-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LAmyF+k0mRUru3O4U6PJ4Trpl9Ol2xKoiWN5BZoJqjaNzUxfKCRLR0R5FzER9QQd Mgfw/FKW5mLxYztAomLUdA== 0001012895-02-000047.txt : 20020415 0001012895-02-000047.hdr.sgml : 20020415 ACCESSION NUMBER: 0001012895-02-000047 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIATECT INTERNATIONAL CORP CENTRAL INDEX KEY: 0000319124 STANDARD INDUSTRIAL CLASSIFICATION: AGRICULTURE CHEMICALS [2870] IRS NUMBER: 953555738 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-10147 FILM NUMBER: 02593590 BUSINESS ADDRESS: STREET 1: 875 SOUTH INDUSTRIAL PARKWAY CITY: HEBER STATE: UT ZIP: 84032 BUSINESS PHONE: 435-654-4370 MAIL ADDRESS: STREET 1: 875 SOUTH INDUSTRIAL PARKWAY CITY: HEBER STATE: UT ZIP: 84032 FORMER COMPANY: FORMER CONFORMED NAME: SAN DIEGO BANCORP DATE OF NAME CHANGE: 19931124 10KSB 1 f01d10k.txt DIATECT 2001 FORM 10KSB 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File number: 0-10147 DIATECT INTERNATIONAL CORPORATION ------------------------------------------- (Exact name of registrant as specified in charter) California 95-355578 ---------- --------- (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 875 S Industrial Parkway, Heber City, Ut 84032 - ---------------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Issuer's telephone number, including area code: (435) 654-4370 Securities registered pursuant to section 12(b) of the Act: Title of each class Name of each exchange on which registered None N/A ---- --- Securities registered pursuant to section 12(g) of the Act: Common Stock, No Par Value ------------------------- (Title of class) Check whether the issuer (1) filed all reports required to be filed by section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes [X] No [ ] (2) Yes [X] No [ ] Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will 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. [X] 2 State the issuer's revenues for its most recent fiscal year: $570,904 State the aggregate market value of the voting stock held by nonaffiliates of the registrant. At March 26, 2001, the aggregate market value of our voting stock held by nonaffiliates was $9,908,099 based on 31,454,282 shares. The average of the bid and asked price of our stock on March 26, 2001, was $0.315 per share. At March 26, 2001, we had 37,229,082 shares of common stock, no par value, issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents if incorporated by reference and the part of the form 10-KSB (e.g., part I, part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or other information statement; and (3) Any prospectus filed pursuant to rule 424(b) or (c) under the Securities Act of 1933: None 3 PART I ITEM 1. BUSINESS General - ------- We are Diatect International Corporation and were incorporated in California in May 19, 1979. We produce a variety of insecticides which utilize so called "natural-killing agents" which are non-toxic to the environment as well as humans and other warm-blooded animal life. Whereas conventional chemical synthesized insecticides can be composed of highly dangerous, toxic chemicals that can seep into the water table and can be washed into rivers and lakes, contaminating water and soil for decades, our products are composed of diatomaceous earth ("DE") and Pyrethrin that degrade after application leaving the environment unharmed. DE and Pyrethrin have been used separately for years as adequate alternatives to hazardous chemical insecticides. By putting these two natural insecticides together in our products, we have created a powerful synergy that leads to more effective insect control than either DE or Pyrethrin can provide individually. We have obtained EPA registrations and labels necessary for the production and marketing of five insecticides. The approval by the EPA of our labels is significant since EPA approval can be a lengthy and expensive process. Due to the long time it took to obtain EPA approval for our labels, we did not actually begin commercial marketing of our products until late 2001. Industry - -------- According to information published in the U.S. Department of Agriculture "Agriculture Statistics (1993)" and the U.S. Department of Commerce Statistical Abstract (119th ed.), over the previous ten years the worldwide market for pesticides grew by 30% as the total amount of acreage planted continued to increase in the United States and the world. Pesticide consumption in dollar terms is expected to grow 4.4% per year through 2003, compared with 3% during 1983-93. Agriculture is the largest end-user sector for insecticides, followed by commercial, industrial, home, garden and government applications. The United States spent approximately $3.3 billion in 1980 for agricultural pesticides and estimated $320 billion in 2000, representing an growing increase over a 20-year period. Four markets---corn, cotton, vegetables, and fruit and nuts---account for 78% of the U.S. insecticide market. Japan is the second-largest market for pesticides in the world, by sales. Insecticides are the leading product category in the pesticide market, with 34% of the Japanese market. Western European insecticide sales amount to approximately 15% of total world insecticide sales. France, Spain and Italy are key markets for insecticides in Western Europe. Export demand for insecticide products take 59% of U.S. insecticide production. Export demand is expected to remain strong. A 1996 Gallup poll reported that 92% of farmers want to use safer pesticides and 66% favored tougher enforcement of pesticide misapplication penalties. The nature of synthesized chemical pesticides has caused concern among the public and regulators particularly over the pesticides persisting in the environment, accumulating in soil and ground water and affecting surrounding wildlife such as fowl and fish. These concerns have led the EPA to require stricter guidelines on new pesticides. Additionally, the EPA has, in many instances, ordered new tests for previously approved products which must now 4 meet the newer, more stringent standards. The additional testing is resulting in some companies electing to remove existing products from the market rather than subject the products to the newer standards. Over the past several years, chemical companies have voluntarily dropped the registration of approximately 28 active ingredients and 5,000 pesticide products that were in use at the time of cancellation. Additionally, since insecticides were first used in the 1940's, more than 600 insect species have developed resistance to many synthetic pesticides, leading the industry to constantly search for new products. Insecticide resistance has cost an estimated $1.4 billion a year in crop losses in the United States alone. Products - -------- We recognize the future demands for environmentally acceptable insecticide products in all agriculture-related industries worldwide. Our business plan calls for formulations which are natural in composition; components which, as stand-alone insecticides, are efficient, non-toxic, user and environmentally friendly, yet cost-effective. The active ingredients used in our products are diatomaceous earth ("DE"), pyrethrin and piperonyl butoxide. DE is a naturally occurring mineral deposit resulting from microscopic single-celled plants called diatoms which took the minerals from the water and created protective shells for themselves. As they died and their shells drifted to the bottom of the sea beds, vast deposits were created. One of the numerous uses for DE is as a natural insecticide, since it causes severe mechanical cutting damage to insects akin to the damage of broken glass swallowed by humans. DE is mined from the earth and ground into usable particles. There are many varieties of diatoms, and the preponderance of the type in any given deposit gives that deposit certain characteristics. In the case of nontoxic insecticides, certain qualities make it possible to kill insects without harming animals, plants or humans. These rare deposits furnish a material that has two very important characteristics (1) when fractured, the particle edges are very sharp and (2) each tiny particle has the ability to absorb liquid. In addition to cutting the covering of an insect's shell to cause dehydration, DE also absorbs the insect's covering and bodily fluids further causing dehydration and eventual death. Moreover, DE causes extensive trauma to insects, both internally and externally. In order to be effective as an insecticide, DE must be free of significant impurities. Additionally, DE is generally slow to reduce insect populations and thus has limited effectiveness, especially against fast-breeding insects. For this reason, our products combine DE with pyrethrin. Pyrethrins are oily liquid esters extracted from the pyrethrum flower, the "African Daisy." The extract is a "botanical insecticide" and acts on insects with phenomenal speed, causing paralysis. Research has determined that Pyrethrin is virtually harmless to mammals. Pyrethrin affects both the peripheral and central nervous system of the insect. Initially, it stimulates nerve cells to produce repetitive discharges, quickly leading to paralysis. Piperonyl Butoxide ("PBO"), the third ingredient in our insecticides, is an extract originally discovered in a variety of sassafras, which has since been synthesized and made available in quantities greater than possible from plants. While early studies suggested that PBO is itself a natural insecticide, it is its use as a synergist that is particularly exciting. A synergist is not generally considered toxic or insecticidal, but 5 is a material used to enhance the activity of the insecticides. PBO is the synergist used in our products. Basically, PBO binds oxidative enzymes and prevents them from degrading the pyrethrin. Combined with small amounts of pyrethrin, it affords a rapid knockdown, a greater mortality, and a longer residual action than pyrethrin by itself. PBO has been found to be safe and free of any normal hazards of toxicity. It is well tolerated in large quantities by warm-blooded animals. Because PBO is substantially less expensive than pyrethrin, its use allows us to offer more competitively priced products. We combine DE, pyrethrin and PBO by using surfactants to ensure a good mix and greatly increase effectiveness and persistence. The combination of these active ingredients results in a compound much more effective than each ingredient individually. When using the ingredients together, DE breaks down the chitin, allowing the pyrethrin to act on an insect's nerve cells directly. The pyrethrin does not evaporate as quickly and is released for hours rather than minutes. PBO increase's the effectiveness of the pyrethrin by as much as ten times. Our products consist of five fully registered EPA Labels: 1. Diatect D-20 Insecticide, EPA Registration No. 42850-1, Indoor Insecticide. Controls roaches, fleas, ants, silverfish, crickets, bedbugs, box elder bugs, and other insects. For use under sinks, behind furniture, in air vents, under tile, stairwells, and basements. 