
limited to five year terms. On October 16, 1996, options to purchase 573,597
shares at the offering price [$3.50] and 25,974 shares at 110% of the offering
price were granted. Such options become exercisable on October 16, 1997.
Information pertaining to options as of June 30, 1997 and for the year then
ended is as follows:
<TABLE>
<CAPTION>
Remaining
Contractual
Weighted Average Life
Common Exercise Price of Options
Shares Per Share Outstanding
------ --------- -----------
<S> <C> <C> <C>
Options Outstanding - July 1, 1995 -- $ -- --
Options Granted --
Options Exercised -- -- --
Options Canceled -- -- --
----------- -------------- ------------------
Options Outstanding - June 30, 1996 -- -- --
Options Granted at Stock Price 573,597 3.50 4.3 Years
Options Granted Above Stock Price 25,974 3.85 8.7 Years
Options Exercised -- -- --
Options Canceled -- -- --
----------- -------------- ------------------
Options Outstanding - June 30, 1997 599,571 $ 3.52 4.5 Years
----------------------------------- =========== ============== ==================
Options Exercisable - June 30, 1997 -- $ -- --
----------------------------------- =========== ============== ==================
</TABLE>
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations, for stock options
issued to employees in accounting for its stock option plan. Because no stock
options were issued below the stock price at date of grant, no compensation
expense has been recognized for the Company's stock-based compensation plan.
Had compensation cost for the Company's stock options issued to employees been
determined based upon the fair value at the grant date for stock options issued
under these plans pursuant to the methodology prescribed under the Statement of
Financial Accounting Standards ["SFAS"] No. 123, "Accounting for Stock-Based
Compensation," the Company's net loss and loss per share would have been
increased, on a pro forma basis, by approximately $935,000 or approximately $.24
per share for the year ended June 30, 1997. The weighted average fair value of
the stock options granted to employees used in determining the pro forma amounts
is estimated at $1.99 during the year ended June 30, 1997, using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in fiscal year 1997: dividend yields of 0%; expected
volatility of 64%; risk-free interest rate of 6.0%; and an expected life of 4.6
years.
24
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #12
[17] Equity Transactions [Continued]
[C] Stock Option Plan [Continued] - Net income [loss] and net income [loss] per
share as reported, and on a pro forma basis as if compensation cost had been
determined on the basis of fair value pursuant to SFAS No. 123 is as follows:
Year Ended
June 30,
1997
----
Net Income [Loss] - As Reported $ (654,304)
===============
Pro Forma $ (1,589,680)
===============
Income [Loss] Per Share - As Reported $ (.16)
===============
Pro Forma $ (.40)
===============
During the year ended June 30, 1997, the Company issued 75,000 stock options to
consultants at an exercise price equal to the market price [$3.50] on the date
of grant. The fair value of issuing these stock options to consultants during
the year ended June 30, 1997, is approximately $144,000 which is for consulting
services related to the public offering, and is being charged to paid-in
capital. The fair value of the stock options granted to consultants for the year
ended June 30, 1997 is estimated at $2.08 using the Black-Scholes option pricing
model and using a risk-free interest rate of 6.1%, an expected volatility of
64%, and an expected life of 5 years. No dividends are expected to be paid
during the expected life of the options.
[18] New Authoritative Pronouncements
The FASB has issued SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities." SFAS No. 125 is effective
for transfers and servicing of financial assets and extinguishment of
liabilities occurring after December 31, 1996. Earlier application is not
allowed. The provisions of SFAS No. 125 must be applied prospectively;
retroactive application is prohibited. Adoption on January 1, 1997 is not
expected to have a material impact on the Company. The FASB deferred some
provisions of SFAS No. 125, which are not expected to be relevant to the
Company.
The FASB issued Statement of Financial Accounting Standards ["SFAS"] No. 128,
"Earnings Per Share," and SFAS No. 129, "Disclosure of Information about Capital
Structure" in February 1997. SFAS No. 128 simplifies the earnings per share
["EPS"] calculations required by Accounting Principles Board ["APB"] Opinion No.
15, and related interpretations, by replacing the presentation of primary EPS
with a presentation of basic EPS. SFAS No. 128 requires dual presentation of
basic and diluted EPS by entities with complex capital structures. Basic EPS
includes no dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution of securities that could
share in the earnings of an entity, similar to the fully diluted EPS of APB
Opinion No. 15. SFAS No. 128 is effective for financial statements issued for
periods ending after December 15, 1997, including interim periods; earlier
application is not permitted. When adopted, SFAS No. 128 will require
restatement of all prior-period EPS data presented; however, the Company has not
sufficiently analyzed SFAS No. 128 to determine what effect SFAS No. 128 will
have on its historically reported EPS amounts.
SFAS No. 129 does not change any previous disclosure requirements, but rather
consolidates existing disclosure requirements for ease of retrieval.
