UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., 20549
FORM 10-KSB
ANNUAL REPORT FILED PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [Fee Required]
For the fiscal year ended December 31, 1997
Commission file No. 0-22024
BAYWOOD INTERNATIONAL, INC.
(Name of small business issuer in its charter)
Nevada
(state or other jurisdiction of incorporation or
organization)
77-0125664
(I.R.S. Employer Identification No.)
14950 North 83rd Place, Suite 1
Scottsdale, Arizona
(Address of principal executive offices)
85260
(Zip Code)
Issuer's telephone number, including area code: (602) 951-3956
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
$.001 par value common stock
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods 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 [ ]
Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is not contained herein, and will not be contained, to the best
of the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
Issuer's revenues for its most recent fiscal year were $3,234,056.
The aggregate market value of voting stock held by non-affiliates of the Company
was approximately $1,369,274 as of March 25, 1998.
The number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date of March 25, 1998 was 17,498,115.
<PAGE>
Baywood International, Inc.
FORM 10-KSB
FOR THE YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
-----------------
<TABLE>
<S> <C> <C>
PART I ........................................................................................4
Item 1 - Description of Business........................................................4
Item 2 - Description of Property........................................................9
Item 3 - Legal Proceedings..............................................................9
Item 4 - Submission of Matters to a Vote of Security Holders...........................11
PART II .......................................................................................11
Item 5 - Market for Common Equity and Related Stockholder Matters......................11
Item 6 - Management's Discussion and Analysis or Plan of Operation.....................11
Item 7 - Financial Statements and Supplementary Data...................................15
Item 8 - Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.............................................15
PART III .......................................................................................15
Item 9 - Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act....................15
Item 10 - Executive Compensation.......................................................17
Item 11 - Security Ownership of Certain Beneficial Owners, Management
and Changes in Control...............................................18
Item 12 - Certain Relationships and Related Transactions...............................21
Item 13 - Exhibits and Reports on Form 8-K.............................................23
SIGNATURES......................................................................................25
</TABLE>
-2-
<PAGE>
"CAUTION REGARDING FORWARD-LOOKING STATEMENTS"
CERTAIN STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT RELATED TO
HISTORICAL RESULTS, INCLUDING, WITHOUT LIMITATIONS, STATEMENTS REGARDING THE
COMPANY'S BUSINESS STRATEGY AND OBJECTIVES AND FUTURE FINANCIAL POSITION, ARE
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT AND SECTION 21E OF THE EXCHANGE ACT AND INVOLVE RISKS AND UNCERTAINTIES.
ALTHOUGH THE COMPANY BELIEVES THAT THE ASSUMPTIONS ON WHICH THESE
FORWARD-LOOKING STATEMENTS ARE BASED ARE REASONABLE, THERE CAN BE NO ASSURANCE
THAT SUCH ASSUMPTIONS WILL PROVE TO BE ACCURATE AND ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT
COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO,
THOSE SET FORTH IN THE FOLLOWING SECTION, AS WELL AS THOSE DISCUSSED ELSEWHERE
IN THIS REPORT. ALL FORWARD-LOOKING STATEMENTS CONTAINED IN THIS REPORT ARE
QUALIFIED IN THEIR ENTIRETY BY THIS CAUTIONARY STATEMENT.
Factors That May Affect Future Results
Management believes that results of operations in any annual period may
be impacted by factors such as delays in the shipment of new or existing
products, difficulty in the manufacturer acquiring critical product components
of acceptable quality and in required quantity, timing of product introductions,
increased competitions, the effect of announcements and marketing efforts of new
competitive products, a slower growth rate in the Company's target markets,
adverse currency valuations against the dollar in Far East markets, lack of
market acceptance of new products and adverse changes in economic conditions in
any of the countries in which the company does business. Specifically, the
timing of registration of new or existing products in different countries in
which the Company is doing business or may do business could delay orders. Also,
the significant portion of sales and net income contributed by international
operations, specifically by one customer, could affect the Company's results of
operations and financial condition in a particular year. Due to the factors
noted above, the Company's future earnings and stock price may be subject to
significant volatility. Any shortfall in revenues or earnings from levels
expected by the investing public or securities analysts could have an immediate
and significant adverse effect on the trading price of the Company's common
stock.
-3-
<PAGE>
PART I
Item 1 - Description of Business
- --------------------------------
General
Baywood International, Inc. (the "Company"), develops, markets and
distributes nutritional supplements and skin care products. The predecessor to
the Company, Baywood Financial, Inc., was originally incorporated in Nevada on
June 13, 1986. Baywood Financial, Inc. remained inactive until January 11, 1988
when it acquired all of the assets of Helth-Pro International, Inc.
("Helth-Pro"), a Nevada corporation. Helth-Pro's primary business was the
marketing of animal food supplements and other related products under an
exclusive marketing agreement previously acquired by Helth-Pro.
From 1988 until 1992, Baywood Financial, Inc. was inactive. In March
1992, the Company changed its name from Baywood Financial, Inc. to Baywood
International, Inc. Thereafter, the Company commenced the acquisition of
formulas, trademarks, marketing rights and product lines of dietary supplements
and skin care products from several companies. The Company had expanded its
product lines into fragrances for men and women and into animal health products
for horses and domestic pets. Due to the higher demand and market potential of
nutritional supplements and skin care products, the Company significantly scaled
down its efforts to promote and sell the fragrance and animal health lines.
Since its inception, the Company has directed most of its sales efforts
toward international markets and has established either distribution or
registration of its products into the Pacific Rim Countries (China, Malaysia,
Hong Kong, Taiwan and Indonesia) as well as Europe (Italy, Germany, Austria,
England and Switzerland). Establishing distribution into health food stores,
chain drug stores, grocery chains and network marketing companies
internationally and in the United States is also part of the Company's marketing
strategy. At this time, the Company is focused on strengthening its
international distribution and building its distribution of branded products
through health food stores in the United States.
The Company's principal executive offices are located at 14950 North
83rd Place, Suite 1, Scottsdale, Arizona 85260 and its telephone number is (602)
951-3956.
Products and Product Development
The Company's main dietary supplement products include bee pollen, bee
propolis, royal jelly and a freeze dried aloe vera and mineral drink. The
Company includes as separate products multiple sizes and potencies of certain
products. At any point depending on customer demand or market opportunity, the
Company may add to its dietary supplement line of making the number of products
and the mix in the types of products sensitive to change constantly toward the
demands of what customers or the markets desire. The Company's most popular
product is a freeze dried aloe vera and mineral drink under the brand name,
Aloe-Minerals Plus(TM), which is part of the Company's Royal(TM) Line. This line
is the primary name under which most of the Company's dietary supplements are
sold internationally. Depending on the demands of a particular customer, the
Company may also supply most products unlabeled, in bulk or under a private
label. Although the Company considers the potential of unlabeled or privately
labeled products to be substantial, emphasizing the Company's own branded
products for presentation to the international and domestic market is important
toward the Company's recognition in the natural products industry.
The Company's dietary supplement products also include products that
target specific nutritional
-4-
<PAGE>
needs, or what are referred to as nutriceuticals. These products are being
marketed through the Company's natural healthcare line. The main product in this
line is a cholesterol product designed and marketed to maintain healthy
cholesterol. Under the Company's Royal(TM) Line marketed internationally, this
product is called Count Down 200(TM). This product is also marketed under
another brand name internationally called LDL Tab(TM). Domestically, this is the
Company's first product called Beta-s(TM) and it is being marketed into health
food stores across the United States. The Company intends to build upon the
successful launch of this product into the United States through the
introduction of other products for the natural healthcare line including those
products which are formulated for certain needs such as joint support and
arthritis, allergy, overall cardiovascular health, memory and concentration,
mood, energy, eyes and the immune system.
In addition to dietary supplements, the Company also has a line of skin
care products. The main products in this line are marketed together as a facial
system and include a cleanser, lift powder with activator, toner and a nurture
cream. The products are aloe vera based and are primarily marketed under the
Company's La Vraie(TM) brand line.
All of the Company's products are currently manufactured by third party
manufacturers. Although management recognizes the primary importance of
establishing brand loyalty of its products internationally or domestically, it
also realizes the eventual importance of certain manufacturing capabilities as
the Company grows to reduce dependence on third party manufacturers, to assist
in maintaining any proprietary nature of its products, to reduce product costs
and to increase product capacity for itself and its large volume customers.
At this time, the Company also relies on its third party manufacturers
to maintain the quality of product components as new products are assessed and
developed. As the Company evaluates the needs for certain products within
existing or new markets, the most effective formulas are developed through the
Company's third party manufacturers and then sampled and tested for final
approval and packaging.
Strategy
Management's primary objective is to become a recognized leader in the
provision of natural products that are based on natural compounds. Acknowledging
the broad reach of the natural products industry, the Company considers its
potential to involve many different opportunities in certain product lines and
distribution channels. Certain product lines include but are not limited to
vitamins, herbs, nutriceuticals, herbal teas, health foods, sports nutrition and
skin care. Certain distribution channels include retail, mail order and network
marketing. The Company's current distribution includes dietary supplements that
are sold mainly into the international market into network marketing companies.
The Company is also marketing its first nutriceutical product for maintaining
healthy cholesterol into health food stores in the United States. Creating new
and innovative products containing all-natural ingredients is a primary focus of
the Company with emphasis on satisfying existing consumer demand or creating
awareness for health through the use of natural products. Through consistent
active involvement in the trends that affect the natural products industry, the
Company creates or improves products to fit market needs. The Company currently
is pursuing the following business strategy:
i. Expand its marketing efforts for existing areas of penetration
in the international market and develop new areas of
distribution in the international markets into such areas as
retail and direct sales. The Company believes that by hiring
additional personnel who have specific strengths in particular
areas in the international and domestic market, forming joint
ventures, acquiring and merging with other successful
companies that it will further strengthen its position.
-5-
<PAGE>
ii. Further develop its line of nutriceutical products and expand
its advertising materials and channels for use by the Company
to further expand distribution into the health food store
market across the United States. The Company believes that
these products have great appeal and expects to explore the
market potential for a number of such products upon the
successful launch of its first product, Beta-s(TM).
iii. Penetrate other areas of the natural products industry where
the Company is not currently involved based on the evaluation
of other companies within the industry who wish to form
marketing alliances and joint ventures or may be acquired by
or merge with the Company. The Company expects that internal
development of products that fall into other lines of business
where it is currently not involved will occur to a lesser
extent as opposed to the Company's involvement with other
companies within the industry that have already established
brand or product identity and distribution in those lines.
Marketing
The Company markets and distributes its products internationally and
domestically. Since inception, the international market has been the primary
area of distribution for the Company's products. Due to the types of products
that the Company currently has available such as bee pollen, bee propolis, royal
jelly and certain aloe vera based products, the Company has been successful
specifically in the Far East (China, Malaysia, Indonesia and Taiwan) where these
types of products are especially in high demand. In addition, the large
populations of such countries has allowed for a continuous and changing source
of demand for these products.
International
The Company currently distributes most of its products into the Far
East into network marketing companies who typically have a large number of
distributors. Given that the companies in this area have been a strong avenue of
distribution for nutritional supplements, the Company will continue to
strengthen and expand its marketing efforts there. The Company's most popular
product in China is the freeze dried aloe vera and mineral drink under the brand
name, Aloe-Minerals Plus(TM), which is part of the Company's Royal(TM) Line.
Most of the Company's other common dietary supplements are also distributed
under the Royal(TM) Line which is the primary name under which most of the
Company's dietary supplements are marketed in these countries.
Dependence on One Customer. Sales to one principal customer in China
accounted for 93.4% and 89.8% of total net sales in the years ended December 31,
1997 and 1996, respectively. The Company is attempting to expand its customer
base both domestically and internationally, but expects that sales to its
Chinese customer will continue to account for a substantial percentage of net
sales. The Company's Chinese customer could discontinue ordering at any time.
Any potential problems with this Chinese customer could have a substantial
adverse impact on the Company's business and could result in diminished revenues
for several quarters or more as the Company attempts to replace that business.
Domestic
The Company is marketing its first nutriceutical product, Beta-s(TM),
through one primary wholesale distributor which distributes to health food
stores across the United States. To create awareness at the retail and consumer
levels, the Company advertises through any number of channels including the
distributor's newsletters and catalogs, independent trade and consumer
publications, direct
-6-
<PAGE>
mailings to health food stores and radio.
Market and Competition
The market for nutritional supplements is highly competitive in each of
the Company's existing and anticipated product lines and methods of
distribution. Numerous manufacturers and distributors compete with the Company
for customers throughout the United States and internationally in the packaged
nutritional supplement industry selling products to retailers such as mass
merchandisers, drug store chains, independent drug stores and health food
stores. Many of the Company's competitors are substantially larger and more
experienced than the Company, have longer operating histories and have
materially greater financial and other resources than the Company. Many of these
competitors are private companies, and therefore, the Company cannot compare its
revenues with respect to the sales volume of each competitor. There can be no
assurance that the Company will be able to compete successfully with its more
established and better capitalized competitors.