2. Diatect Multi-Purpose Insecticide, EPA Registration No. 42850-2. Distributed in the agriculture market, the largest end-user market for insecticides; commercial; industrial; and government markets as "Diatect Multi-Purpose Insecticide." This insecticide is approved by the EPA for use in a wide variety of areas, e.g., edible growing crops, animal quarters, livestock, ornamentals, etc., under the least hazardous classification and is effective on a wide variety of insects. This insecticide can be applied as a dust or sprayed in solution with water and can be used on crops and fruits up to and including the day of harvest. 3. Diatect Pet Powder, EPA Registration No. 42850-3. Marketed on a retail basis under the trade name "Results." 4. Diatect II Multi-Purpose Insecticide, EPA Registration No. 42850-4. The Diatect II product is formulated using a larger measure of pyrethrin (.2%) which provides a quicker, more positive knockdown. Designed and approved for use in the same applications as the No. 42850-2 formulation (which contains .1% pyrethrin), the user receives a significantly better return on their insecticide dollar using Diatect II because of its added knockdown strength. This insecticide can be applied as a dust or sprayed in solution with water and can be used on crops and fruits up to and including the day of harvest. The above product is distributed in the retail market for use in the home and garden markets under the trade name "Results" under the following retail labels: - Results Fire Ant Insecticide. Applying the insecticide directly to fire ant mounds provides quick, effective control in eliminating these aggressive, dangerous pests. Each year approximately 65,000 Americans seek hospital treatment for venomous fire ant stings and two of those people die. Unlike bees, fire ants can sting repeatedly and have a very aggressive behavior. 6 - Results Ant and Insect. Controls ants, aphids, caterpillars, leafhoppers, lice, mites, mosquitoes, ticks, and other insects. - Results Tomato and Garden. Protects garden plants from many varieties of worms, beetles, leafhoppers, stink bugs, squash vine borers, and other insects. - Results Rose and Floral. Protects azaleas, begonias, African violets, chrysanthemums, dogwood, elm, roses, tulips, and many other plants. Destroys insects such as mealybugs, fruit flies, white flies, and caterpillars that ruin the beauty of garden flowers and plants. 5. Diatect V Insecticide, EPA Registration No. 42850-5. The Diatect V product was designed and formulated to meet the needs of the organic food industry which requires insecticides with no synthetic ingredients. Using a powerful bug-killing measure of pyrethrin (.5%) blended with DE, Diatect V becomes what we believe should be the product of choice for those users requiring an organic certification. We believe the Diatect and Results products are far more effective than major competitive synthetic chemical products. Regulatory Approval - ------------------- In general all insecticides, purchased in stores today must, have EPA-approved labels that disclose various required information about the product. These insecticide labels provide an extensive amount of information and indicate that the insecticide has been tested, evaluated, and regulated by the EPA. In fact, no insecticides can be legally registered, much less sold, without going through these procedures. 7
Toxicity Category Signal Words (required on Oral LD50 Probable Lethal an insecticide label by EPA) (mg/kg) Adult Human Dose (1) - ----------------- ---------------------------- ---------- ------------------------- I--Highly Toxic DANGER or POISON, plus skull 0 to 50 A few drops to 1 teaspoon and crossbones symbol II--Moderately Toxic WARNING 50 to 500 1 teaspoon to 2 teaspoons III--Slightly Toxic CAUTION 500 to 5,000 1 ounce to 1 pint (1 pound) IV--Almost non-toxic CAUTION more than 5,000 1 ounce to 1 pint (1 pound) (1) Toxicity of Insecticides and Determining the LD50," Kenneth J. Stein and F. William Ravlin, Department of Entomology, Virginia Polytechnic Institute and State University, 1995
Oral toxicity testing on our Products resulted in an LD50 of more than 5,000 mg/kg. The oral toxicity for the product is less than that for table salt or aspirin. (Because the product was mildly irritating to the eyes of New Zealand rabbits, the product does carry the Level III Signal Word "Caution" with the appropriate wording. However, it is of importance to note that this wording is because of the irritation to the eyes of the rabbits, not the oral or dermal toxicity of the product.) As previously stated, all new insecticides must be "registered" with the EPA, which specifies the conditions of their use as part of its mandate under the Federal Insecticide, Fungicide and Rodenticide Act ("FIFRA"). An insecticide user or manufacturer who fails to comply with FIFRA restrictions risks enforcement actions from both the EPA and state authorities, including, but not limited to, suspended product sales and fines. Our products comply with FIFRA restrictions and are registered with the EPA. The pesticide regulatory program instituted by Congress and implemented by the EPA is having a profound effect on the availability of old as well as new synthetic chemical pesticides. Many of the old pesticides were registered before their long-term health and environmental effects were fully understood. In 1972, Congress decreed that the EPA should reexamine the risks of all active ingredients in pesticides registered before modern testing methods became available. In 1988, impatient with the slow pace of the registration program, Congress imposed timetables on the EPA and levied fees on chemical companies wishing to re-register their products. Although the EPA has banned many unsafe pesticides in recent years, we believe the impact of Congress' action has been significant. As stated above, chemical companies have voluntarily dropped registration of 68 active ingredients and 12,000 pesticide products that were in use at the time of cancellation over the past few years. The cost of developing a new chemical for registration has also risen enormously in recent years, partially because of expensive tests required to show that the chemical poses low environmental and human health risks. The typical pesticide is put through more than 6000 tests and approval can take more than eight to ten years. Once approved, labeling instructions must be followed for proper use, handling, storage and disposal. We believe the effect of these tighter restrictions and the removal of these active ingredients has opened the door for our products. 8 Competition in the Insecticide Industry - --------------------------------------- The principal players in the U.S. plant care industry, particularly the insecticide industry, are major companies such as Dow, duPont, Monsanto, Shell Oil and Chevron. Those companies all have more extensive resources than we do and have established product recognition and loyalty. We believe, however, that by focusing on the non-synthetic insecticides, we are able to acquire market niches which have not been a focus of the larger, better established companies. We believe we have an advantage in the products and market niche we have identified in that we have already obtained EPA approval of our products and labels. The EPA approval is important due to the time and cost associated with receiving such approval which can take years and be extremely costly. Management Changes - ------------------ In May 2001, Douglas K. Goff resigned from the Board of Directors. In July, 2001, David Andrus was appointed to the Board of Directors. In September 2001, George H. Henderson, Lamar N. Jensen, Sherman B. Jensen, and Jeff Bates resigned from the Board as Directors. In December 2001, John H. Zenger and Nelson A. Carter were appointed to the Board of Directors. We have the following operating subsidiaries: Diatect International, Inc., a Kansas corporation, is a wholly-owned subsidiary through which our production operations were conducted through October 2001. No operations are currently being conducted in this subsidiary. Magic International, Inc., a wholly-owned subsidiary, was acquired by us for the purposes of conducting our marketing operations. Its executive offices are located at 875 South Industrial Parkway, Heber City, Utah 84032. As of this filing, Magic International, Inc. has no employees. 