25
<PAGE>
CHEM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #13
[18] New Authoritative Pronouncements [Continued]
The FASB has issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130
is effective for fiscal years beginning after December 15, 1997. Earlier
application is permitted. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. SFAS No. 130 is not
expected to have a material impact on the Company.
The FASB has issued SFAS No. 131, "Disclosures About Segments of an Enterprise
and Related Information." SFAS No. 131 changes how operating segments are
reported in annual financial statements and requires the reporting of selected
information about operating segments in interim financial reports issued to
shareholders. SFAS No. 131 is effective for periods beginning after December 15,
1997, and comparative information for earlier years is to be restated. SFAS No.
131 need not be applied to interim financial statements in the initial year of
its application. SFAS No. 131 is not expected to have a material impact on the
Company.
[19] Subsequent Events [Audited]
[A] Related Party Note - On August 15, 1997, the Company and Gerob extended the
terms of the Company's note payable [See Note 8(b)].
[B] Recall of Product - On July 7, 1997, the Company was informed by one of its
suppliers of a recall of the supplier's raw material used in the manufacturing
of tablets sold containing the recalled raw material. On July 17, 1997, the
Company issued a voluntary recall to three customers affected by this and
accordingly reduced its sales and accounts receivable at June 30, 1997 by
$127,000. The Company believes they have recourse against the supplier for the
full value of the tablets sold containing the recalled raw material. The Company
does not believe there will be any significant additional costs relating to this
recall.
[20] Subsequent Event [Unaudited]
In September of 1997 in connection with the product recall [Note 19B], the
Company instituted suit to recover all damages.
. . . . . . . . . . . . .
26
<PAGE>
Price Range of Common Stock
On October 30, 1996, the Company's units (Consisting of two shares of
Common Stock and two Class A Redeemable Warrants), Common Stock and Class A
Redeemable Warrants commenced trading on the National Association of Securities
---------
Dealers Automated Quotation SmallCap Market System "NASDAQ" under the symbols
CXILU, CXIL and CXILW, respectively. In November 1996 the Company unbundled its
public unit. In November 1996 the Company authorized NASDAQ to deist the Unit
(CXILU) and cease trading it. Prior to the Company's initial public offering in
October 1996 the Common Stock was traded sporadically in the over-the-counter
market on the NASD's Electronic Bulletin Board during the period commencing
December 18, 1995 through May 5, 1996, at which time it was voluntarily
withdrawn from trading.
The following table sets forth the high and low prices for each of the
Unit, the Common Stock and the Class A Redeemable Warrant for the periods
indicated as reported by NASDAQ.
HIGH LOW
UNITS (CXILU)
Time Period:
October 30, 1966 through November 27, 1996
(Trading ceased on November 29, 1996) 27 8
COMMON STOCK (CXIL)
Time Period:
October 30, 1996 through December 31, 1996 10 5 1/4
January 1, 1997 through March 31, 1997 10 1/4 6 1/4
April 1, 1997 through June 30, 1997 8 3/4 2 1/2
CLASS A REDEEMABLE WARRANTS (CXILW)
Time Period:
October 30, 1996 through December 31, 1996 5 2 1/4
January 1, 1997 through March 31, 1997 5 1/2 2 1/2
April 1, 1997 through June 30, 1997 4 3/4 3/8
27
<PAGE>
<TABLE>
<S> <C> <C>
Board of Directors SEC Form 10-KSB Stockholders Inquiries
E. Gerald Kay A copy of the Company's annual Inquiries regarding transfer
President, Chief Executive report to the Securities and requirements, lost certificates
Officer and Chairman of the Exchange Commission on Form and changes of address
Board 10-KSB is available without should be directed to the
charge upon written request to: the transfer agent.
Riva Kay Chief Financial Officer
Vice President Chem International, Inc. Transfer Agent and Registrar
225 Long Avenue Continental Stock Transfer
Christina Kay Hillside, N.J. 07205 And Trust Company
Vice President 2 Broadway
New York, N,Y. 10004
Robert Canarick Dividends
Vice President UVW The Company has not paid or Legal Counsel
Elizabeth Group LLC declared any dividends since Shanley & Fisher, P.C
its organization and has no 131 Madison Ave.
Leonard Stowe present intention of paying cash Morristown, N.J. 07962
Vice President Nations dividends on its Common Stock.
Credit Commercial Funding It is the present policy of the Independent Auditors
Board of Directors to retain Moore Shephens, P.C.
Corporate Officers all earnings, if any, to finance 340 North Avenue
E. Gerald Kay the development of the Cranford, N.J. 07016
President and Chief Company's business.
Executive Officer Number of Holders of
Corpoprate Headquarters Common Stock
Eric Friedman 225 Long Avenue As of June 30, 1997 there
Chief Financial Officer Hillside,N.J. 07205 were 163 holders of
and Vice President Telephone:973-926-0816 record of the Company's
Facsimile: 973-926-1735 Common Stock.
Riva Kay
Vice President
Christina Kay
Vice President
Eleanor DiMartino
Secretary
Ronald Smalley
Vice President-Technology
</TABLE>