Although certain of the Company's competitors are substantially larger
than the Company and have greater financial resources, the Company believes that
it competes favorably with other nutritional supplement companies because of its
quality of products and focus on certain niche products for certain niche
markets both internationally and domestically.
Dependence on Third Party Suppliers
There are numerous companies that produce or supply the types of
products the Company distributes. The Company does not manufacture any of its
products and depends entirely on third party manufacturers and suppliers.
Typically, the Company does not have supply agreements, but submits purchase
orders for its products. The Company currently purchases from two suppliers.
The Company's largest supplier, located in Colorado, accounted for
approximately 99% and 67% of product purchases in the fiscal years ended
December 31, 1997 and 1996, respectively. The Company's other supplier, located
in Texas, accounted for less than 1% and approximately 33% of product purchases
in the fiscal years ended December 31, 1997 and 1996, respectively.
Although the Company believes that a number of alternative sources of
supply are available if required and that it could quickly replace its main
suppliers with alternative sources at comparable prices and terms, a disruption
in product supply from either of its third party suppliers could have a
significant adverse impact on the Company's operations.
Proprietary Information
The Company does not hold any patents and currently relies upon a
combination of contractual rights, trademark laws and specially formulated
products to protect its proprietary rights in its products or packaging. The
Company seeks to protect its proprietary rights in its formulas through
restrictions on disclosure and use. Despite the Company's efforts to protect its
formulas, it may be possible for third parties, without authorization, to copy
or duplicate proprietary formulas or packaging, or to obtain and use its
proprietary information. Existing trademark laws afford only limited practical
protection for the Company's product lines. The laws and the level of
enforcement of such laws in certain foreign countries where the Company markets
its products often do not protect the Company's proprietary rights in its
products to the same extent as the laws of the United States. Because of the
rapid pace of the natural product industry's development, the Company believes
that the legal protection for its products is less significant to the Company's
success than the knowledge, technical expertise and marketing skills of
-7-
<PAGE>
the Company's personnel, the frequency of product expansion and pace of market
penetration.
Product Liability
The Company believes that its distribution of consumable products
generally involves a higher level of risk for product liability claims than the
distribution of its non-consumable products. The Company protects itself from
possible claims through product liability insurance coverage that is reviewed
and renewed annually depending on the changes in distribution and sales of the
Company's consumable and non-consumable products. In addition to carrying its
own coverage, the Company also requires its manufacturers to carry product
liability insurance.
Government Regulation
Advertising claims made by the Company with respect to its products are
subject to the jurisdiction of the Federal Trade Commission ("FTC") as well as
the Food and Drug Administration ("FDA"). In both cases the Company is required
to obtain scientific data to support any advertising or labeling health claims
it makes concerning its products, although no pre-clearance or filing is
required to be made with either agency.
The Company's products and its business operations may at any time be
subject to regulation by one or more federal agencies. The FDA in particular, is
primarily responsible for regulation of the labeling, manufacture and sale of
nutritional supplements which the FDA believes to be unapproved drugs or food
additives rather than food supplements. These products are primarily regulated
by the FDA under the auspices of the Federal Food, Drug and Cosmetic Act (the
"FFDCA"). Under the FFDCA, most dietary supplements are currently regulated as
foods, which require no approval from the FDA prior to marketing. Therefore, the
regulation of dietary supplements is far less restrictive than that imposed upon
manufacturers and distributors of prescription drugs. Dietary supplements,
however, must be labeled correctly to avoid being misbranded under the FFDCA.
Health claims made by nutritional supplement companies with respect to their
product are specifically regulated by the FDA. If such products make unapproved
health claims, the FDA may consider them as unapproved drugs, which require
approval by the FDA prior to marketing.
To the extent the Company establishes its own manufacturing facilities
in the future and produces products deemed by the FDA now or in the future to be
a food or dietary supplement, the operation of the Company's manufacturing
facilities will be subject to regulation by the FDA in compliance with good
manufacturing practices (GMP) just as the Company's third party manufacturers
currently are subjected to. Although the Company does not anticipate any
difficulties in complying with the GMP, any such difficulties that are
encountered at such a time could have a material adverse effect on the Company.
The regulations prohibit the use of any health claim on a dietary
supplement unless the health claim is supported by a significant scientific
agreement and is pre-approved by the FDA. Accordingly, most dietary supplements
will be precluded from bearing most health claims. The FDA regulations do not at
present limit consumer access to dietary supplements, unless such products
present safety concerns. The Company cannot determine at this time whether the
new regulations will have any adverse effect on its operations, although it
believes that they will not have a material adverse effect.
Overseas, registration is mandatory in each country prior to
distribution. This process may take from several months to over a year. The
Company, at any one time, may have several products awaiting approval for
registration and eventual distribution. The Company can provide no assurance as
to the
-8-
<PAGE>
timing of such approvals.
Employees
At December 31, 1997, the Company had three (3) full-time employees.
Consultants are utilized as needed in marketing and sales. Commissioned
personnel include one (1) full-time employee and four (4) representatives
overseas in addition to two (2) independent sales managers that work with
domestic accounts.
Item 2 - Description of Property
- --------------------------------
The Company's principal executive office is located at 14950 North 83rd
Place, Suite 1, Scottsdale, Arizona 85260. The Company leases its offices under
an operating lease that expires on July 31, 2000. In 1997 the Company disposed
of the remaining items in its warehouse that were either spoiled or unsalable.
Due to the nature of the Company's orders which are drop shipped directly from
the manufacturer into the international market, the need for smaller space for
inventory items and to cut down on certain costs, the Company is able to utilize
its remaining office space to handle necessary functions at the current time.
Future minimum annual lease obligations for the remaining term of the lease are
as follows:
1998 $ 38,955
1999 40,903
2000 24,542
---------
$ 104,400
The Company holds no other real estate interests.
Item 3 - Legal Proceedings
- --------------------------
The Company was included as a defendant in a New York state court
action filed October 10, 1995 by St. Anthony's Parish of Somerville,
Massachusetts and other plaintiffs against Krystal Kleer, Inc. The lawsuit was
dismissed on March 20, 1996 in favor of an Arizona federal court action filed
February 29, 1996. Plaintiffs seek compensatory and punitive damages of $900,000
against the Company and other defendants. Plaintiffs have obtained a judgment
against Krystal Kleer, Inc. in the amount of $645,000 and are seeking to collect
damages from the Company on the theory that the Company was involved in a
fraudulent transfer in connection with the issuance of common stock in exchange
for certain equipment, fixtures and furnishings of Krystal Kleer, Inc. The
Company has pending a motion for its dismissal as a defendant on the basis that
its transaction with defendant Krystal Kleer, Inc. was not fraudulent. The
Company has obtained an expert opinion that the Company's transaction with
Krystal Kleer, Inc. was unfair to the Company and not to Krystal Kleer, Inc. The
Company appears to have a strong basis for and intends to vigorously pursue its
defenses and dismissal. At this stage of the proceeding, no prediction can be
made of the likelihood of an unfavorable outcome and no estimate can be made of
the amount or range of potential loss, if any.
John A. Shannon filed a demand for arbitration with the American
Arbitration Association on April 15, 1997 seeking a determination that 1,000,000
in options granted to him on January 1, 1993 were valid and in effect until
January 1, 1998, for compensatory damages based upon the Company's refusal of
his attempt to exercise a portion of the options in February 1997 and for his
costs and attorneys' fees. On December 8, 1997, the arbitrator declared that the
options were valid for exercise until their expiration on January 1, 1998 and
awarded Shannon his attorneys' fees on the options claim. Shannon allowed the
-9-
<PAGE>
options to expire unexercised, but filed a petition for $124,338.17 in attorneys
fees. The Company has contested the amount and nature of fees and costs sought
and the arbitrator has indicated that he will grant an evidentiary hearing on
the issue of attorneys' fees. At this stage of the proceeding, no prediction can
be made of the likelihood of an unfavorable outcome and no estimate can be made
of the amount or range of potential loss, if any.
On April 28, 1997, the Company filed an action in Maricopa County
Superior Court against Mr. Shannon, as the Company's former Chairman and
continuing substantial shareholder, and his affiliated company. The complaint
alleged claims against certain or all of the defendants for breaches of
fiduciary duty, fraudulent issuance of securities, misappropriation and
conversion of corporate assets, self-dealing in issuing stock for overvalued or
worthless intangibles, fraudulent transfer of assets, fraud, constructive fraud
and negligent misrepresentation. The complaint sought the cancellation of
certain of the Shannons' shares, indemnification, punitive damages, pre-judgment
and post-judgment interest and the Company's costs and attorneys' fees. The
Superior Court action claims were dismissed and consolidated as counterclaims in
the American Arbitration Association action. The arbitrator bifurcated the
counterclaims from the stock options issues and ordered that the counterclaims
would be determined in a hearing at a later date, but a hearing has not yet been
set. The Company believes it has a strong basis for its counterclaims, but at
this stage of the proceeding, no prediction can be made of the nature or amount
of the outcome.
On March 3, 1997, former director and officer Georgia Aadland filed a
demand for arbitration against the Company with the American Arbitration
Association. Ms. Aadland seeks $210,374 plus interest, attorney's fees and costs
for breach of an employment agreement. The Aadland arbitration date has been
postponed until an unspecified hearing date which is unlikely to occur prior to
the summer of 1998. The Company intends to vigorously defend against Ms.
Aadland's claims and, at this stage of the proceeding, no prediction can be made
of the likelihood of an unfavorable outcome and no estimate can be made of the
amount or range of potential loss, if any.
On June 2, 1997, the Company filed a lawsuit in Federal District Court
in Arizona against John and Darlene Shannon for recovery of "short swing"
profits pursuant to Section 16(b) of the Securities Exchange Act of 1934, as
amended ("Exchange Act"). The action alleges sales and purchases of Company
securities by the Shannons (or their affiliates) within six (6) month periods
while Mr. Shannon was a director or officer of the Company or a greater than ten
percent (10.0%) beneficial owner of the Company's shares. The action seeks
disgorgement of short-swing profits, interest from the time the profits were
realized, post-judgment interest and the Company's costs and attorneys' fees.
The Company has moved for summary judgment on a portion of Shannon's
transactions that he has not yet publicly disclosed. The Company believes that
it has a strong basis to be awarded approximately $9,000 on its motion for
partial summary judgment. With regard to the undisclosed transactions, at this
stage of the proceeding, no prediction can be made of the nature or amount of
the outcome.
Under the terms of a January 8, 1993 agreement between the Company and
Royal for the sale to Royal of certain sales and distribution rights relating to
the Aurore-B beauty and hygiene line, Royal is obligated to make annual payments
to the Company including principal and interest on July 1st of each year from
July 1, 1993 to July 1, 2002. Royal defaulted on the agreement by failing to
make its July 1, 1997 payment. On July 22, 1997 the Company filed an action in
Maricopa County Superior Court to collect the defaulted payment plus interest,
attorneys' and costs. On December 10, 1997, the court awarded the Company
summary judgment in the matter for $35,555.25 plus interest until the judgment
is paid.
Reference should also be made to Note 14 of the financial statements,
which is incorporated
-10-
<PAGE>
herein by this reference.
Item 4 - Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
No matter was submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 1997.
PART II
Item 5 - Market for Common Equity and Related Stockholder Matters
- -----------------------------------------------------------------
The Company's common stock under the registered name of Baywood
International, Inc. was first quoted in May of 1992, and began trading on the
Over-the-Counter ("OTC") Bulletin Board under the symbol "BYWD".
Set forth below are the high and low closing prices for the Company's
common stock as reported on the OTC Bulletin Board for the last eight quarters:
Year Ended December 31, 1997 High Low
- ---------------------------- ---- ---
March 31, 1997 .56 .28
June 30, 1997 .32 .18
September 30, 1997 .39 .20
December 31, 1997 .27 .10
Year Ended December 31, 1996
- ----------------------------
March 31, 1996 .56 .31
June 30, 1996 .57 .41
September 30, 1996 .55 .40
December 31, 1996 .60 .34
The above quotations represent inter-dealer quotations without retail
markup, markdown or commissions and may not represent actual transactions.
As of December 31, 1997, there were approximately 680 holders of record
of the Company's common shares not including those shares held in brokerage
accounts.
The Company has not paid dividends on its common shares and has no
present intention of paying dividends in 1998. The declaration and payment of
dividends and the amount paid, if any, is subject to the discretion of the Board
of Directors and will necessarily be dependent on the earnings, financial
condition, capital and surplus requirements of the Company and any other factors
the Board of Directors may consider relevant.