9 ITEM 2. PROPERTIES Diatect International Corporation, 875 South Industrial Parkway, Heber City, Utah 84032. This facility is a 20,254 square foot class C masonry office/warehouse building on 1.928 acres in the Heber City, Utah Industrial Park. During October 2001, we relocated both our office and operating facilities to Heber City, Utah. We are currently negotiating the purchase of our new facilities at a cost of $825,000. Under terms of the agreement, we may continue occupying the facilities with no charge until closing occurs but not longer than July 2002. Other terms of the agreement call for a down payment of $28,500, escrow deposit in the amount of $384,000 and a letter of credit in the amount of $412,500. We paid the down payment of $28,500 during the fourth quarter of the year ended December 31, 2001. During the same period, we also secured cash in the amount of $400,000, which is considered restricted and will be used for closing on the building. We occupied the facilities on October 10, 2001 and closing is scheduled to occur in July 2002. Diatect International, Inc., Lebanon Production Plant, 108 E. Schoolhouse Rd., Lebanon, Kansas. 25,000 sq. ft. - Brick. We own this facility outright and since November 2001 we have been seeking a buyer. ITEM 3. LEGAL PROCEEDINGS Sloan, Listrom, Eisenbarth, Sloan & Glassman, LLC - ------------------------------------------------- In November 1999, our former legal counsel was awarded a default judgment against us in the amount of $42,166 plus post-judgment interest. During fiscal 2001, we reclassified this amount to a settlement payable in the amount of $40,166, which settlement remains outstanding and unpaid. Ogilvy, Adams & Rinehart - ------------------------ Ogilvy, Adams & Rinehart (Ogilvy) obtained a judgment against us on November 1, 1995 in the sum of $24,346. The entire judgment amount plus attorney's fees and interest thereon is approximately $36,000. During fiscal 2001, we reclassified this amount to a settlement payable, which settlement remains outstanding and unpaid. Since mid-1996, there has been no communication with the plaintiff or its attorneys, nor has the plaintiff made any attempt to satisfy or settle this case. L. Craig Hunt - ------------- L. Craig Hunt obtained a judgment against us on February 1, 1999 in the sum of $61,543. During fiscal 2001, we reclassified this amount to a settlement payable, which settlement remains outstanding and unpaid. To date, plaintiffs have made no attempt to collect on this judgment. Mid-America Venture Capital Fund, Inc. - -------------------------------------- Mid-America Venture Capital Funds, Inc. obtained a judgment against us on August 4, 1997 for a total of $39,336 including principal, interest, and attorney's fees and costs. During fiscal 2001, we reclassified this amount to a settlement payable. At December 31, 2001, we have paid a total of $6,000 and are currently in arrears on the payment schedule. Mike Glazer - ----------- A consultant rendered services to a subsidiary during 1996 in the amount of $17,230 and has brought action for this amount. We chose not to contest this case, and the full amount was paid during the year ended December 31, 2001. 10 Danny Wirken - ------------ We are considering litigation against Danny Wirkin, (one of the brokers involved in the selling of our stock (which gave rise to the previously reported litigation with Gruntal & Co.), with the objective of obtaining a judgment for damages and foreclosing on our obligation under our note to Mr. Wirkin. In June 2001, we declared this note and the interest accrued thereon as invalid and void based on advice from our main legal counsel. Our main legal counsel further asserted that our obligation has passed the statute of limitations for Mr. Wirkin to bring an action for collection thereon. George Brink - ------------ George Brink filed suit against us in the year 2000 to collect on a promissory note in the amount of $37,500. We chose not to contest this case. During fiscal 2001, we reclassified this amount to a settlement payable, which settlement remains outstanding and unpaid. To date, plaintiffs have made no attempt to collect on this judgment. Terrance Dunne - -------------- Terrance Dunne, a former auditor, initiated action against us for payment of unpaid fees. In response to the allegations, we have countersued for reimbursement of fees paid for work not performed. The outcome of this action is uncertain. Creditors' Judgments - -------------------- During 1994 and 1995, we were sued by a number of creditors, which actions we allowed to go to judgment. These actions and the consequential judgments arose as a direct result of our inability to fund our operations and make payments to our creditors. The collection judgments, which are substantially unpaid at December 31, 2001, total approximately $90,000, and are included in our accounts payable and other obligations. A settlement has been approved under which we are scheduled to pay this liability on or before March 31, 2002. Environmental Protection Agency - ------------------------------- During October 2000, we joined other plaintiffs represented by a public interest law firm in filing action against the Environmental Protection Agency (EPA). The action seeks relief from EPA's practice of using certain guidelines as a basis for hazard classification and risk assessments pursuant to the Federal Insecticide, Fungicide and Rodenticide Act. Plaintiffs claim that the EPA must use final guidelines promulgated for such reviews. The outcome of the case is uncertain as of the date of these financial statements. Former Officers and Consultant - ------------------------------ In September 2000, we received notice from two former officers and a former consultant that they intend to bring action for nonpayment of back wages. During May 2001, we issued 188,000 shares of its common stock to one former officer valued at $47,000 ($0.25 per share) in full settlement. During August 2001, we paid $5,000 in settlement to another former officer in settlement of $38,500 claimed as back wages. The remaining amount in dispute totals $25,745 and we plan to contest the claims. We are not aware of any other threatened litigation against us or our subsidiaries. However, there remains a possibility of litigation against us and/or our subsidiaries by creditors. 11 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS We did not submit any matters to a vote of our securities holders in the fourth quarter ended December 30, 2001. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The following table sets forth, for the respective periods indicated, the prices for our common stock in the over-the-counter market as reported by a weekly reporting service and according to the NASD's OTC Bulletin Board. The bid prices represent inter-dealer quotations, without adjustments for retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions. At March 26, 2002, our common stock was quoted under the symbol "DTCT" and had a high of $0.34 and a low of $0.29. All bid prices below have been rounded to the nearest whole cent. Bid Prices --------------- Fiscal Year Ended December 31, 2001 HIGH LOW ----------------------------------- ------ ------ Fourth Quarter $ 0.52 $ 0.09 Third Quarter $ 0.14 $ 0.07 Second Quarter $ 0.14 $ 0.07 First Quarter $ 0.25 $ 0.09 Fiscal Year Ended December 31, 2000 ----------------------------------- Fourth Quarter $ 0.18 $ 0.08 Third Quarter $ 0.24 $ 0.08 Second Quarter $ 0.13 $ 0.06 First Quarter $ 0.10 $ 0.04 Fiscal Year Ended December 31, 1999 ----------------------------------- Fourth Quarter $ 0.10 $ 0.06 Third Quarter $ 0.12 $ 0.08 Second Quarter $ 0.15 $ 0.10 First Quarter $ 0.15 $ 0.07 We have not paid any dividends on our Common Stock, and we do not anticipate that we will pay dividends in the foreseeable future. The future payment of dividends, if any, on the common stock is within the discretion of the Board of Directors and will depend on our earnings, if any, our capital requirements and financial condition, and other relevant factors. At March 26, 2001, we had approximately 1,037 shareholders of record based on information provided by our transfer agent. 12 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Cautionary Statement Regarding Forward-looking Statements - --------------------------------------------------------- This report may contain "forward-looking" statements. Examples of forward- looking statements include, but are not limited to: (a) projections of revenues, capital expenditures, growth, prospects, dividends, capital structure and other financial matters; (b) statements of plans and objectives of our management or Board of Directors; (c) statements of future economic performance; (d) statements of assumptions underlying other statements and statements about us and our business relating to the future; and (e) any statements using the words "anticipate," "expect," "may," "project," "intend" or similar expressions. General - ------- Our founders envisioned establishing a business venture built upon the creation, development, production and marketing of a quality line of natural, environmentally-friendly insecticide products. We have lacked the financial resources to compete head-to-head with the international corporations that dominate the industry, but regulatory pressures and public concern for the environment have provided opportunities for us to gain a foothold in niche markets. We have researched the markets and acquired product formulations and EPA Labels for them. We have emerged from legal battles and management changes and have worked through many of our financial problems. In the past year we reorganized management, relocated administration and production in Heber City, Utah, expanded production capability and hired a marketing team. While all this has been going on we have narrowed our initial marketing effort to focus our sales of our FireAnt product to retail outlets. We intend to pursue penetration into the commercial agriculture and grain storage markets, but current we have determined that we could penetrate the FireAnt retail market quickly and meet the Spring 2002 demand for product. Results of Operations - --------------------- Year ended December 31, 2001 compared to year ended December 31, 2000 - --------------------------------------------------------------------- Revenues. We