Item 6 - Management's Discussion and Analysis or Plan of Operation
- ------------------------------------------------------------------
General
The Company's main dietary supplement products include bee pollen, bee
propolis, royal jelly
-11-
<PAGE>
and a freeze dried aloe vera and mineral drink. The Company's most popular
product is a freeze dried aloe vera and mineral drink under the brand name,
Aloe-Minerals Plus(TM), which is part of the Company's Royal(TM) Line. This line
is the primary name under which most of the Company's dietary supplements are
sold internationally. The majority of the Company's sales were comprised of
Aloe-Minerals Plus(TM) to one particular customer in China. This major customer
accounted for 93.4% of total net sales. The Company's freeze dried aloe vera and
mineral drink accounted for 94.3% of total net sales. Sales of skin care
products decreased sharply. Net sales of skin care products for the years ended
December 31, 1997 and 1996 were $2,603 or less than 1% of net sales and
$1,256,454 or 31.4% of net sales, respectively. The decrease in sales of skin
care was through one particular customer in China with several products in the
Company's La Vraie(TM) line such as cleanser, toner, nurture cream, activator
and lift powder. The reduction in total net sales of $766,083 or 19.2% was
mainly due to the suddenly imposed import restrictions of finished skin care
product to China and delays of other product registrations into other countries.
Chinese Government regulations which may change periodically, prohibit any
further import of both finished cosmetic and skin care products. Both cosmetic
and skin care products must be manufactured in China and must carry a Chinese
manufacturing labor content of over fifty percent. The Company believes that the
decrease is not a result of the decreased demand for the products and is
currently in the process of pursuing the establishment of a manufacturing
operation for the Company's skin care products in China. The Company believes
that sales of the skin care products will resume in China upon the successful
organization of this manufacturing operation in 1998. However, it can neither be
certain that such sales will resume nor is it certain that any such sales will
reach their historical levels of 1996. Branded product sales made up 97.6% of
the Company's total net sales. International sales comprised 99.1% of total net
sales.
The concentration with the Company's major customer leaves the Company
vulnerable should the customer reduce or cease its orders. The Company continues
to attempt to diversify its customer base but believes that sales to this
customer will continue to comprise a large portion of its revenue in the near
future.
Domestically, the Company's first product, Beta-s(TM), marketed under
the natural healthcare line in health food stores across the United States,
accounted for less than 1% of total net sales. The Company intends to build upon
the successful launch of this product into the United States through the
introduction of other products for the natural healthcare line.
The Company concentrates on increasing profits by expanding sales
volume while containing or reducing costs since growth opportunities in the
Company's markets are driven by volume increases rather than price increases.
The Company's cost reduction efforts will be driven by economies of scale and
current out-sourcing of the production items supplied to the manufacturer such
as packaging and labels. As the Company grows, it also realizes the eventual
importance of certain manufacturing capabilities to reduce dependence on third
party manufactures, to assist in maintaining any proprietary nature of its
products, to reduce product costs and to increase product capacity for itself
and its large volume customers.
The Company anticipates that future growth of its business will come
through the efficient execution of its business strategy both internationally
and domestically. The Company can provide no assurance as to the timing and
success in the execution of its business strategy.
The Company's reliance on computer information systems is such that it
does not anticipate encountering difficulties with the year 2000 problem. The
Company is not aware of any significant problems being encountered by its
customers and vendors.
-12-
<PAGE>
Results of Operations
The following table sets forth income statement data of the Company as
a percentage of net sales for the periods indicated.
1997 1996
% %
- -
Net Sales 100.0 100.0
Cost of Sales 62.7 58.4
----- -----
Gross Profit 37.3 41.6
S, G & A Expenses:
Marketing 13.4 15.3
General and Administrative 26.8 17.7
Depreciation and Amortization 1.6 1.3
----- -----
Other (Income) and Expense - net .4 (5.1)
----- -----
Income (Loss) Before Income Taxes (4.9) 12.4
Income Tax Benefit - 3.8
----- -----
Net Income (Loss) (4.9) 16.2
===== =====
Comparisons of Year 1997 to 1996:
Net sales for the year ended December 31, 1997 were $3,234,056 compared
to net sales of $4,000,139 for the year ended December 31, 1996, a decrease of
19.2%. The decrease in nets sales was mainly due to the decreased volumes of
skin care product sold through one particular customer in China. In 1997
international sales represented 99.1% of the Company's total net sales compared
to 96.6% for 1996. Distribution of nutritional supplements remained as the main
source of revenue for 1997. Net sales of nutritional supplements and skin care
products for the year ended December 31, 1997 were $3,231,453 or 99.9% of total
net sales and $2,603 or less than 1% of total net sales, respectively. Net sales
of nutritional supplements and skin care products for the year ended December
31, 1996 were $2,726,260 or 68.2% of total net sales and $1,256,454 or 31.4% of
total net sales, respectively.
The Company's gross profit margin for the year ended December 31, 1997
was 37.3% compared to 41.6% in 1996. The decrease in gross profit for the year
ended December 31, 1997 is mainly due to the higher margins on skin care
products that had been sold in 1996. Additionally, cost of sales in 1997
included an additional write-down of $105,000 for the remainder of the Company's
obsolete inventories.
Marketing, general and administrative expenses for the year ended
December 31, 1997 were $1,299,649 compared to $1,322,097 for the same period
ended December 31, 1996, a decrease of 1.7%. The primary factors in the overall
decrease were an overall reduction in sales commission expense as a percentage
of net sales in 1997 as compared to 1996 and also a larger write-off of
uncollectible trade receivables in 1996 as compared to 1997. Sales commissions
averaged approximately 5% and 10% of total net sales for the years ended
December 31, 1997 and 1996, respectively. The decrease in sales commission
expense is due to a restructuring of most of the Company's sales commission
agreements in 1997. The single largest expense in 1997 was for legal fees which
totalled $240,042 or 18.5% of total marketing, general and administrative
expenses.
Net loss before income taxes for 1997 and 1996 was $(157,260) or $(.02)
per share as compared to net income of $646,891 or $.04 per share, respectively.
An income tax benefit was recorded in 1996 in the amount of $149,950 related to
a reduction in the deferred tax asset valuation allowance.
-13-
<PAGE>
Other Information
Interest Expense was zero and $22,172 in 1997 and 1996, respectively.
The decrease was due to the payoff of all of the Company's interest bearing debt
in June of 1996.
Interest income for 1997 was generated from the Company's invested cash
balance in interest-bearing money market accounts. In 1996 interest income was
comprised of mainly interest generated from the Company's note receivable due
from Royal for the sale of the Aurore-B beauty and hygiene line. Due to
non-payment by Royal on this note receivable, the Company had not recognized any
interest income during 1997 and has accrued an allowance for the remaining
balance of the note.
The Company expects its expenditures for marketing costs to increase as
it attempts to diversify its customer base and expand in the domestic market.
The Company will be selective in its expenditures for marketing related items
and intends to begin advertising more heavily in domestic publications.
The Company has experienced some loss in revenue due to economic and
currency problems in Asia. To date these losses have not been significant but
such problems may reduce short-term potential for revenue growth in that region.
China has not experienced the extent of problems as that of other Asian
countries. Excluding the loss of skin care products revenue, sales to the
Company's Chinese customer actually increased in 1997.
The nutritional products industry is highly competitive. There are many
companies with greater financial strength and marketing and distribution
capabilities than the Company. As indicated in industry publications, the
industry is evolving rapidly and undergoing major changes as the United States
market becomes saturated with new companies and more similar products. The
Company recognizes that its business in the natural products industry may be at
risk because the Company is small and competes against better known companies
with large advertising and marketing budgets and substantially greater sales
volume and financial resources.
Capital Expenditures
During 1997 and 1996, the Company purchased property and equipment of
zero and $1,571, respectively. As of December 31, 1997, the Company had no
material commitments for capital expenditures.
Liquidity and Capital Resources
As of December 31, 1997, the Company had $1,136,371 in current assets
of which $668,906 or 58.9% was cash. Total current liabilities for the same
period totalled $429,722. This represents a current ratio of current assets to
current liabilities of 2.64. Trade accounts payable remained in good standing
due to good relations, credit terms and payment histories with major suppliers
and vendors. The Company believes that as it increases its sales volume,
liquidity will improve greatly. Sales terms generally include either a 50%
deposit at the time of the order and the balance prior to shipment or 100%
payment prior to shipment for new customers. The Company has from time to time
extended credit to its major customers once they have established good payment
histories. The Company drop ships most of its shipments directly from the
manufacturer and therefore does not require large inventories to satisfy
customer demand. The Company may require additional warehousing capabilities as
the distribution grows in the Unites States Market since the nature of the
shipments are more volume of smaller orders rather than less equal or less
volume of substantially larger orders. The need for significant working capital
is not anticipated for accounts receivable and inventories due to timely
turnover on accounts
-14-
<PAGE>
receivable and the use of drop shipments.
The Company neither anticipates any significant capital expenditures
nor are material capital expenditures required to meet expected growth through
existing operations. The Company may require additional capital and may attempt
to raise capital through the sale of preferred and common stock and through
private placements in the short and long term for the purpose of acquiring other
companies. Management recognizes the need to expand its distribution not only
through effective marketing of its current products in order to maintain its
competitive position in the marketplace, but also through either the merger
and/or acquisition of other companies in the natural products industry. The
Company believes that it will be able to obtain adequate sources of financing
should the opportunities for any potential mergers or acquisitions arise.
At this time the Company does not anticipate any large expenditures of
cash for research and development costs. Marketing costs associated with the
distribution of new products will be paid for by cash flows from existing
operating activities.
Item 7 - Financial Statements and Supplementary Data
- ----------------------------------------------------
An audited balance sheet for the year ended December 31, 1997 and
audited statements of income, changes in stockholders' equity and cash flows for
the years ended December 31, 1997 and 1996 are set forth commencing on page 28.
Item 8 - Changes in and Disagreements with Accountants on Accounting and
- --------------------------------------------------------------------------------
Financial Disclosure
- --------------------
None
PART III
Item 9 - Directors, Executive Officers, Promoters and Control Persons;
- --------------------------------------------------------------------------------
Compliance with Section 16(a) of the Exchange Act
- -------------------------------------------------
Directors and Executive Officers
Name Age Position or Offices Held
- ---- --- ------------------------
Neil T. Reithinger 28 Interim President, Director, Chief
Financial Officer, Secretary and Treasurer
Karl H. Rullich 64 Director
Stephen L. Kuehn 51 Director
Glen Holt 67 Director
Dr. Michael B. Shapiro, M.D. 42 Director
Mr. Neil T. Reithinger assumed the office of interim president upon the
resignation of Harvey J. Turner on December 10, 1997. He was elected as a
Director on February 18, 1997. He was elected Chief Financial Officer, Secretary
and Treasurer on October 28, 1997. Mr. Reithinger has been Controller of the
Company since January 1994. Prior to joining the Company and from July 1992
through December 1993, Mr. Reithinger worked in branch operations for Bank of
America. He received a Bachelors degree in accounting from the University of
Arizona in 1992 and his certification as a Certified Public Accountant in 1996.
-15-
<PAGE>
Mr. Karl H. Rullich has been a Director since 1991. He has served as
the Company's Director of International Sales since May 1996. Prior to April 19,
1996, he served as President, Chief Executive Officer and Treasurer of the
Company. He worked as a Marketing Director, General Manager and Vice President
for Pfizer Hospital Products Group in their international businesses and
operations for over 25 years. Mr. Rullich holds a degree in economics from the
Business College in Essen, Germany. He emigrated from Germany to the United
States in 1956 and became a naturalized citizen in 1961.
Mr. Stephen L. Kuehn has been a Director of the Company since 1991. Mr.
Kuehn previously served as a consultant to the Company in the area of sales. He
is currently President & C.E.O. of J.I.T. Medical Supply, Inc., a highly
computerized disposable medical supply fulfillment house in Clearwater, Florida.
He has domestic and international business experience including a number of
years serving Pfizer. His last position was as Managing Director for Pfizer
Hospital Products Group United European Division based in London. He served as
International Managing Director and Partner of KBA Associates of Slough, England
and as Sales Director of PMSI of Tampa, Florida. He attended Lycoming Pre-med
and studied business at Penn State University.
Mr. Glen Holt has been a Director of the Company since 1992. As a
rancher and successful breeder for over 35 years, Mr. Holt, is an expert on
animal health and nutrition. He is a graduate from the University of Smith
Cornel. He is married to actress Annette Funicello, who is associated with the
Company's Cello by Annette(TM) fragrance line.
Dr. Michael B. Shapiro has been a Director of the Company since August
1995. Dr. Shapiro is an ophthalmologist at the University of Wisconsin, Madison.
He has also been Chairman of Davis Duehr Eye Associates, S.C. in Wisconsin since
1994 and is currently President of Eye-Deal Ocular Safety Products. Dr. Shapiro
received his degree in medicine from the Washington University in St. Louis,
Missouri. He completed his internship at Mercy Hospital and Medical Center at
the University of San Diego and his residency at the University of Wisconsin,
Madison. Dr. Shapiro has consulted for companies such as Bausch and Lomb,
Allergan and Unilens.
Mr. Harvey J. Turner resigned as Chairman of the Board, Chief Executive
Officer and President on December 10, 1997 and resigned as a Director on
February 25, 1998. He previously served as a Director and Chairman of the Board
of Directors of the Company since April 19, 1996.
Compliance with Section 16(a) of the Exchange Act
The following persons were, during the last fiscal year, either
directors, officers, or beneficial owners of more than ten percent (10%) of a
class of equity securities registered pursuant to Section 12 of the Exchange Act
of 1934 and failed to file on a timely basis the following reports required by
Section 16(a) during the most recent fiscal year or prior years and which have
not previously been disclosed:
Karl H. Rullich filed a timely Form 5 on January 22, 1998, reporting
six transactions that were not reported on a timely basis and that should have
been reported on two Forms 4.
The following persons did not file any Forms 4 during, or a Form 5 for,
the fiscal year ended December 31, 1997 and have not provided the Company with a
written representation that no such forms were required: Harvey J. Turner,
Stephen L. Kuehn, Glen Holt, Dr. Michael B. Shapiro, M.D. and John A. Shannon.
-16-
<PAGE>
Item 10 - Executive Compensation
- --------------------------------
Officers
The Company paid Mr. Harvey Turner total salary compensation of
$120,750 during fiscal year 1997. Mr. Turner also held options, approved by the
Company's Shareholders on August 29, 1996, to purchase 200,000 common shares at
$0.52 per share which expired on February 10, 1998. Mr. Turner also received a
car allowance and phone allowance totalling $12,000 and $900, respectively, in
his capacity as Chairman of the Board.
Summary Compensation Table
Summary compensation information for Mr. Harvey Turner, the Company's
former Chief Executive Officer beginning April 19, 1996 (the only "named
executive officer" within the meaning of Regulation S-B, Item 402(a)(2)
Instruction (1)) is as follows:
<TABLE>
<CAPTION>
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Other Restricted
Name and Annual Stock Securities All Other
Principal Compen- Awards Underlying LTIP Payouts Compensation
Position Year Salary ($) Bonus ($) sation ($) ($) Options/SARs (#) ($) ($)
-------- ---- ---------- --------- ---------- --- ---------------- --- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mr. Turner (1) 97 120,750 -0- -0- -0- -0- -0- 54,567 (2)
CEO 96 81,000 30,000 -0- 26,550 200,000 -0- 49,600
95 - - - - - - -
</TABLE>
(1) Mr. Turner was elected Chairman of the Board and appointed as
President and Chief Executive Officer on April 19, 1996. He resigned as Chairman
of the Board, Chief Executive Officer and President on December 10, 1997 and
resigned as a Director on February 25, 1998.
(2) The Company paid Mr. Turner a car allowance and phone allowance of
$12,000 and $900, respectively, during fiscal year 1997 in his capacity as
Chairman of the Board. Under the terms of an employment agreement with its
former President and Chairman, the Company accrued the remaining compensation
remaining to be paid under that agreement through April 18, 1998. The balance of
$41,667 representing compensation from the effective employment termination date
of December 10, 1997 through April 18, 1998, was accrued at December 31, 1997.
-17-
<PAGE>
Directors
Director Compensation Table
<TABLE>
<CAPTION>
(a) (b) (c) (1) (d) (2) (e) (f)
Number of
Securities
Annual Retainer Consulting Number of Underlying
Name Fees ($) Meeting Fees ($) Fees/Other Fees ($) Shares (#) Options/SARs (#)
---- -------- ---------------- ------------------- ---------- ----------------
<S> <C> <C> <C> <C> <C>
Neil Reithinger -0- -0- 900 -0- -0-
Karl Rullich -0- -0- 900 -0- -0-
Stephen Kuehn -0- -0- -0- -0- -0-
Glen Holt -0- -0- -0- -0- -0-
Dr. Michael Shapiro -0- -0- -0- -0- -0-
Harvey Turner -0- -0- 12,900 -0- -0-
</TABLE>
(1) Each "outside" Director not residing in Arizona (Messrs. Holt and
Kuehn) each received reimbursement for travel related expenses during fiscal
year 1997 associated with their attendance at the Company's annual meeting.
(2) Mr. Reithinger and Mr. Rullich received a phone allowance of $900
in their capacity as Directors of the Company. Mr. Turner received a car
allowance and a phone allowance of $12,000 and $900, respectively, in his
capacity as Chairman of the Board.
Employment Contracts
The Company had previously entered into an Employment Agreement with
Harvey J. Turner on July 19, 1996. On December 10, 1997, Mr. Turner resigned as
the Company's Chairman of the Board, President and Chief Executive Officer. The
Company and Mr. Turner entered a Settlement Agreement, dated January 9, 1998,
which provided that Mr. Turner would continue to receive his current monthly
salary until April 18, 1998, that he would cooperate with the Company in
maintaining its relationships and that he would remain subject to the covenant
not to compete provisions of his original Employment Agreement.
Additional Information Concerning the Board of Directors of the Company
During 1997, the Board of Directors held four (4) meetings. All
Directors attended at least 75% of the meetings. The Audit Committee of the
Company held one (1) meeting in which all members were present. In addition to
regularly scheduled meetings, a number of Directors were involved in numerous
informal meetings with management, offering advice and suggestions on a broad
range of corporate matters.
Item 11 - Security Ownership of Certain Beneficial Owners, Management and
- --------------------------------------------------------------------------------
Changes in Control
- ------------------
The following table sets forth certain information regarding shares of
common stock beneficially owned as of March 25, 1998 by (i) each person or
group, known to the Company, who beneficially owns more than 5% of the common
stock; (ii) each of the Company's officers and directors; and (iii) all officers
and directors as a group. The percentage of beneficial ownership is based on
17,498,115 shares
-18-
<PAGE>
outstanding on March 25, 1998 plus, for each person or group, any securities
that person or group has the right to acquire within 60 days pursuant to
options, warrants, conversion privileges or other rights. Unless otherwise
indicated, the following persons have sole voting and investment power with
respect to the number of shares set forth opposite their names:
Security Ownership of Certain Beneficial Owners
<TABLE>
<CAPTION>
(1) (2) (3) (4)
Amount and Nature of Percent of
-------------------- ----------
Title of Class Name and Address of Beneficial Owner Beneficial Owner Class
- -------------- ------------------------------------ ---------------- -----
<S> <C> <C> <C>
Common Linda Lee (1) 2,386,147 12.96%
Hong Kong, China
Common John Shannon (2) 1,833,025 10.48%
Scottsdale, AZ
</TABLE>
(1) Ms. Lee is a citizen of Hong Kong, China and a prior Director of the
Company. Ms. Lee holds 1,466,147 common shares. She also holds 920,000
preferred shares which may each be converted to shares of common stock
on or after May 8, 1998, in a number of shares which depend upon the
average share price at the time of conversion.
(2) Mr. Shannon beneficially owns 1,833,025 common shares of which he holds
578,975 directly of record and 950,000 jointly with his wife, Darlene
Shannon through JDS Investments Limited Partnership, an estate planning
vehicle. Mr. Shannon is the beneficial owner of 304,050 common shares
which are held of record or beneficially by Royal Products, Inc.
(7,000), Krystal Kleer, Inc. (80,000), and Desert Health Products, Inc.
(217,050).
-19-
<PAGE>
Security Ownership of Management
<TABLE>
<CAPTION>
(1) (2) (3) (4)
Amount and Nature of Percent of
-------------------- ----------
Title of Class Name and Address of Beneficial Owner Beneficial Owner Class
- -------------- ------------------------------------ ---------------- -----
<S> <C> <C> <C>
Common Neil Reithinger (1)(6) 44,000 (2)
Scottsdale, AZ
Common Karl H. Rullich (3)(6) 530,000 3.02%
Scottsdale, AZ
Common Stephen Kuehn (6) 117,000 (2)
St. Petersburgh, FL
Common Glen Holt (4)(6) 275,000 1.57%
Encino, CA
Common Dr. Michael Shapiro (6) 160,000 (2)
Madison, WI
Common Harvey Turner (5) 670,000 3.83%
Scottsdale, AZ
Common All Officers and Directors 1,796,000 10.16%
as a Group (1) - (6)
</TABLE>
(1) Mr. Reithinger is Interim President, a Director, Secretary, Treasurer
and Chief Financial Officer of the Company. He holds 24,000 common
shares and an option, granted January 29, 1997, which expires January
29, 2007 to purchase 20,000 common shares at $0.42 per share. Members
of Mr. Reithinger's immediate family hold an additional 200,000 common
shares for which Mr. Reithinger disclaims all beneficial interest and
control.
(2) Less than one percent
(3) Mr. Rullich is a Director. Mr. Rullich beneficially owns 530,000
shares, 505,000 shares of which are owned in joint tenancy with his
wife, Florence Rullich. He also holds an option, granted January 29,
1997, which expires January 29, 2007, to purchase 25,000 common shares
at $0.42 per share.
(4) Mr. Holt directly owns 125,000 common shares. He also beneficially owns
150,000 common shares held by his wife, Annette Funicello.
(5) Mr. Turner resigned as the Chairman of the Board of Directors and the
President and Chief Executive Officer of the Company on December 10,
1997 and as a Director on February 25, 1998. Mr. Turner holds 670,000
common shares and held options, approved by the Company's Shareholders
on August 29, 1996, to purchase 200,000 common shares at $0.52 per
share which expired on February 10, 1998.
(6) Director
-20-
<PAGE>
Changes in Control
The Company has previously disclosed, that on April 11, 1997, the
Company issued 800,000 shares of Preferred Stock to Linda Lee, an independent
investor and citizen of Hong Kong. The "Class B" shares of Preferred Stock were
redeemable for cash or convertible to shares of Common Stock on May 8, 1997. On
May 5, 1997, the Company reached an informal agreement with Ms. Lee, which was
later ratified by the Board of Directors resolution and a Subscription Agreement
with Ms. Lee, by which Ms. Lee would exchange all of her "Class B" shares for
920,000 "Class C" Preferred Shares, which would have no right of redemption for
cash, but which would be convertible to shares of Common Stock on or after May
8, 1998, in a number of shares which depend upon the average share price at the
time of conversion.
Item 12 - Certain Relationships and Related Transactions
- --------------------------------------------------------
On January 29, 1997, the Board of Directors granted Neil Reithinger and
Karl Rullich each an option to purchase 20,000 and 25,000 shares of Common Stock
at $0.42 per share, respectively, exercisable immediately and until its
expiration on January 29, 2007. The options were granted pursuant to the
Company's 1996 Incentive Option Plan which was approved by the Stockholders.
On May 17, 1996, the Company entered into bonus plans with Mr. Turner
and Mr. Reithinger. At the time of entry into the plans, Mr. Turner was a
Director and an officer of the Company and Mr. Reithinger was an employee. Under
these plans as part of the Company's performance in 1996, Mr. Turner and Mr.
Reithinger were paid $30,000 and $9,000, respectively. No bonuses were paid as
part of the Company's performance for 1997.
The Company contracted for freight services with M-7 Consolidation,
Inc. and paid $104,737 to this entity in the year ended December 31, 1997. The
Company's accounts payable at December 31, 1997 includes $6,555 due to M-7.
Harvey J. Turner, the Company's former Chairman of the Board, President and
Chief Executive Officer, has been a substantial stockholder of M-7 since May of
1997 and a director of M-7 since August of 1997.
Prior to becoming a director and officer of the Company, Harvey J.
Turner acted as a consultant to the prior Chairman of the Board, John A.
Shannon, from January to April 1996. As a finder's fee for his work as a
consultant in the private placement with Linda Lee, the Company paid $40,000 and
issued 100,000 common shares to Mr. Turner on May 9, 1996. As general
compensation for his work as a consultant, Mr. Turner received 500,000 common
shares from Aloe Vera Development Corporation, in a private placement in
satisfaction of agreements with Mr. Shannon dated February 12, 1996. Mr. Turner
and Mr. Shannon personally guaranteed the repayment of $800,000 to Ms. Linda Lee
in a letter dated April 22, 1996.
The Company shared personnel, office and warehouse space in 1996 with
Royal Products, Inc. and Krystal Kleer, Inc., two companies controlled by John
A. Shannon, the Company's single largest shareholder. These companies were
billed $8,300 during the year ended December 31, 1996. The Company recorded
sales to Royal Products, Inc. and Desert Health Products, Inc., two entities
controlled by Mr. Shannon, of $11,741 and $56,200 for the years ended December
31, 1997 and 1996, respectively. The Company sold product to these companies at
its cost plus 5% prior to July 1, 1996 and at 25% gross margin thereafter.
The Company paid John A. Shannon consulting fees totalling $20,000 in
the year ended December 31, 1996 and a finder's fee of $40,000 related to the
sale of common and preferred stock.
-21-
<PAGE>
The Company issued an aggregate of 100,000 restricted shares to William
Brin on July 9, 1996 in satisfaction of past compensation owed. Mr. Brin was a
Director and the Company's National Sales Manager at the time of the issue.