had revenues of $570,904 and cost of sales of $249,782 with a gross profit of $321,122 for the year ended December 31, 2001, compared to revenues of $161,364 and cost of sales of $91,938 with a gross profit of $69,426 for the prior year period. The substantial increase in revenues and compared to prior year reflects the success of our increased marketing efforts. We believe the increase in sales is indicative of a positive trend which we expect to continue through the next fiscal year. Our cost of sales decreased from approximately 57% of revenues in 2000 to approximately 44% of revenues in 2001. We anticipate that our cost of sales as a percentage of revenues will continue to decrease as our sales volume rises. However, we believe we will not be able to accurately project our cost of sales as a percentage of revenues until we have established a consistent revenue stream over extended and comparable periods of time. 13 Operating Expenses. For our fiscal year ended December 31, 2001, we had total operating expenses of $1,427,578 compared to $1,138,196 for prior year, an overall increase of $289,382. We believe the overall increase in operating expenses is primarily attributable to increases in executive compensation of $294,817, distributor expenses of $190,918, other operating expenses of $112,643, and salaries, wages and benefits of $26,141. These increases were offset by decreases of $176,410 in consulting fees and $137,814 in legal and professional fees. The increase in executive compensation is a result of our decision to entering into employment agreements with our officers. The increase in distributor expenses is due to our decision to restructure our distribution strategy. The increases in other operating expenses and salaries, wages and benefits are related to increased sales and production staffing requirements. The decreases in consulting fees is due to the fact that certain expenses booked as consulting expenses in the prior year were booked as executive compensation in fiscal 2001 and outside consulting services were therefore minimized. The decrease in legal and professional fees was due to our efforts to bring consolidate certain professional functions, such as accounting, and bring them in house, as well as maintain tighter control and scrutiny on legal fees. We anticipate that our overall operating expenses may increase as our sales increase due to additional production and distribution expenses. However, we believe such increases in production and distributions expenses will be offset for corresponding increased sales revenue. Other Income and Expense. Other expense for the year ended December 31, 2001 totaled $380,042, consisting primarily of interest and finance fees of $278,501, loan incentive and guarantee fees of $77,175, and litigation settlement expense of $20,000. Other expense for the year ended December 31, 2000 totaled $321,697, consisting primarily of interest expense of $234,284, loan incentive and guarantee fees of $80,625, and litigation settlement expense of $8,750. Because we have a substantial number of claims against us, we expect to continue to incur interest and finance fees and litigation settlement expenses during the upcoming fiscal year. We cannot at this time accuracy project what these expenses will be. We experienced a net loss before extraordinary items of $1,486,498 for the year ended December 31, 2001, compared to $1,390,467 for the year ended December 31, 2000. During 2001, a former supplier of ours agreed to write off a balance owed them in the amount of $8,100, and we declared a note payable and the interest accrued thereon as invalid and void, reflected in the financial statements as an extraordinary item as $611,252 gain from debt forgiveness. Offsetting this gain, in 2001 we also experienced product returns due to changes we made in our distribution system which resulted in loss of $176,176 as an extraordinary item. There were no extraordinary items in fiscal 2000. For purposes of comparison, our losses in fiscal 2001 before the extraordinary items are comparable with prior periods. The basic loss per share before extraordinary items in 2001 was $0.05 per share based on the weighted average of 30,824,930 shares outstanding. The basic loss per share for the year ended December 31, 2000 was $0.06, based on the weighted average number of shares outstanding of 22,950,545 shares. We cannot predict at this time whether or not we will experience any gains or losses due to settlement of debt or other matters, nor do not expect to take any write offs or write downs during the upcoming fiscal year. 14 Liquidity and Capital Resources - ------------------------------- During the year ended December 31, 2001, our liquidity was substantially derived from the issuance of notes payable and the issuance of common stock for cash. Although revenues increased substantially, cash used in operations far exceeded revenues. We hope that the next twelve months will prove the effectiveness of our marketing and distribution efforts and anticipate increases in production and sales will bring us closer to profitability. At December 31, 2001, we had current assets of $893,703, consisting of cash of $888, cash in escrow of $400,000 restricted for closing on our new facility in Heber City, Utah, accounts receivable of $202,660, prepaid interest of $154,019, prepaid royalties of $26,804, and inventories of $109,332, and current liabilities of $2,602,313 for a working capital deficit of $1,706,610. At December 31, 2001, we had property, plant and equipment assets totaling $170,883, net of depreciation, and other assets of $1,791,322, consisting primarily of our investment in EPA labels, net of amortization of $1,736,322, plus deposits of $28,500 and goodwill of $27,050. Cash used in our operations for the year ended December 31, 2001 was $934,394 compared to $292,243 for the prior year. In 2001 and 2000, our operations were funded primarily by loans, issuance of common stock and sales of our products. Our cash flows used by investing activities during the year ended December 31, 2001, was $134,705, consisting of a deposit of $28,500 on our new facility in Heber City, and $106,205 paid for the purchase of property, plant and equipment. In the prior year, cash flows used by investing activities was $2,444 for the purchase of property, plant and equipment. Our cash flows from financing activities during the year ended December 31, 2001 was $1,066,603, consisting of $144,000 from the sale of our common stock and $1,074,000 from the issuance of notes payable, offset by $20,730 in settlement payments and $130,667 in payments on existing notes. Our cash flows from financing activities during the year ended December 31, 2000 was $292,911, consisting of $97,000 from a line of credit and $195,911 from the issuance of notes payable. During fiscal year 2002, we may seek working capital from several sources, including the equity markets and private investors. In February 2002, we engaged Wood Roberts, LLC to assist us in formulating and developing a strategic financing plan and to advise and assist us in implementing the plan with respect to institutional and other sources of equity and/or debt financing. The agreement calls for the initial payment of 100,000 shares of our restricted common stock, with additional fees including cash and issuance of warrants for the purchase of common stock to be paid upon completion of certain transactions. We issued the 100,000 shares of our stock to Wood Roberts in March 2002. There is no assurance, however, that any fund raising efforts will be successful. We believe that in 2002, we will increase revenues from operations as we continue to move from the development stage of our products to a full marketing and sales program. With our products in the marketplace, we anticipate revenues to offset ongoing expenses. We are uncertain, however, as to whether there will be sufficient revenue to cover past obligations, therefore, we will continue to attempt to make offers in settlement and compromise on such obligations in an effort to reduce our contingent and other liabilities. 15 We lack working capital and that affects our ability to effectively market our products. We believe two of the largest and most important markets for our products are the agricultural and home and garden markets. When we obtain sufficient working capital, we plan to conduct affordable advertising and maintain a sales force that can effectively reach these markets. Accordingly, although we anticipate more revenue from the sale of our products than we have received in the past, we will not be as profitable without additional cash to fund our advertising and marketing campaign. ITEM 7. FINANCIAL STATEMENTS Our financial statements are set forth immediately following the signature page to this Form 10-KSB. (See ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K for Index to Financial Statements.) ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE We have had no disagreements with our certified public accountants with respect to accounting practices or procedures or financial disclosure. 