On May 3, 1996, the Company paid $111,000 in cash to Dr. Michael
Shapiro in repayment of all of the principal and certain interest due under a
note payable. On September 20, 1996, the Company issued 30,000 shares to Dr.
Shapiro in satisfaction of the remaining interest payable under the note. At the
time of the payments and issuance of stock, Dr. Shapiro was a Director of the
Company.
On September 20, 1996, the Company issued 30,000 restricted shares in
satisfaction of interest due to Ronald Patterson. At the time of the issuances,
Mr. Patterson was a greater than 5% beneficial holder of the Company's common
shares.
Under the terms of a January 8, 1993 agreement between the Company and
Royal Products, Inc. ("Royal") for the sale to Royal of certain sales and
distribution rights relating to the Aurore-B beauty and hygiene line, Royal is
obligated to make annual payments to the Company including principal and
interest on July 1st of each year after July 1, 1993. John A. Shannon is a
director, officer and 70% shareholder of Royal and a substantial shareholder of
the Company.
On April 30, 1997, the Securities and Exchange Commission ("SEC")
received a complaint from Mark Dallamore regarding a certificate for 100,000
shares of Preferred Stock of the Company. The Company responded to the SEC that
the certificate did not appear in the Company's records, that the Company
received no consideration for the issuance and that the documents submitted by
Mr. Dallamore showed that John A. Shannon caused the stock to be invalidly
issued in exchange for the forgiveness of personal debts owed by Shannon and
Shanwick International Corp., a company he owns and controls. By letters dated
December 2 and 3, 1997, counsel for Mr. Dallamore demanded that the Company
recognize the Preferred certificate as valid. In further negotiations between
Dallamore and the Company, however, the Company has determined that it is not in
its best interest to defend the claim against Mr. Dallamore. The Company has
reached a preliminary agreement to recognize the certificate and convert it to
100,000 shares of Common Stock in exchange for Dallamore's release of claims.
The Dallamore certificate remains the subject of the Company's counterclaim
against Mr. Shannon for breaches of fiduciary duty in the American Arbitration
Association action.
-22-
<PAGE>
Item 13 - Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit Number Exhibit Name Method of Filing
- -------------- ------------ ----------------
<S> <C> <C>
3.1 Articles of Incorporation, as amended *
3.2 By-Laws **
4.1 Specimen Common Stock Certificate ***
4.2 Description of Common Stock ****
4.3 Specimen Preferred Stock Certificate *****
4.4 Conditions of Preferred Certificate ******
4.5 Certificates Describing Rights and Restrictions of Class Exhibit filed herewith
"A", "B" and "C" Preferred Shares as filed with the
16.1 Secretary of State of Nevada on July 18, 1997.
Amended Current Report on Form 8-K, regarding Mr. ********
27.1 Turner's resignation filed December 17, 1997
Financial Data Schedule Exhibit filed herewith
</TABLE>
* Incorporated by reference to Exhibit 3.1 of annual report on
Form 10-KSB (file no. 33- 10236) filed on April 18, 1997.
** Incorporated by reference to Exhibit 3 of Registration
Statement on Form S-1 (file no. 33-10236) filed on January 27, 1987, and
declared effective on February 14, 1988.
*** Incorporated by reference to Exhibit 1 of Registration
Statement on Form 8-A (File no. 022024) filed on July 2, 1993, and declared
effective on July 9, 1993.
**** Incorporated by reference to page 31 of Registration Statement
on Form S-1 (file no. 33- 10236) filed on January 27, 1987, and declared
effective on February 14, 1988.
***** Incorporated by reference to Exhibit 4.3 of annual report on
Form 10-KSB (file no. 33- 10236) filed on April 18, 1997.
****** Incorporated by reference to Exhibit 4.4 of annual report on
Form 10-KSB (file no. 33- 10236) filed on April 18, 1997.
******* Incorporated by reference to Exhibit 1 of Registration
Statement on Form S-8 (file no. 33-10236) filed on November 22, 1997.
******** Incorporated by reference to the Company's Amended Current
Report on Form 8-K (file no. 33-10236) filed January 24, 1997.
-23-
<PAGE>
(b) Reports on Form 8-K
(i) On December 17, 1997, the Company filed a Current
Report on Form 8-K regarding Mr. Turner's resignation
as Chairman, President and Chief Executive Officer.
(ii) Subsequent to December 31, 1997, on February 25,
1998, the Company filed a Current Report on Form 8-K
regarding Mr. Turner's resignation as a Director.
-24-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 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.
Dated: March 26, 1998 /s/ Neil Reithinger
Baywood International, Inc. --------------------------------------------
Neil Reithinger
Interim President, Director, Chief Financial
Officer, Secretary and Treasurer
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
Company and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Neil Reithinger Interim President, Director, Chief 03/26/98
- -------------------------- Financial Officer, Secretary and
Neil Reithinger Treasurer
/s/ Karl H. Rullich Director 03/26/98
- --------------------------
Karl H. Rullich
/s/ Glen Holt Director 03/26/98
- --------------------------
Glen Holt
/s/ Dr. Michael Shapiro Director 03/26/98
- --------------------------
Dr. Michael Shapiro
-25-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
December 31, 1997 and 1996
INDEX TO FINANCIAL STATEMENTS
-----------------------------
PAGE
----
REPORT OF INDEPENDENT AUDITORS 27
BALANCE SHEET AS OF DECEMBER 31, 1997 28
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED
DECEMBER 31, 1997 AND 1996 29
STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 30
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
DECEMBER 31, 1997 AND 1996 31 - 32
NOTES TO FINANCIAL STATEMENTS 33 - 44
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS 45
-26-
<PAGE>
[KING, WEBER & ASSOCIATES, P.C. LETTERHEAD]
INDEPENDENT ACCOUNTANTS' REPORT
To the Stockholders and Board of Directors of
Baywood International, Inc.:
We have audited the accompanying balance sheet of Baywood International, Inc. as
of December 31, 1997 and the related statements of operations, stockholders'
equity and cash flows for each of the two years in the period ended December 31,
1997. These financial statements are the responsibility of Baywood's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards required 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 our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Baywood International, Inc. as
of December 31, 1997, and the results of its operations and cash flows for each
of the two years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles.
Our audit was conducted for the purpose of forming an opinion on the financial
statements taken as a whole. The accompanying SCHEDULE II - Valuation and
Qualifying Accounts is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. The information contained in the accompanying SCHEDULE II -
Valuation and Qualifying Accounts has been subjected to the auditing procedures
applied in the audit of the financial statements and, in our opinion, is fairly
stated in all material respects in relation to the financial statements taken as
a whole.
/s/ King, Weber & Associates, P.C.
Tempe, Arizona
March 13, 1998
-27-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
BALANCE SHEET
-------------
As of December 31, 1997
ASSETS
------
CURRENT ASSETS
Cash and equivalents $ 668,906
Accounts receivable (Note 9) 274,450
Inventories 22,391
Deferred income taxes (Note 12) 150,000
Prepaid expenses and other current assets 20,624
-----------
Total current assets 1,136,371
-----------
PROPERTY & EQUIPMENT
Furniture, fixtures, computers and equipment (Note 3)
(net of accumulated depreciation of $79,777) 15,602
-----------
OTHER ASSETS
Contracts & marketing rights (Note 1)
(net of accumulated amortization of $72,807) 82,093
Formulas & product lines (Note 1)
(net of accumulated amortization of $72,807) 82,093
-----------
Total other assets 164,186
-----------
Total assets $ 1,316,159
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Accounts payable $ 265,567
Sales commissions payable 46,889
Accrued liabilities (Note 14) 117,266
-----------
Total current liabilities 429,722
-----------
STOCKHOLDERS' EQUITY
Preferred stock, $1 par value,
10,000,000 shares authorized (Note 5)
Class A, 135,000 shares issued, aggregate
liquidation preference of $135,000 135,000
Class C, 920,000 shares issued, aggregate
liquidation preference of $920,000 920,000
Common stock, $.001 par value, 50,000,000
shares authorized, 17,498,115 shares
issued and outstanding (Note 10) 17,498
Additional paid-in capital 5,314,139
Accumulated deficit (5,500,200)
-----------
Total stockholders' equity 886,437
-----------
Total liabilities and stockholders' equity $ 1,316,159
===========
See accompanying notes to financial statements.
-28-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
STATEMENTS OF OPERATIONS
------------------------
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996
------------ ------------
<S> <C> <C>
NET SALES $ 3,234,056 $ 4,000,139
COST OF SALES 2,029,077 2,334,201
------------ ------------
Gross profit 1,204,979 1,665,938
------------ ------------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Marketing expenses 433,747 612,215
General and administrative expenses 865,902 709,882
Depreciation and amortization 49,939 51,270
------------ ------------
Total selling, general and administrative expenses 1,349,588 1,373,367
------------ ------------
------------ ------------
Operating profit (loss) (144,609) 292,571
------------ ------------
OTHER INCOME (EXPENSE):
Interest income 16,914 25,252
Miscellaneous expense (Note 14) (38,853) (1,086)
Miscellaneous income 9,288 202,376
Interest expense -- (22,172)
------------ ------------
Total other income (expense) (12,651) 204,370
------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES (157,260) 496,941
INCOME TAX BENEFIT -- 149,950
------------ ------------
NET INCOME (LOSS) $ (157,260) $ 646,891
============ ============
NET INCOME (LOSS) PER COMMON SHARE $ (0.02) $ 0.04
============ ============
DILUTED NET INCOME (LOSS) PER COMMON SHARE $ -- $ 0.04
============ ============
WEIGHTED AVERAGE OF COMMON SHARES OUTSTANDING 17,498,115 17,440,620
============ ============
</TABLE>
See accompanying notes to financial statements.
-29-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
----------------------------------
<TABLE>
<CAPTION>
Additional
Preferred Stock Common Stock Paid-in
Shares Amount Shares Amount Capital
-------------- --------------- -------------- --------------- --------------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 1,210,500 $ 1,210,500 14,661,468 $ 14,662 $ 5,021,394
Issuance of common and preferred stock 800,000 800,000 1,466,147 1,466 (1,466)
stock for cash
Reclassification from stockholders' equity
for redemption feature of preferred stock (800,000) (800,000)
Conversion of preferred to common stock (1,175,500) (1,175,500) 1,175,500 1,176 1,174,324
Issuance of common stock for services
and for payment of interest payable 290,000 290 47,050
Fees paid in connection with offering of
common and preferred stock (82,729)
Reclassification (Note 15) (648,429)
Receipt of common stock as payment
for Note Receivable (Note 5)
NET INCOME
============== =============== ============== =============== ==============
BALANCE, DECEMBER 31, 1996 35,000 $ 35,000 17,593,115 $ 17,593 $ 5,510,144
============== =============== ============== =============== ==============
Recognition of preferred stock in
connection with claim 100,000 100,000 (100,000)
Retirement of Treasury Stock (95,000) (95) (96,005)
Reclass of Redeemable Preferred Stock 800,000 800,000
Issuance of Preferred Stock Dividend 120,000 120,000
NET LOSS
============== =============== ============== =============== ==============
BALANCE, DECEMBER 31, 1997 1,055,000 $ 1,055,000 17,498,115 $ 17,498 $ 5,314,139
============== =============== ============== =============== ==============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Treasury Accumulated
Stock Deficit Total
--------------- -------------- ---------------
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 $ (62,500) $ (6,518,261) $ (334,205)
Issuance of common and preferred stock 800,000
stock for cash
Reclassification from stockholders' equity
for redemption feature of preferred stock (800,000)
Conversion of preferred to common stock -
Issuance of common stock for services
and for payment of interest payable 47,340
Fees paid in connection with offering of
common and preferred stock (82,729)
Reclassification (Note 15) 648,429 -
Receipt of common stock as payment
for Note Receivable (Note 5) (33,600) (33,600)
NET INCOME 646,891 646,891
=============== ============== ===============
BALANCE, DECEMBER 31, 1996 $ (96,100) $ (5,222,939) $ 243,698
=============== ============== ===============
Recognition of preferred stock in
connection with claim
Retirement of Treasury Stock 96,100
Reclass of Redeemable Preferred Stock
Issuance of Preferred Stock Dividend (120,000) 800,000
NET LOSS (157,260) (157,260)
=============== ============== ===============
BALANCE, DECEMBER 31, 1997 $ - $ (5,500,200) $ 886,437
=============== ============== ===============
</TABLE>
See accompanying notes to financial statements
-30-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
STATEMENTS OF CASH FLOWS
------------------------
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996
---------------- ---------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ (157,260) $ 646,891
Adjustments to reconcile net income (loss) to cash (used) in
provided by operating activities:
Depreciation and amortization 49,939 51,270
Issuance of common stock as payment for services performed - 26,000
Gain recognized in settlement of trade accounts payable - (69,409)
Gain recognized for change in common stock valuation
related to interest accrual payment - (98,903)
Loss on sale of computers and equipment - 1,061
Gain on sale of equipment (1,292) -
Net decrease in inventory reserve - (13,866)
Allowance on note and interest receivable 81,073 73,466
Common stock issued as payment for interest on notes - 21,240
Common stock received as payment of interest on note receivable - (20,340)
Deferred income taxes - (150,000)
Changes in assets and liabilities:
(Increase) decrease in accounts receivable 229,376 (469,039)
Decrease in interest receivable - 610
Decrease in inventory 57,126 165,001
(Increase) in prepaid expenses (11,474) (6,028)
(Decrease) in interest payable - (42,770)
(Decrease) in customer deposits - (16,140)
Increase (decrease) in accounts payable and accrued liabilities (349,534) 272,119
---------------- ---------------
Net cash provided (used) by operating activities (102,046) 371,163
---------------- ---------------
INVESTING ACTIVITIES:
Proceeds on sale of computers and equipment 2,000 1,280
Purchase of furniture, computers and equipment - (1,571)
Principal payments received on note receivable - 5,000
---------------- ---------------
Net cash provided by investing activities 2,000 4,709
---------------- ---------------
</TABLE>
-31-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
STATEMENTS OF CASH FLOWS (CONT'D)
---------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
FINANCING ACTIVITIES:
Issuance of common and preferred stock for cash - 800,000
Fees paid in connection with offering of common and preferred stock - (82,629)
Proceeds from notes payable - 50,000
Principal payments on notes payable - (482,000)
---------------- ---------------
Net cash provided by financing activities - 285,371
---------------- ---------------
CASH AND EQUIVALENTS PROVIDED (USED) DURING YEAR (100,046) 661,243
CASH AND EQUIVALENTS, BEGINNING OF YEAR 768,952 107,709
================ ===============
CASH AND EQUIVALENTS, END OF YEAR $ 668,906 $ 768,952
================ ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ - $ 38,126
Income taxes $ 10,174 $ 50
NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of preferred stock dividend $ 120,000 $ -
Principal payment received on note receivable
in the Company's common stock $ - $ 13,260
Payment of trade payable through disposal of equipment $ 3,000 $ -
Class B redeemable preferred stock converted to Class C preferred stock $ 800,000 $ -
</TABLE>
See accompanying notes to financial statements
-32-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
Note 1 - ORGANIZATION AND BASIS OF PRESENTATION
Baywood International, Inc. develops, markets and distributes
nutritional supplements and skin care products. Since its inception, the Company
has directed most of its sales efforts toward international markets and has
established either distribution or registration of its products into the Pacific
Rim Countries (China, Malaysia, Hong Kong, Taiwan and Indonesia) as well as
Europe (Italy, Germany, Austria, England and Switzerland). Establishing
distribution into health food stores, chain drug stores, grocery chains and
network marketing companies internationally and in the United States is also
part of the Company's marketing strategy. At this time, the Company is focused
on strengthening its international distribution and building its distribution of
branded products through health food stores in the United States.