16 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT The following table sets forth as of March 26, 2001, the name, age and position of each of our executive officers and directors and their respective terms of office. Director and/or Name Age Position Officer Since - ------------------- --- -------- --------------- Jay W. Downs 54 Director March 1999 President September 2001 Chairman of the Board September 2001 John L. Runft 64 Director February 1995 Secretary August 1997 Robert B. Crouch 77 Director October 1993 M. Stewart Hyndman 46 Director December 1997 David H. Andrus 37 Director July 2001 Vice-President September 2001 John H. Zenger 67 Director December 2001 Nelson A. Carter 56 Director December 2001 Our directors serve for a term of one year or until his or her successor is elected at our annual shareholders meeting, subject to removal by our Company's shareholders. All officers serve at the pleasure of the Board of Directors or until his or her successor is elected at the annual meeting of the Board of Directors. Set forth below is certain biographical information regarding each of our executive officers and directors. Jay W. Downs joined the Board of Directors in 1999 and assumed the post of President and Board Chairman in September, 2001 when Herb Henderson retired. Jay has over 30 years experience in Sales and Market planning. He is a leader and engenders respect and loyalty from all those who work with him. He thinks and has the ability to negotiate successfully without alienating his opponent. Jay spent 10 years in the institutional fund sale & supply business and then operated his own insurance brokerage which developed and marketed complete employee benefit packages throughout the U.S. with over 700 field representatives serving 40 states. In 1992, at the request of the Company, Jay and his family spent six months in Kenya learning the pyrethrum business in detail and establishing relationships with the Kenya Pyrethrum Board. He spent three years consulting and formulating a market plan for the company. He then established and operated a successful full line mortgage banking business serving Utah, Idaho, Wyoming, and Colorado which he gave up in 2000, when he was appointed Senior Vice President of Diatect International. John L. Runft has been practicing law since 1965, emphasizing business organizations and litigation. He received his BA from Albertson's College of Idaho in 1962, and his J.D. from the University of Chicago School of Law in 1965 John is a member of the Idaho Bar,and has appeared as lead counsel in litigation or appeals before the United States Court of Appeals for the Federal Circuit, and the United States Supreme Court. He is a member of the Board of Litigation of the Mountain States Legal Foundation, is a member of the Idaho Law Foundation, served as a Director of the Idaho Community Foundation (1989-1996), and has served as Civilian Aide to the Secretary of the Army of the United States for the State of Idaho (1988-1996). 17 Robert B. Crouch been an Officer and Director for eight years. Bob received his BSCE degree from the University of Idaho in 1949 and his LL.B. degree from George Washington University in 1953. He has extensive experience in patent law with the U.S. Naval Bureau of Aeronautics, General Electric, IBM Corporation and Information Storage Systems. He now maintains a private law practice in the state of Utah. M. Stewart Hyndman is the President of Magic Miles Ltd; Inc., Meridan, Idaho, an export trading company established in 1995 specializing in the export of agricultural commodities and industrial products. Following his graduation from the University of Idaho, Stewart has continued to play an active role in industry, agriculture, marketing and business development. David H. Andrus began an affiliation with Diatect in 1992. Dave served in the U.S. Marine Corps for 10 years in the logistics and intelligence field, and was medically retired in 1991. He formed Venture Creations which performed contract research and development for EnviroGuard (now Diatect). As R&D project manager, Dave supervised extensive field trials of the Diatect Insect Control within the poultry industry and for Fireant concerns in that region. In 1998, Dave became manager of National Diatect, a distributor of Diatect insecticides (later acquired by us). As technical manager for Diatect, Dave was responsible for all field studies of our product, and was instrumental in our transition from research and development to commercialization. Since August 2001, Dave has served as Vice-president of Operations and was appointed a director. John H. (Jack) Zenger, B.S. Psychology, BYU 1953, MBA, UCLA 1959, PHD Business Administration, USC 1974. Jack has extensive experience as a management consultant and in personnel administration, having been V.P. Human Resources at Syntex Corp for 11 years and a VP of Times Mirror and in charge their Training Company for 5 years. He has been actively engaged in community affairs in Palo Alto, Calif and here in Midway, Utah. Nelson A. Carter, B.S. Economics & Ag Finance BYU 1969. Nelson has spent time in Israel and speaks Hebrew. He has over 30 years experience in banking with First Security, Utah Farm Credit Services and Zions Bank where he is a V.P. and Commercial Loan Officer. Involvement in Certain Legal Proceedings - ---------------------------------------- See ITEM 3. LEGAL PROCEEDINGS of this Form 10-KSB. Compliance with Section 16(a) of the Exchange Act - ------------------------------------------------- Other than those disclosed below, we know of no person, who at any time during the subsequent fiscal years, was a director, officer, beneficial owner of more than 10 percent of any class of our equity securities registered pursuant to Section 12 ("Reporting Person"), that failed to file on a timely basis any reports required to be furnished pursuant to Section 16(a). None. 18 ITEM 10. EXECUTIVE COMPENSATION The following tables set forth certain summary information concerning the compensation paid or accrued for each of our last three completed fiscal years to our chief executive officer and each of our other executive officers that received compensation in excess of $100,000 during such period (as determined at December 31, 2001, the end of our last completed fiscal year):
Long Term Compensation ---------------------- Annual Compensation Awards Payouts Other Restricted Name and Annual Stock Options LTIP All other Principal Position Year Salary Bonus($) Compensation Awards /SARs Payout Compensation - ------------------ ---- ------ -------- ------------ ------- ------- ------ ------------ Jay W. Downs 2001 $120,000 -0- -0- 60,000 -0- -0- -0- C.E.O.(1) George H Henderson 2001 $ 90,000 -0- -0- 40,000 -0- -0- 50,000 C.E.O.(2) 2000 $ -0- -0- -0- -0- -0- -0- 19,000 1999 $ -0- -0- -0- -0- -0- -0- 14,400 David Andrus 2001 $ 90,000 -0- -0- 40,000 -0- -0- -0- Vice President
(1) Jay Downs was appointed as President and C.E.O. in September 2001. On his appointment, he received a bonus of 750,000 shares of our restricted common stock valued at $0.08 per share. (2) George Henderson resigned as President and C.E.O. in September 2001. Upon his resignation, he received a settlement and severance package consisting of $50,000 cash and 500,000 shares of our restricted common stock valued at $0.08 per share. (3) Dave Andrus was appointed vice-president in September 2001. Pursuant to his employment agreement, he received a bonus of 500,000 shares of our restricted common stock valued at $0.08 per share. Employment Agreements - --------------------- Jay Downs signed an employment agreement effective January 2001 for a term of three years at an annual salary of $120,000 per year, with a signing bonus of 350,000 options for the purchase of our common stock at $0.10 per share. At the filing date of this report, all 350,000 options have been exercised. The agreement includes provisions for bonus pay based on 1% of gross sales receipts as determined on a quarterly basis. No bonuses have been authorized or paid to date. David Andrus signed an employment agreement effective July 1, 2001 for a term of three years at an annual salary of $90,000 per year, with a signing bonus of 500,000 shares of our restricted common stock. The agreement includes provisions for a reasonable automobile allowance and bonuses based on a proposed employee bonus program. 19 On April 25, 2000, we executed a retainer agreement with John L. Runft to act as our legal counsel. Mr. Runft received a signing bonus of an option to acquire 500,000 shares of our common stock at $0.06 per share. The options were originally to vest over a three year period. At December 31, 2001, the vesting provisions were modified to permit immediate exercise of the remaining unvested options. At the filing date of this report, all the remaining options have been exercised. George Henderson, our former president, resigned in September 2001. His employment agreement was terminated pursuant to a settlement of the balance of our obligations under the agreement. The settlement consisted of $50,000 cash and 500,000 shares of our restricted common stock. Board Compensation - ------------------ There is no current plan for compensating our board members for their services, however, we have discussed such a plan and may adopt one in the near future. As of the date of this report, our Board members are not compensated for services performed in connection with their duties as Board members. 