The Company's main dietary supplement products include bee pollen, bee
propolis, royal jelly and a freeze dried aloe vera and mineral drink. At any
point depending on customer demand or market opportunity, the Company may add to
its line vitamins and herbs making the number of products and the mix in the
types of products sensitive to change constantly toward the demands of what
customers or the markets desire. The main products in the Company's skin care
line are marketed together as a facial system and include a cleanser, lift
powder with activator, toner and a nurture cream. Depending on the demands of a
particular customer, the Company may also supply most types of products
unlabeled, in bulk or under a private label. Although the Company considers the
potential of unlabeled or privately labeled products to be substantial,
emphasizing the Company's own branded products for presentation to the
international and domestic market is essential toward the Company's recognition.
Due to the nature of the products, production processes, markets and
marketing methods, the Company considers its business to revolve around one
industry segment, consumer products in the health and beauty industry.
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
- -------------------
Revenue is recognized when the product is shipped. A majority of the
product is shipped to the customer directly from the Company's suppliers and
manufacturers. Payments from customers prior to shipment are recorded as
customer deposits. Sales returns are recorded as a reduction to sales when a
customer and the Company agree a return is warranted. Sales returns historically
have not been significant.
Property, Equipment and Depreciation
- ------------------------------------
Furniture, fixtures, computers and equipment are depreciated using the
straight-line method over their estimated useful lives of five years.
Cash and Equivalents
- --------------------
The Company considers cash to be all short-term, highly liquid
investments that are readily
-33-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
convertible to known amounts of cash and have original maturities of three
months or less. Cash equivalents include funds invested in money market funds.
Inventories
- -----------
Inventories consist of finished product, packaging and labelling
materials and are recorded at the lower of cost or market on a first-in,
first-out basis.
Intangible Assets
- -----------------
The cost of marketing rights, contracts, investments in formulas and
product lines acquired by the issuance of preferred or common stock was recorded
at fair value of the stock issued or assets acquired. Fair value of restricted
common stock issued to acquire the assets was generally considered to be the
average bid price during the thirty day period prior to the transaction,
discounted 50 percent for the restrictions imposed on sale or transfer of the
stock for two years from date of issuance.
Intangible assets are amortized on a straight line basis over ten
years. The Company evaluates the carrying value of intangible assets based on
estimated future cash flows from product sales to which the specific contracts,
rights or formulas relate.
Stock-Based Compensation
- ------------------------
In accordance with Statements of Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," the Company has elected to continue
accounting for stock based compensation using the intrinsic value method
prescribed by Accounting Principle Board Opinion No. 25, "Accounting for Stock
Issued to Employees." The proforma effect of the fair value method is discussed
in Note 10.
Income Taxes
- ------------
The Company accounts for income taxes under the liability method
pursuant to the Statement of Financial Accounting Standards No. 109 (SFAS 109),
Accounting for Income Taxes. Deferred taxes arise from temporary differences,
due to differences between accounting methods for tax and financial statement
purposes.
Income (Loss) Per Share
- -----------------------
Net income (loss) per share is calculated using the weighted average
number of shares of common stock outstanding during the year. The Company has
adopted SFAS No. 128 Earnings Per Share the effect of such was not material. Net
Income per Common Share for the year ended December 31, 1996 was recalculated
under the provisions of SFAS No. 128 and the effect was not material.
Convertible preferred stock and outstanding options were not considered
in the calculation for diluted earnings per share for the year ended December
31, 1997 because the effect of their inclusion would be antidilutive. The result
of the calculation of diluted earnings per share for the year ended December 31,
1996 was the same as basic earnings per share.
-34-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
---- ----
Per Per
Income Shares Share Income Shares Share
------ ------ ----- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Net Income (Loss) $ (157,260) $ 646,891
Preferred Stock Dividends (120,000)
Basic Earnings Per Share
Income (Loss) Available to
Common Shareholders (277,260) 17,498,115 $(0.02) 646,891 17,440,620 $0.04
Effect of Dilutive Securities N/A
Preferred Stock 976,941
Diluted Earnings Per Share N/A 646,891 18,417,561 $0.04
</TABLE>
Preferred stock convertible into at least 1,055,000 shares of common
stock and options to purchase 1,755,000 shares of common stock were outstanding
at December 31, 1997 but were excluded from the computation of diluted earnings
per share because the effect of their inclusion would be anti-dilutive.
Advertising Expenses
- --------------------
The Company expenses advertising costs as incurred. Advertising expense
totaled approximately $61,000 and $24,000 for the years ended December 31, 1997
and 1996, respectively, and is included in marketing expenses in the
accompanying financial statements.
Financial Instruments
- ---------------------
Financial instruments consist primarily of cash, accounts receivable, a
related party note receivable and obligations under accounts payable and accrued
expenses. The carrying amounts of cash, accounts receivable, accounts payable
and accrued expenses approximate fair value because of the short term maturity
of those instruments. The Company has not determined the fair value of the note
receivable due to the related party nature of the note and the difficulty in
evaluating the credit worthiness of the related party.
Use of 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.
-35-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
Note 3 - PROPERTY AND EQUIPMENT
Furniture and Fixtures $ 42,033
Computer Equipment 50,290
Other Equipment 3,056
Less: Accumulated Depreciation (79,777)
----------
$ 15,602
==========
Depreciation expense for the years ended December 31, 1997 and 1996 was
$18,959 and $20,290, respectively.
Note 4 - RELATED PARTY NOTE RECEIVABLE
In 1993 the Company sold all sales and distribution rights of the
Aurore-B beauty and hygiene product line covering the United States, Mexico and
Canada for a note receivable to Royal Products, Inc., an entity controlled by
the Company's former Chairman of the Board and single largest shareholder. The
note was discounted assuming a 10% annual discount factor resulting in a
principal balance of $212,228. The note requires ten annual varying payments
commencing July 1, 1993. The Company encountered difficulties collecting the
1996 and 1997 scheduled installments. The scheduled installments of $34,775 and
$35,555 were due July 1 of each respective year. When the 1996 installment was
not received on the payment due date, collection was pursued. As payment, the
Company later received $5,000 cash and 70,000 shares of the Company's common
stock, which was included as treasury stock. The common stock received was
valued at $33,600 on the basis of closing prices at and near the time of the
transaction. Restrictions applied to 20,000 of the shares and the value of those
shares was discounted by 50% of the quoted closing price. The 70,000 treasury
shares were retired in 1997.
The Company did not receive timely payment again for the 1997
installment. The Company pursued collection efforts again and obtained a
judgement against Royal. The Company has reserved the right to enforce the
judgement but believes collection will be difficult.
The note is uncollateralized and expected future cash flows from the
note are uncertain. The remaining balance of the note of $146,892 has been fully
charged off. Interest earned on the note was $0 and $19,370 for the years ended
December 31, 1997 and 1996, respectively. Interest income for the year ended
December 31, 1996 includes a late payment penalty of $4,128. The statement of
operations for the years ended December 31, 1997 and 1996 include charges to bad
debt expense of $73,425 and $73,466 respectively.
Note 5 - PREFERRED STOCK
The Company has issued three classes of preferred stock with differing
features and privileges. The first series, Class A preferred stock ($1 par
value, 135,000 shares issued and outstanding at December 31, 1997) is
convertible by the holder at any time into common stock on the basis of one
share of preferred for one share of common stock. The Class A preferred shares
have a preference in liquidation of up to $1.00 per share. The Class A preferred
shares are non-voting and have no stated
-36-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
dividend preferences or rights. In 1997, an individual claimed ownership to
100,000 shares of Class A preferred stock that had not been previously
recognized or recorded by the Company. The stock certificate stated that it was
issued in 1992 but the Company had no record of the stock certificate and no
Board of Directors' minutes reflecting approval of the shares. The Company
believed that the shares were invalidly issued but rather than contesting the
validity of the issuance and incurring legal cost related to such, the Company
agreed to recognize the 100,000 preferred shares. Subsequent to December 31,
1997, the shareholder agreed to convert the shares to 100,000 shares of the
Company's common stock. The 100,000 shares of preferred stock have been
reflected in the accompanying financial statements as if they were issued on
January 1, 1997.
In 1996, the Company issued 800,000 shares of $1.00 par value
redeemable and convertible Class B preferred stock. The shares were issued from
the authorized preferred stock. The Class B preferred shares were issued in
conjunction with the issuance of 1,466,147 shares of the Company's common stock
where the Company raised $800,000 cash less finder's fees of $80,000 resulting
in net capital raised of $720,000. The Class B preferred shares were convertible
into common stock of the Company at the option of the holder after May 8, 1997
in an amount equal to 800,000 divided by the average share price of the
Company's common stock for the previous three month period, provided, however,
that the average price of the Company's common stock for this period equals or
exceeds $1.00 per share. Alternatively, the holder had rights to redeem the
preferred shares for the par value of $1.00 per share ($800,000) payable in cash
by the Company within 30 days of receipt of the election to redeem. The holder
could elect for redemption only if the average price of the Company's common
stock for the three month period prior to redemption is less than $1.00 per
share. The Class B preferred stock was converted to Class C preferred stock in
the year ended December 31, 1997.
In the year ended December 31, 1997, the Company issued a preferred
stock dividend in the form of 120,000 Class C $1 par value convertible preferred
shares to the holder of the Class B preferred shares. In conjunction with the
stated redemption date of the Class B preferred stock and issuance of the Class
C shares, the holder of the Class B preferred shares has forgone the redemption
privilege of the Class B preferred shares and the 800,000 Class B preferred
shares were converted to 800,000 Class C preferred shares. The Class C preferred
shares include conversion rights, at the option of the holder, of one share of
common per one share of preferred if the average price of the Company's common
stock for the three month period prior to May 8, 1998 is greater than $1.00. If
that average price is less than $1.00, the conversion rate is equal to the
number of common shares resulting from dividing $920,000 by that average price.
Based on the three month average closing price of the Company's common stock for
the period ending March 13, 1998, the number of common shares issuable would be
5,859,873. The Class C preferred shares also have par value liquidation
preferences, dividend preferences and no voting rights.