20 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following tables set forth as of March 26, 2002, the name and address and the number of shares of our Common Stock, held of record or beneficially by each person who held of record, or was known by us to own beneficially, more than 5% of the 37,229,082 issued and outstanding shares, and the name and share holdings of all officers and directors as a group. Security Ownership of Certain Beneficial Owners - ----------------------------------------------- Title of Name and Address of Amount and Nature of Percent Class Beneficial Owner Beneficial Ownership of Class - -------- ------------------- -------------------- -------- Common George H. Henderson 2,135,146 5.74 1134 North Orchard, Suite 206 Boise, Idaho 83706 Common John L. Runft 1,858,703 5.00 1134 North Orchard, Suite 206 Boise, Idaho 83706 Common Jay W. Downs 2,154,136 5.79 875 S. Industrial Parkway Heber City, Utah 84032 Security Ownership of Officers and Directors - -------------------------------------------- Title of Name and Position of Amount and Nature of Percent Class Officer and Director Beneficial Ownership of Class - -------- -------------------- -------------------- -------- Common Jay W. Downs -see above- Director/President Chairman of the Board Common John L. Runft, Director/Secretary -see above- Common David Andrus, Director 674,000 1.81 Vice-president Common Robert B. Crouch, Director 787,161 2.11 Common M. Stewart Hyndman, Director 300,800 0.81 Common John H. Zenger, Director - - Common Nelson A. Carter, Director - - ---------------- All Officers/Directors as a Group (7 persons) 5,774,800 15.51 ================ ====== 21 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Transactions with Management - ---------------------------- Except as indicated below, and for the periods indicted, there were no material transactions, or series of similar transactions, since the beginning of our last fiscal year, or any currently proposed transactions, or series of similar transactions, to which we are a party, in which the amount involved exceeds $60,000, and in which any director or executive officer, or any security holder who is known by us to own of record or beneficially more than 5% of any class of our common stock, or any member of the immediate family of any of the foregoing persons, has an interest. We have has notes payable to twenty-four shareholders and one officer totaling $1,528,714 and $1,086,624 as of December 31, 2001 and 2000, respectively. See Note 5. Our secretary performs services as our main legal counsel. Legal services performed by this officer totaled $45,226 and $42,640 for the years ended December 31, 2001 and 2000, respectively, of which $28,167 are included in accounts payable - related party at December 31, 2000. Our former president performed consulting services for us during the first quarter of 2000. Consulting services preformed by this former officer totaled $20,560 for the year ending December 31, 2000. Included in accounts payable - related party is $2,628 at December 31, 2000. No consulting services were preformed by our former president during the year ending December 31, 2001. We have employment contracts to pay our president and vice-president of operations annual compensation in the amounts of $120,000 and $90,000 respectively. During January 2001, our president received as a signing bonus an option to acquire 350,000 shares of common stock at an exercise price of $0.10 per share. Upon his appointment to the position of C.E.O., he received a bonus of 750,000 shares of our restricted common stock, valued at $0.08 per share, for additional compensation of $60,000. Our vice-president also received a signing bonus on his employment agreement of 500,000 shares of our restricted common stock, valued at $0.08 per share, for additional compensation of $40,000. We also had an employment contract to pay our former president annual compensation of $120,000, which was terminated in September 2001. As settlement and severance, he received $50,000 cash and 500,000 shares of our restricted common stock, valued at $.08 per share, for additional compensation of $40,000. See ITEM 10, EXECUTIVE COMPENSATION. Our president contributed office furniture and equipment valued at $30,320 in exchange for a non-interest bearing convertible note payable. The note was subsequently converted to 86,629 shares of our common stock valued at $0.35 per share. See Note 18 to our financial statement included with this report. Certain Business Relationships - ------------------------------ Except as indicated, and for the periods indicated, there were no material relationships regarding officers or directors that exist, or have existed during our last fiscal year. 22 PART IV ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a)(1) Financial Statements. The following financial statements are included in this report: Title of Document Page - ----------------- ---- Independent Auditors Report of Williams & Webster, P.S., Certified Public Accountant 24 Consolidated Balance Sheets as of December 31, 2001 and 2000 25 Consolidated Statement of Operations for the years ended December 31, 2001 and 2000 27 Consolidated Statement of Stockholders' Equity for the years ended December 31, 2001 and 2000 28 Consolidated Statement of Cash Flows for the years ended December 31, 2001 and 2000 30 Notes to Financial Statements 32 (a)(2) Financial Statement Schedules. Not applicable (a)(3)Financial Statements. The following exhibits are included in this report: None. (b) Reports on Form 8-K. The following reports on Form 8-K were filed with the Commission during the quarter ended December 31, 2001. None. 23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this amended report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: DIATECT INTERNATIONAL CORPORATION Date: March 29, 2002 /s/ Jay W. Downs, Chief Executive Officer, Principal Accounting Officer /s/ John L. Runft, Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this amended report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: Date: March 29, 2002 /s/ Jay W. Downs, Director /s/ John L. Runft, Director /s/ Robert B. Crouch, Director /s/ David Andrus, Director /s/ M. Stewart Hyndman, Director /s/ John H. Zenger, Director /s/ Nelson A. Carter, Director 24 Board of Directors Diatect International Corp. Heber City, UT Independent Auditor's Report We have audited the accompanying consolidated balance sheets of Diatect International Corp. as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to in the first paragraph present fairly, in all material respects, the financial position of Diatect International Corp. as of December 31, 2001 and 2000, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 14, the Company has significant operating losses, negative equity, unsatisfied collection judgments and delinquencies in repaying its debt obligations. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans regarding those matters also are described in Note 14. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. As discussed in Note 19 to the financial statements, certain errors resulting in understatement of previously reported notes payable as of December 31, 2000, were discovered by management of the Company during the current year. Accordingly, an adjustment has been made to retained earnings as of December 31, 2000, to correct the error. /S/ Williams & Webster, P.S. Williams & Webster, P.S. Certified Public Accountants Spokane, Washington March 22, 2002 25 DIATECT INTERNATIONAL CORP. CONSOLIDATED BALANCE SHEETS December 31, 2001 and 2000 2001 2000 ---------- ---------- Assets CURRENT ASSETS Cash $ 888 $ 3,384 Cash in escrow 400,000 - Accounts receivable 202,660 58,014 Prepaid interest 154,019 42,550 Prepaid royalties 26,804 37,500 Inventories 109,332 123,975 ---------- ---------- Total Current Assets 893,703 265,423 ---------- ---------- PROPERTY, PLANT AND EQUIPMENT Mining property 540 - Building 23,501 23,501 Furniture & equipment 185,180 49,195 Less accumulated depreciation (38,338) (25,573) ---------- ---------- Total Property, Plant and Equipment 170,883 47,123 ---------- ---------- OTHER ASSETS Deposits 28,500 150,000 Goodwill 27,050 27,050 Investment in EPA labels, net of amortization 1,736,322 2,019,534 ---------- ---------- Total Other Assets 1,791,872 2,196,584 ---------- ---------- TOTAL ASSETS $ 2,856,458 $ 2,509,130 ========== ========== The accompanying notes are an integral part of these financial statements. 26 DIATECT INTERNATIONAL CORP. CONSOLIDATED BALANCE SHEETS (Continued) December 31, 2001 and 2000 2001 2000 ---------- ---------- Liabilities and Stockholders' Equity (Deficit) CURRENT LIABILITIES Accounts payable $ 259,459 $ 234,871 Accounts payable - related parties - 30,795 Bank overdraft 22,268 - Deposit payable - 20,000 Line of credit 97,000 97,000 Interest payable 288,928 725,465 Other accrued liabilities 16,051 1,021 Settlements payable 214,693 - Notes payable 1,703,914 1,413,568 ---------- ---------- Total Current Liabilities 2,602,313 2,522,720 ---------- ---------- COMMITMENTS AND CONTINGENCIES 461,605 236,923 ---------- ---------- STOCKHOLDERS' EQUITY (DEFICIT) Common stock, no par value; 50,000,000 shares authorized; 36,928,161 and 28,716,073 shares issued and outstanding, respectively. 13,391,574 12,260,630 Common stock subscribed (70,000) - Stock options 84,901 51,370 Accumulated deficit (13,613,935) (12,562,513) ---------- ---------- Total Stockholders' Equity (Deficit) (207,460) (250,513) ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 2,856,458 $ 2,509,130 ========== ========== The accompanying notes are an integral part of these financial statements. 27 DIATECT INTERNATIONAL CORP. CONSOLIDATED STATEMENTS OF OPERATIONS Years ended December 31, 2001 and 2000 2001 2000 ---------- ---------- REVENUES $ 570,904 $ 161,364 COST OF SALES 249,782 91,938 ---------- ---------- GROSS PROFIT 321,122 69,426 ---------- ---------- OPERATING EXPENSES Salaries, wages and benefits 72,155 46,014 Executive compensation 409,937 115,120 Consulting 85,146 261,556 Depreciation and amortization 295,977 316,890 Legal and professional fees 156,469 294,283 Distributor expenses 190,918 - Other operating expense 216,976 104,333 ---------- ---------- Total Operating Expenses 1,427,578 1,138,196 ---------- ---------- OPERATING LOSS $(1,106,456) $(1,068,770) ---------- ---------- OTHER INCOME (EXPENSES) Interest and finance fees (278,501) (234,284) Loan incentive and guarantee fees (77,175) (80,625) Litigation settlement (20,000) (8,750) Miscellaneous (4,366) 1,962 ---------- ---------- Total Other Income (Expenses) (380,042) (321,697) ---------- ---------- LOSS BEFORE EXTRAORDINARY ITEMS (1,486,498) (1,390,467) ---------- ---------- EXTRAORDINARY ITEMS Product returns distribution system changed (176,176) - Gain from termination of debt 611,252 - ---------- ---------- Total Extraordinary Items 435,076 - ---------- ---------- LOSS BEFORE INCOME TAXES (1,051,422) (1,390,467) INCOME TAXES - - ---------- ---------- NET LOSS $(1,051,422) $(1,390,467) ========== ========== NET LOSS PER COMMON SHARE, BASIC AND DILUTED Loss before extraordinary items $ (0.05) $ (0.06) Net gain from extraordinary itmes 0.02 - ---------- ---------- NET LOSS PER COMMON SHARE $ (0.03) $ (0.06) ========== ========== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING, BASIC AND DILUTED 30,824,930 22,950,545 ========== ========== The accompanying notes are an integral part of these financial statements. 28 DIATECT INTERNATIONAL CORP. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 2001 and 2000