The Board of Directors may determine any preferences and features for
the unissued shares of preferred stock as they are issued in the future.
Note 6 - RELATED PARTY TRANSACTIONS
The Company shared personnel, office and warehouse space in 1996 with
two companies controlled by the Company's former Chairman of the Board and
single largest shareholder. The related companies were billed $8,300 during the
year ended December 31, 1996. The Company recorded sales
-37-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
to two related entities controlled by the former chairman of $11,741 and $56,200
for the years ended December 31, 1997 and 1996, respectively. The Company sold
product to the related companies at its cost plus 5% prior to July 1, 1996 and
at 25% gross margin thereafter.
Prior to becoming an employee, the Company paid a finder's fee of
$40,000 cash and 100,000 shares of the Company's common stock to a former
President and Chairman of the Board in the year ended December 31, 1996. The fee
was paid in connection with the raising of $800,000 cash in the sale of common
and preferred stock.
The Company paid another former chairman and a significant shareholder
consulting fees totalling $20,000 in the year ended December 31, 1996 and a
finder's fee of $40,000 related to the sale of common and preferred stock.
In the year ended December 31, 1996, the Company paid certain debt and
accrued interest to a director and a greater than 5% shareholder by issuance of
60,000 shares of the Company's common stock.
The Company had accrued expenses of $53,400 at December 31, 1995 due to
former and current officers or related entities that were settled or negotiated
without payment. That amount is included in miscellaneous income for the year
ended December 31, 1996.
The Company contracted for freight services with a company in which the
Company's former Chairman of the Board, President and Chief Executive Officer is
a stockholder and director. The Company paid $104,737 to this related entity in
the year ended December 31, 1997. Accounts payable at December 31, 1997 includes
$6,555 due to this related entity.
Note 7 - LEASE OBLIGATIONS
The Company leases its offices and warehouse under an operating lease
that expires on July 31, 2000. Future minimum annual lease obligations for the
remaining term of the lease are as follows:
1998 $ 38,955
1999 40,903
2000 24,542
----------
$ 104,400
==========
Rent expense was $61,000 and $74,000 for the years ended December 31,
1997 and 1996, respectively.
Note 8 - GEOGRAPHIC AREA DATA BY PRODUCT LINE
The Company's revenue is generated from sales concentrated with one
primary customer. The Company's product lines include nutritional supplements
and skin care products. The Company operates in only one reportable segment and
holds all of its assets in the United States. The following table outlines the
breakdown of sales to unaffiliated customers domestically and internationally:
-38-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
1997 1996
---- ----
Nutritional Supplements:
United States $ 52,872 $ 125,203
China 3,019,162 2,353,187
Other 159,419 265,295
----------- -----------
Total 3,231,453 2,743,685
----------- -----------
Skin Care
United States 1,415 3,600
China 0 1,239,653
Other 1,188 13,201
----------- -----------
Total 2,603 1,256,454
----------- -----------
Total Revenue $ 3,234,056 $ 4,000,139
=========== ===========
NOTE 9 - CREDIT RISK AND OTHER CONCENTRATIONS
The Company generated 93.4% and 89.8% of its sales, $3,019,162 and
$3,592,840 from one Chinese customer in years ended December 31, 1997 and 1996,
respectively. Trade accounts receivable at December 31, 1997 includes amounts
due from this customer of $257,547. For the year ended December 31, 1997, sales
are also concentrated in one product, the freeze dried aloe vera and mineral
drink. Sales of this product were approximately $3,050,000 for the year ended
December 31, 1997, which includes all sales to this customer. Any significant
reduction in sales to this one customer would have an adverse effect on the
Company's operations. Historically, there have been no significant write-offs or
collection difficulties with this customer. Billing and collections from this
customer are conducted in U.S. dollars.
From time to time, the Company's bank balances exceed federally insured
limits. At December 31, 1997, the Company's balance exceeded insured limits by
approximately $566,000.
The Company holds a note receivable from a related party with a
remaining principal balance of $146,892 at December 31, 1997. The Company
maintains no collateral on the note. The Company recorded an allowance for
doubtful collection against this note for the full amount of the principal at
December 31, 1997 (See Note 4).
The Company receives virtually all of its products from two vendors.
Management believes alternative sources are available if required.
NOTE 10 - STOCKHOLDERS' EQUITY
The Company issues stock options from time to time to executives and
key employees. The Company has adopted the disclosure-only provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," and continues to account for stock based compensation using the
intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". Accordingly, no compensation cost
has been
-39-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
recognized for the stock options. Had compensation cost for the Company's stock
options been determined based on the fair value at the grant date for awards in
1997 consistent with the provisions of SFAS No. 123, the Company's net earnings
(loss) and earnings (loss) per share would have been reduced to the pro forma
amounts indicated below:
1997 1996
---- ----
Net Earnings (Loss) - as reported $(157,260) $646,891
Net Earnings (Loss) - pro-forma $(190,473) $585,054
Earnings (Loss) per share - as reported $(.02) $.04
Earnings (Loss) per share - pro-forma $(.02) $.03
Under the provisions of SFAS No. 123, the number of fully vested
options granted of 55,000 and proportionately vested options of 41,000 for the
year ended December 31, 1997 and 100,000 fully vested plus 59,000
proportionately vested for the year ended December 31, 1996 were used to
determine net earnings and earnings per share under a pro forma basis.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions for
years ended December 31:
1997 1996
---- ----
Dividend yield None None
Volatility 0.927 0.925
Risk free interest rate 5.69% 6.19%
Expected asset life 5 years 5 years
Under the Employee Incentive Stock Option Plan approved by the
stockholders in 1996, the total number of shares of common stock that may be
granted is 500,000. The plan provides that shares granted come from the
Corporation's authorized but unissued common stock. The price of the options
granted pursuant to these plans will not be less than 100 percent of the fair
market value of the shares on the date of grant. The options expire ten years
from date of grant.
-40-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
The summary of activity for the Company's stock options is presented
below:
<TABLE>
<CAPTION>
Weighted Weighted
-------- --------
Average Average
------- -------
Exercise Exercise
-------- --------
1997 Price 1996 Price
---- ----- ---- -----
<S> <C> <C> <C> <C>
Options outstanding at beginning
of year 1,700,000 $ 0.37 2,100,000 $ 0.43
Granted 55,000 $ 0.42 200,000 $ 0.52
Exercised 0 0
Options voided that were
previously recognized 0 (600,000) $ 0.25
Terminated 0 0
Options outstanding at end of year 1,755,000 $ 0.37 1,700,000 $ 0.37
Options exercisable at end of year 1,755,000 $ 0.37 1,600,000 $ 0.36
Options available for grant at
end of year 445,000 500,000
Price per share of options outstanding $0.25 - $1.00 $0.25 - $1.00
Weighted Average Remaining
Contractual Lives 2.0 years 2.2 years
Weighted Average fair value of
options granted during the year $ 0.31 $ 0.39
</TABLE>
Management had determined, after investigation and consultation with
the Company's legal counsel, that options to purchase 300,000 shares of the
Company's common stock, allegedly granted to a Director on January 1, 1993, are
legally invalid. In a letter dated January 30, 1997 and an Acknowledgment and
Release of Invalid Options dated February 24, 1997, the Director accepted the
Company's determination regarding the invalidity of the options. Management had
also determined, after investigation and consultation with the Company's legal
counsel, that options to purchase 300,000 shares of the Company's common stock,
allegedly granted to another former officer and Director on January 1, 1993, are
legally invalid. The total of 600,000 options have been subtracted from the
options exercisable a the end of 1996.
In addition, management had determined, after investigation and
consultation with the Company's legal counsel, that options to purchase
1,000,000 shares of the Company's common stock, allegedly granted to the
Company's former chairman on January 1, 1993, were legally invalid. The former
chairman contested the determination and after an arbitration hearing, the
options were reaffirmed. The options, exercisable at $0.25 were originally
excluded from the options exercisable at December 31, 1996. However, the
1,000,000 have been included in the table above and the 1996 amounts have been
restated. The 1,000,000 options expired unexercised on January 1, 1998. These
options were not included in the earnings per share calculation. The 1996
earnings per share have not been restated for 1,000,000 since they were not
reaffirmed until December 1997, and have since expired.
-41-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
The effect of these options would be anti-dilutive, and therefore not included
in 1997 loss per share.
In 1995, as an inducement to convert notes payable to common stock, the
Company issued options to purchase 500,000 shares of the Company's common stock
at $1.00 per share. The options expire on May 3, 2000. The options price
approximated the closing prices of the Company's common stock at the time the
options were granted.
NOTE 11 - COMMON STOCK ISSUED FOR SERVICES RENDERED
The Company issues shares of its common stock from time to time as
payment for services rendered, inducements to lend to the Company and
inducements to convert existing debt. In 1996, the Company issued 100,000 shares
of its common stock as payment for a consulting fee. Those shares were valued at
$26,000. Also in 1996, the Company issued 90,000 shares of its common stock
valued at $21,240 as settlement of accrued interest on notes payable.
In addition to these transactions, the Company issued 90,000 shares of
its common stock in 1996 as payment for inducements made in 1995 to make loans
to the Company. The Company had been estimating the value of these common shares
and had recorded an accrual for estimated value at December 31, 1995 of
$126,780. The value of the stock had dropped to $21,240 when it was actually
issued and the obligation paid in 1996. The difference in the estimate resulted
in a gain of $105,540 which is included in miscellaneous income for the year
ended December 31, 1996.
Note 12 - INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. No deferred tax
liabilities existed at December 31, 1997.
Deferred tax assets totalling $2,149,000 were mostly offset by a
valuation allowance of $1,999,000 resulting in a net deferred tax asset of
$150,000. The valuation allowance was provided due to the uncertainty of future
realization of federal and state net operating loss carryforwards that give rise
to approximately $2,061,000 of the deferred tax asset. The net deferred tax
asset balance relates to differences in book and tax accounting relative to
allowances on the note receivable of approximately $59,000, income tax basis
deferred compensation of approximately $21,000 and the estimated realization of
net operating loss carryforwards of approximately $70,000. The Company has
federal and state net operating loss carryforwards of $4,843,000 and $4,731,000,
respectively, at December 31, 1997. The deferred federal loss carryforwards
expire in 2002 through 2013 and state loss carryforwards expire 1998 through
2003.
-42-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
Income taxes for years ended December 31:
1997 1996
---- ----
Current Provision $ 0 $ (247,197)
Current Benefit 33,529 0
Deferred Benefit 10,060 397,147
Valuation Allowance (43,589) 0
------------ ----------
Net income tax benefit $ 0 $ 149,950
============ ==========
The income tax benefit of $43,589 generated for the year ended December
31, 1997 was offset by an equal increase in the valuation allowance.
Income tax returns for years prior to 1995 were amended in 1996
resulting in a reduction of the net operating loss carryforward. The effect,
recognized in the year ended December 31, 1996, reduced the deferred income tax
asset by $384,000 which was offset by an equal reduction of the valuation
allowance. The deferred income tax asset and valuation allowance was further
reduced by $247,197 for recognition of the net operating loss carryforward for
taxable income generated in the year ended December 31, 1996. Management
believed that the Company would continue to generate taxable income and
therefore reduced the valuation allowance by an additional $120,422 as of
December 31, 1996.
A reconciliation for the differences between the effective and
statutory income tax rates is as follows:
<TABLE>
<CAPTION>
1997 1997 1996 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Federal statutory rates $(46,444) (26)% $168,960 34 %
State income taxes - net of federal benefit (9,435) (6)% 29,816 6 %
Recognition of operating loss carryforward 0 0 % (247,197) (50)%
Valuation allowance for operating loss
carryforwards 43,589 28 % 0 0 %
Recognition of deferred tax asset and reduction
of valuation allowance 0 0 % 101,529 (20)%
Other 6,290 4 % 0 0 %
--------- ----- -------- -----
Effective rate $ 0 0 % $149,950 (30)%
========= ===== ======== =====
</TABLE>
Note 13 - RECLASSIFICATION
In connection with certain prior period adjustments recorded in 1995,
one of the adjustments was incorrectly classified in the accumulated deficit
rather than additional paid in capital. A reclassification of $648,429 between
additional paid in capital and accumulated deficit was made in 1996. The
reclassification had no effect on results of operations or net equity.
Note 14 - COMMITMENTS AND CONTINGENCIES
In 1997, the Company entered into an agreement with a third party to
market and distribute its products in certain European countries. Under the
agreement, the Company paid $25,000 at the
-43-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
December 31, 1997 and 1996
inception of the agreement and agreed to pay an additional $25,000 and issue the
third party 100,000 shares of $1 par value convertible preferred stock. The
agreement was not finalized prior to December 31, 1997. The $50,000 cash
payments were charged to marketing expense in the year ended December 31, 1997.
The value of the preferred stock to be issued was estimated to be $15,000 based
on average closing prices of the Company's common stock for a three month period
ending March 13, 1998. The common stock value was used as a comparable estimate
of the preferred stock value because it is readily convertible into common
stock. The estimated value of $15,000 was accrued in the accompanying financial
statements for the year ended December 31, 1997.
Under the terms of an employment agreement with its former President
and Chairman, the Company accrued the remaining compensation remaining to be
paid under that agreement through April 18, 1998. The balance of $41,667,
representing compensation from the effective employment termination date of
December 10, 1997 through April 18, 1998, was accrued at December 31, 1997.
The Company was named as a defendant in a $900,000 claim filed against
an entity controlled by its former chairman related to the transfer of certain
furnishings and equipment by that related entity. Management believes that it
was named in the suit only by its association with a former chairman and the
Company intends to vigorously defend this claim. Management believes it has a
strong defense but is unable to predict the outcome of this matter or the
likelihood of an unfavorable outcome.
A former Director and officer filed a demand for arbitration against
the Company. The demand seeks $210,374 plus interest, attorney's fees and costs
for a breach of an employment agreement, but does not further specify the nature
of the claim. The matter is scheduled for arbitration in 1998. The Company
believes that there was no breach of the employment agreement and intends to
vigorously defend this claim. Management believes it has a strong defense but is
unable to predict the outcome of this matter or the likelihood of an unfavorable
outcome.
An arbitrator ruled against the Company in a case related to the
invalidation of 1 million options allegedly issued to the Company's former
president and chairman. The Company had claimed that the options were issued
without proper and legal Board of Directors' approval. The arbitrator awarded
the 1,000,000 options to the former president and chairman. The options were
exercisable at $0.25 and they were allowed to expire on January 1, 1998. The
arbitrator also awarded an unspecified amount of legal fees and the former
president requested legal fees of $124,338. The Company is contesting the
reasonableness of the fee application. The arbitrator has agreed to review the
matter in a hearing but such is yet to be scheduled. The Company intends to
offer a settlement of approximately $30,000 and has accrued that amount in the
accompanying financial statements for the year ended December 31, 1997.
Management is unable to predict the outcome of this matter or the likelihood of
an unfavorable outcome in excess of the amount accrued.
-44-
<PAGE>
BAYWOOD INTERNATIONAL, INC.
SCHEDULE II
-----------
Schedule of Valuation and Qualifying Accounts
December 31, 1997
<TABLE>
<CAPTION>
Additions
-------------------------------
Balance at Charged to Charged to Balance at
Beginning of Costs Other End of
Description Year Expenses Accounts Deductions Year
- ------------------------------------- --------------- ------------- ------------- ------------- --------------
<S> <C> <C> <C>
Allowance for doubtful collection
on related party note receivable $ 73,425 $ 73,466 $ 146,891
Deferred tax asset
valuation allowance $ 1,955,708 $ 43,589 $ 1,999,297
</TABLE>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
DECEMBER 31, 1997 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS
-45-
CERTIFICATE OF DESIGNATION FOR
CLASS "A" PREFERRED SHARES
SECRETARY OF THE
STATE OF NEVADA
C4086-86
- --------
This Certificate sets forth the voting powers, designations,
preferences, limitations, restrictions, and relative rights of the Class "A"
Preferred Shares of Baywood International, Inc. ("Baywood") to be issued after
or the ratification of issuance of which is effective after the filing of such
certificate with appropriate state authorities.
1. Conversion Privileges. At the option of the holder thereof
("Shareholder"), the Class A Preferred Shares are convertible at any time into
common stock on the basis of one share of Class A Preferred for one share of
common stock.
2. Redemption. Shareholder shall have no right to redeem the Class A.
Preferred Shares.
3. Par Value. The Class A Preferred Shares shall have a par value of $1.00
per share.
4. Distribution of Capital. In the event of dissolution, bankruptcy, or
termination of this corporation, the par value of all the Class A Preferred
Stock shall be paid in full before the common stock or any part thereof or any
dividend thereon is paid.
5. Voting Rights. The Shareholder of the Class A Preferred Shares shall
have no voting power.
6. Dividends. The Class A Preferred Shares shall have no preference as to
dividends and assets.
7
<PAGE>
CERTIFICATE OF DESIGNATION FOR
CLASS "B" PREFERRED SHARES
This Certificate sets forth the voting powers, designations,
preferences, limitations, restrictions and relative rights of the 800,000 Class
"B" Preferred Shares of Baywood International, Inc. ("Baywood") the ratification
of issuance of which is effective after the filing of such certificate with
appropriate state authorities. Such shares shall automatically be converted into
Class "C" Preferred Shares upon the effectiveness of the filing of the
certificate for such Class "C" Preferred Shares.
1. Conversion Privileges. At the end of twelve consecutive months after
the date of issuance of the Class "B" Preferred Shares, at the option of the
holder thereof ("Shareholder"), the Class "B" Preferred Shares are convertible
into common stock of Baywood, in an amount equal to the number of the Class "B"
Preferred Shares (800,000) divided by the average share price of Baywood's
common shares for the last three-month period; PROVIDED, however, that the
average price of Baywood's common shares for the previous three months equals or
exceeds $1.00 per share.
2. Redemption. Alternatively, at the end of twelve consecutive months
after the date of issuance of the Class "B" Preferred Shares, the shareholder
may demand redemption of the Class "B" Preferred Shares by Baywood at an amount
equal to the par value ($1.00) of the Class "B" Preferred Shares, paid to the
shareholder in cash within thirty (30) days of his written notice of redemption;
PROVIDED, however, that the average price of Baywood's common shares for the
previous three months is less than $1.00 per share. Such redemption may not be
for less than all of the Class "B" Preferred Shares.
3. Par Value. The Class "B" Preferred Shares shall have a par value of
$1.00 per share.
4. Distribution of Capital. In the event of dissolution, bankruptcy, or
termination of this corporation, the par value of all the Class "B" Preferred
share shall be paid in full before the common stock or any part thereof or any
dividend thereon is paid.
5. Voting Rights. The Class "B" Preferred Shares shall have no voting
rights.
6. Dividends. The Class "B" Preferred Shares shall be preferred both as to
dividends and assets and shall be entitled to receive out of the surplus or net
profits of the company, in each fiscal year, dividends at such rate or rates, as
shall be determined by the Board of directors in connection with the issue of
the respective series of said stock and expressed in the stock certificate
therefor, before any dividends shall be paid upon the common stock, but such
dividends shall be noncumulative. No dividends shall be paid, declared, or set
apart for the payment on the common stock of the company, in any fiscal year,
unless the full dividends on the Class "B" Preferred Shares for such year shall
have been paid or provided for.
8
<PAGE>
CERTIFICATE OF DESIGNATION FOR
CLASS "C" PREFERRED SHARES.
This Certificate sets forth the voting powers, designations,
preferences, limitations, restrictions and relative rights of the Class "C"
Preferred Shares of Baywood International, Inc. ("Baywood") to be issued after
or the ratification of issuance of which is effective after the filing of such
certificate with appropriate state authorities.
1. Conversion Privileges. On May 8, 1998, at Shareholder's option, the
Class "C" pre-split Preferred Shares are convertible into pre-split or
post-split Common stock of Baywood as follows:
a. Average Price; Reverse Split. "Average Price," as used herein,
shall mean the average share price of Baywood's Common Shares
for the three months prior to May 8, 1998. "Reverse Split"
shall mean the reverse 1 for 2-1/2 split of the Company's
common stock approved by the Company's shareholders on April
10, 1997, but which shall not become effective until the
Company files Articles of Domestication in the Office of the
Arizona Corporation Commission.
b. Average Price Less than $1.00. If the Average Price is less
than $1.00, the Class "C" Preferred Shares shall be
convertible into:
(i) (Pre-Split) that number of pre-split Common Shares which
is equal to the number which results from $920,000 divided by
the Average Price if the Reverse Split is not yet effective;
or
(ii) (Post-Split) that number of post-split Common Shares
which is equal to the number which results from $368,000
divided by the Average Price if the Reverse Split has already
become effective.
c. Average Price of $1.00 or Greater. If the Average Price is
$1.00 or more, the 920,000 pre-split Class "C" Preferred
shares shall be convertible:
(i) (Pre-Split) on a one-for-one (1:1) basis into pre-split
Common Shares, such that Shareholder shall receive a total of
920,000 Common Shares if the Reverse Split is not yet
effective; or
(ii) (Post-Split) on a one-for-two and one-half (1:2-1/2)
basis into post-split Common Shares, such that Shareholder
shall receive a total of 368,000 post-split Common Shares if
the Reverse Split has already become effective.
2. Redemption. Shareholder shall have no right to redeem the Class "C"
Preferred Shares.
9
<PAGE>
3. Par Value. The Class "C" Preferred Shares shall have a par value of
$1.00 per share.
4. Distribution of Capital. In the event of dissolution, bankruptcy, or
termination of this corporation, the par value of all the Class "C" Preferred
Shares shall be paid in full before the Common Stock or any part thereof or any
dividend thereon is paid.
5. Voting Rights. The Shareholder of the Class "C" Preferred Shares shall
have no voting power.
6. Dividends. The Class "C" Preferred Shares shall be preferred both as to
dividends and assets and shall be entitled to receive out of the surplus or net
profits of the Company, in each fiscal year, dividends at such rate or rates, as
shall be determined by the Board of Directors in connection with the issue of
the respective series of said stock and expressed in the stock certificate
therefor, before any dividends shall be paid upon the Common Stock, but such
dividends shall be noncumulative. No dividends shall be paid, declared, or set
apart for the payment on the Common Stock of the Company, in any fiscal year,
unless the full dividends on the Class "C" Preferred Shares for such year shall
have been paid or provided for.
7. No Dilution by Reverse Stock Split. The reverse stock split of the
Company's Common Stock, authorized by the Company's shareholders on April 10,
1997, shall have no effect on the number of Class "C" Preferred Shares issued ad
outstanding in the name of the Stockholder, which shall, upon the automatic
conversion of Class "B" Preferred Shares into Class "C" Preferred Shares total
920,000 Class "C" Preferred Shares. The reverse stock split shall also have no
effect on the number of Common Shares into which such Class "C" Preferred Shares
are convertible on May 8, 1998.
10
<PAGE>
The undersigned certify that the attached Certificates of Designation
for Class "A", "B", and "C" Preferred Shares were duly approved by resolution of
the Board of Directors of Baywood International, Inc. pursuant to Article IV of
the corporation's Articles of Incorporation and N.R.S. ss. 78.195 and 78.1955
and that no further shareholder approval or action is necessary. No shares of
each class so designated have been issued or the ratification of issuance by the
Board of Directors is not effective until after such Certificates of Designation
have been filed.
/s/ Harvey J. Turner
----------------------------------
Harvey J. Turner, President
/s/ Neil T. Reithinger
----------------------------------
Neil T. Reithinger, Secretary
STATE OF ARIZONA )
) ss.
County of Maricopa )
ON THIS the 16th day of July, 1997, before me, the undersigned officer,
personally appeared Harvey J. Turner, known to me to be the President of Baywood
International, Inc. and acknowledged that he executed the certification of the
attached Certificates Describing the Rights and Restrictions of Class "A," "B,"
and "C" Preferred Shares for the purposes therein contained on behalf of the
corporation.
IN WITNESS WHEREOF, I hereunto set my hand and official seal.
/s/ Neil T. Reithinger
----------------------------------
Notary Public
STATE OF ARIZONA )
) ss.
County of Maricopa )
ON THIS the 16th day of July, 1997, before me, the undersigned officer,
personally appeared Neil T. Reithinger, known to me to be the Secretary of
Baywood International, Inc. and acknowledged that he executed the certification
of the attached Certificates Describing the Rights and Restrictions of Class
"A," "B," and "C" Preferred Shares for the purposes therein contained on behalf
of the corporation.
IN WITNESS WHEREOF, I hereunto set my hand and official seal.
/s/ Janice L. Innocenzi
----------------------------------
Notary Public
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 806175
<NAME> Baywood International, Inc.
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 668,906
<SECURITIES> 0
<RECEIVABLES> 274,450
<ALLOWANCES> 0
<INVENTORY> 22,391
<CURRENT-ASSETS> 1,136,371
<PP&E> 15,602
<DEPRECIATION> 79,777
<TOTAL-ASSETS> 1,316,159
<CURRENT-LIABILITIES> 429,722
<BONDS> 0
0
1,055,000
<COMMON> 17,498
<OTHER-SE> (186,061)
<TOTAL-LIABILITY-AND-EQUITY> 1,316,159
<SALES> 3,234,056
<TOTAL-REVENUES> 3,234,056
<CGS> 2,029,077
<TOTAL-COSTS> 1,349,588
<OTHER-EXPENSES> 12,651
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (157,260)
<INCOME-TAX> 0
<INCOME-CONTINUING> (157,260)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (157,260)
<EPS-PRIMARY> (0.02)
<EPS-DILUTED> 0
</TABLE>