Common Common Stock Stock Stock Accumulated Shares Amount Options Subscribed Deficit Total ----------- ----------- ----------- ----------- ----------- ------------ Balances as of December 31, 1999 as originally stated 19,535,231 $ 10,366,608 $ - $ 186,238 $(11,134,589) $ (581,743) Restatement for notes payable - - - - (37,457) (37,457) Balances as of December 31, 1999 19,535,231 10,366,608 - 186,238 (11,172,046) (619,200) Issuance of shares for guarantee of line of credit at $0.10 per share 500,000 50,000 - - - 50,000 Issuance of shares to contractors, directors and others for services at $0.25 per share 1,399,591 342,398 - - - 342,398 Issuance of shares for purchase of investment at $0.20 per share 600,000 60,000 - - - 60,000 Issuance of shares for purchase of rights to EPA labels at $0.10 per share 110,000 11,000 - - - 11,000 Issuance of shares for forbearance of notes payable at $0.25 per share 122,500 30,625 - - - 30,625 Issuance of shares to officers for exercise of options at $0.06 per share 1,517,667 91,049 - - - 91,049 Issuance of shares subscribed 290,000 186,238 - (186,238) - - Issuance of shares for debt at $0.25 per share 4,291,084 1,072,712 - - - 1,072,712 Issuance of shares for loan incentive at prices ranging from $0.10 to $0.25 per share 350,000 50,000 - - - 50,000 Options granted to officers as bonus for new contracts - - 51,370 - - 51,370 Net loss for the year ended, December 31, 2000 - - - - (1,390,467) (1,390,467) ----------- ----------- ----------- ----------- ----------- ------------ Balances as of December 31, 2000 28,716,073 12,260,630 51,370 - (12,562,513) (250,513) ----------- ----------- ----------- ----------- ----------- ------------
The accompanying notes are an integral part of these financial statements. 29 DIATECT INTERNATIONAL CORP. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 2001 and 2000
Common Common Stock Stock Stock Accumulated Shares Amount Options Subscribed Deficit Total ----------- ----------- ----------- ----------- ----------- ------------ Balances as of December 31, 2000 (brought forward) 28,716,073 12,260,630 51,370 - (12,562,513) (250,513) Issuance of shares for debt at $0.15 to $0.25 per share 1,408,343 266,619 - - - 266,619 Issuance of shares for guarantee of debt and line of credit at $0.07 to $0.50 per share 2,107,500 196,550 - - - 196,550 Issuance of shares for cash at $0.10 to $0.12 per share 400,000 44,000 - - - 44,000 Issuance of share in settlement of salary claim at $0.25 per share 188,000 47,000 - - - 47,000 Issuance of shares for consulting at $0.08 per share 50,000 3,750 - - - 3,750 Issuance of shares to officers for services at $0.08 per share 1,250,000 93,750 - - - 93,750 Issuance of shares for settlement of distributor agreement and severance agreement at $0.08 per share 1,000,000 75,000 - - - 75,000 Issuance of shares for cash and receivable at $0.10 to $0.25 per share 800,000 170,000 - (70,000) - 100,000 Issuance of shares for payment of accounts payable at $0.21 per share 200,000 41,035 - - - 41,035 Issuance of shares for payment of legal fees and exercise of options at $0.06 per share 499,998 85,354 (55,354) - - 30,000 Issuance of shares to officers for payment of accrued legal fees and debt at $0.35 per share 308,247 107,886 - - - 107,886 Options granted to officer as bonus for contract - - 18,890 - - 18,890 Options granted to stockholder for financing and extension of options to officer - - 69,995 - - 69,995 Net loss for the year ended, December 31, 2001 - - - - (1,051,422) (1,051,422) ----------- ----------- ----------- ----------- ----------- ------------ Balances as of December 31, 2001 36,928,161 $ 13,391,574 $ 84,901 $ (70,000) $(13,613,935) $ (207,460) =========== =========== =========== =========== =========== ============
The accompanying notes are an integral part of these financial statements. 30 DIATECT INTERNATIONAL CORP. CONSOLIDATED CASH FLOW STATEMENTS December 31, 2001 and 2000 2001 2000 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $(1,051,422) $(1,390,467) Adjustments to reconcile net loss to net cash used by operating activities: Gain from debt termination (611,252) - Depreciation and amortization 295,977 316,890 Issuance of stock for services 182,000 316,058 Issuance of stock options for services 18,890 51,370 Issuance of stock options for financing 66,010 - Extension of options to officer for services 3,984 - Issuance of stock for finance charges and interest 76,175 400,096 Issuance of stock for distributor expense 37,500 - Issuance of note payable for distributor expense 50,000 - Stock issued for payment of accrued expenses - 170,527 Litigation settlement 20,000 20,000 Accrued settlements and commitments - 7,148 Distributor expenses paid from deposits 150,000 - Notes and settlement gains charged to operations 763,591 - Changes in assets and liabilities: Cash in escrow (400,000) - Accounts receivable (144,646) (53,014) Prepaid interest 8,906 7,450 Prepaid royalties 10,696 - Inventories 14,643 57,308 Accounts payable 24,588 38,474 Accounts payable - related parties (30,795) (202,070) Bank overdraft 22,268 - Advances from officers - (5,168) Deposit payable (20,000) 20,000 Interest payable (436,537) (26,225) Other accrued liabilities 15,030 (620) ---------- ---------- NET CASH FLOWS USED BY OPERATING ACTIVITIES (934,394) (272,243) ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES Deposits paid (28,500) - Purchase of property, plant and equipment (106,205) (2,444) ---------- ---------- NET CASH FLOWS USED BY INVESTING ACTIVITIES (134,705) (2,444) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from line of credit - 97,000 Issuance of common stock for cash 144,000 - Payments on settlements (20,730) - Payment of notes payable (130,667) - Proceeds from notes payable 1,074,000 195,911 ---------- ---------- NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES 1,066,603 292,911 ---------- ---------- NET INCREASE (DECREASE) IN CASH (2,496) (1,776) CASH AT BEGINNING OF YEAR 3,384 5,160 --------- ---------- CASH AT END OF YEAR $ 888 $ 3,384 ========= ========== The accompanying notes are an integral part of these financial statements. 31 DIATECT INTERNATIONAL CORP. CONSOLIDATED CASH FLOW STATEMENTS(Continued) December 31, 2001 and 2000 2001 2000 ---------- ---------- SUPPLEMENTAL CASH FLOW DISCLOSURES: Interest expense paid $ 32,177 $ - Income taxes paid $ - $ - NON-CASH FINANCING ACTIVITIES: Issuance of common stock for prepaid finance charges $ 120,375 $ 50,000 Issuance of common stock for services $ 182,000 $ 316,058 Issuance of common stock for investment$ $ - $ 60,000 Issuance of common stock for rights to EPA labels $ - $ 11,000 Issuance of common stock for payment of accrued expenses $ - $ 170,527 Issuance of common stock for forbearance of notes payable, finance charges and interest $ 76,175 $ 400,096 Issuance of stock options for services $ 18,890 $ 51,370 Issuance of common stock for debt $ 445,540 $ 724,971 Issuance of note payable for investment deposit $ - $ 110,000 Issuance of common stock for settlement of distributor agreement $ 37,500 $ - Issuance of note payable for distributor expense $ 50,000 $ - Issuance of stock options for financing $ 66,010 $ - Issuance of note payable for furniture and equipment $ 30,320 $ - Extension of stock options for services $ 3,984 $ - The accompanying notes are an integral part of these financial statements. 32 DIATECT INTERNATIONAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS Diatect International Corp. (formerly Applied Earth Technologies, Inc.) (formerly San Diego Bancorp) (SDBC) was incorporated in California in 1979 as a bank holding corporation. During 1986, the Company liquidated its subsidiaries and became a dormant "shell" corporation. On August 22, 1996, the Company changed its name from San Diego Bancorp to Applied Earth Technologies, Inc. to better reflect the Company's principal business activities, which primarily consist of developing and marketing pesticide products. The Company later became informed that another corporation already had been authorized to use the name Applied Earth Technologies, Inc. and approval of this name had been granted in error. In response to this information, the Company changed its name to Diatect International Corp. on June 5, 1998. The Company's wholly owned subsidiaries consist of Magic international, Inc., Enviro-Guard Corporation, Diatect International, Inc. and D.S.D., Inc. Apart from Diatect International, Inc. and Magic International, Inc., the Company's subsidiaries are inactive. Magic International, Inc. - ------------------------- On May 24, 1999, the Company entered into an agreement to purchase Magic International, Inc. ("Magic") in exchange for $3,000 cash, effective payment of an outstanding obligation in the amount of $4,050 and 200,000 shares of Diatect International Corporation's common stock. This transaction was valued at $27,050. At the time of the transaction, the authorized level of the Company's capitalization did not permit an issuance of 200,000 shares of stock. The Company increased its authorized capital, issued the aforementioned stock and finalized the acquisition in March 2000, at which time Magic became a wholly owned subsidiary. National Diatect, Inc. - ---------------------- In July 2000, the Company signed a letter of intent to purchase National Diatect, Inc. in a transaction which requires the issuance of 400,000 shares of the Company's common stock, payment of future royalties in the amount of $120,000 payable at the rate of $0.10 per pound of certain products and assumption of a note payable in the amount of $110,000 (bearing interest at 12% and collateralized by inventory and equipment). The Company has issued 400,000 shares and the agreement has been ratified by the board of directors to a mutually agreed upon reduced note payable balance of $70,419 as of the date of these financial statements. See Note 13. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This summary of significant accounting policies of Diatect International Corp. is presented to assist in understanding the Company's financial statements. The financial statements and notes are representations of the Company's management, which is responsible for their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements. 33 DIATECT INTERNATIONAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Accounting Method - ----------------- The Company's financial statements are prepared using the accrual method of accounting in accordance with accounting principles generally accepted in the United States of America. Principles of Consolidation - --------------------------- The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, after elimination of the intercompany accounts and transactions. Wholly owned subsidiaries of the Company are listed in Note 1. Cash and Cash Equivalents - ------------------------- For purposes of the statement of cash flows, the Company considers all highly liquid investment (or short-term debt) purchased with original maturity of three months or less to be cash equivalents. Allowance for Doubtful Accounts - ------------------------------- Provision for losses on trade accounts receivable is made in amounts required to maintain an adequate allowance to cover anticipated bad debts. Accounts receivable are charged against the allowance when it is determined by the Company that payment will not be received. Inventories - ----------- Inventories consist primarily of raw materials and finished product and are valued at the lower of cost (first in, first out) or market. Property and Equipment - ---------------------- Property, plant and equipment are stated at cost including the allocable purchase price applicable to the respective assets of purchased subsidiaries. All expenditures for improvements, replacements and additions are added to the asset accounts at cost. Expenditures for normal repairs and maintenance are charged against earnings as incurred. The cost and related accumulated depreciation are eliminated from the accounts and the resulting gain or loss is reflected in the statements of operations when depreciable assets are retired or otherwise disposed. Depreciation is provided for by the use of straight-line and accelerated methods over the estimated useful lives of the assets. Depletion is computed using the unit-of-production method, for any mining property placed in production. Depreciation expense for the nine months ended December 31, 2001 and 2000 was $12,765 and $10,103, respectively. Intangible Assets - ----------------- Most intangible assets are amortized over the remaining useful life on a straight-line basis, which ranges from 15 to 17 years. EPA labels are amortized on a straight-line basis over a 15-year life, commencing with the beginning of product sales. Amortization expense for the years ended December 31, 2001 and 2000 was $283,212 and $306,787, respectively. 34 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Goodwill - -------- Goodwill represents the excess of the purchase price and related direct costs over the fair value of net assets acquired as of the date of the acquisition. Goodwill is amortized on a straight-line basis over 15 years. The Company periodically reviews its goodwill to assess recoverability based on projected undiscounted cash flows from operations. Impairments are recognized in operating results when a permanent diminution in value occurs. Income Taxes - ------------ Income taxes are provided based upon the liability method of accounting pursuant to SFAS No. 109 "Accounting for Income Taxes." Under this approach, deferred income taxes are recorded to reflect the tax consequences on future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end. A valuation allowance is recorded against deferred tax assets if management does not believe the Company has met the "more likely than not" standard imposed by SFAS No. 109 to allow recognition of such an asset. At December 31, 2001, the Company had net deferred tax assets of approximately $2,005,000, principally arising from net operating loss carryforwards for income tax purposes. As management of the Company cannot determine that it is more likely than not that the Company will realize the benefit of the net deferred tax asset, a valuation allowance equal to the net deferred tax asset has been established at December 31, 2001. At December 31, 2001, the Company has net operating loss carryforwards of approximately $13,000,000, which expire in the years 2011 through 2021. Basic and Diluted Loss Per Share - -------------------------------- Loss per share was computed by dividing the net loss by the weighted average number of shares outstanding during the year. The weighted average number of shares was calculated by taking the number of shares outstanding and weighting them by the amount of time they were outstanding. Outstanding options were not included in the computation of net loss per share because they would be antidilutive. Revenue Recognition Policy - -------------------------- Revenues from sales of product are recognized when the product is shipped. Shipping and Handling Fees and Costs - ------------------------------------ The Emerging Issues Task Force ("EITF") issued EITF No. 00-10, "Accounting for Shipping and Handling Fees and Costs", which was adopted during fiscal 2001. The impact of adopting EITF No. 00-10 was to increase revenues and cost of sales by approximately $25,543 and $3,740 in fiscal 2001 and 2000 respectively. All amounts in the accompanying Consolidated Statements of Operations and Comprehensive Loss have been reclassified to reflect this adoption. 35 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Product Warranties - ------------------ The Company sold the majority of its products to distributors along with replacement warranties. Warranty expense is included in cost of sales. Compensated Absences - -------------------- Employees of the Company are entitled to paid vacation, paid sick days and personal days off, depending on job classification, length of service, and other factors. Due to the existence of a relatively high employee turnover rate, it is impractical to estimate the amount of compensation for future absences. Accordingly, no liability has been recorded in the accompanying financial statements. The Company's policy is to recognize the costs of compensated absences when actually paid to employees. Estimates - --------- The process of preparing financial statements in conformity with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions regarding certain types of assets, liabilities, revenues, and expenses. Such estimates primarily relate to unsettled transactions and events as of the date of the financial statements. Accordingly, upon settlement, actual results may differ from estimated amounts. Fair Value of Financial Instruments - ----------------------------------- The Company's financial instruments as defined by SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," include cash, advances to affiliate, trade accounts receivable, investment in securities available-for-sale, restricted cash, accounts payable and accrued expenses and short-term borrowings. All instruments other than the investment in securities available-for-sale are accounted for on a historical cost basis, which, due to the short maturity of these financial instruments, approximates fair value at December 31, 2001. The Company has no investment in securities available-for-sale at December 31, 2001. Derivative Instruments - ---------------------- The Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB No. 133", and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities", which is effective for the Company as of January 1, 2001. This standard establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. 36 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Derivative Instruments (Continued) - ---------------------------------- If certain conditions are met, a derivative may be specifically designated as a hedge, the objective of which is to match the timing of gain or loss recognition on the hedging derivative with the recognition of (i) the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk or (ii) the earnings effect of the hedged forecasted transaction. For a derivative not designated as a hedging instrument, the gain or loss is recognized in income in the period of change. Historically, the Company has not entered into derivatives contracts to hedge existing risks or for speculative purposes. At December 31, 2001, the Company has not engaged in any transactions that would be considered derivative instruments or hedging activities. Segment Information - ------------------- The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," during the 2001. SFAS No. 131 established standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also established standards for related disclosures about products and services and geographic areas. Operating segments are defined as components of an enterprise about which separate financial information is available, evaluated regularly by the chief operating decision makers, or a decision making group, in deciding how to allocate resources and in assessing performance. Accounting Pronouncements - ------------------------- In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS 144 replaces SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This new standard establishes a single accounting model for long-lived assets to be disposed of by sale, including discontinued operations. Statement 144 requires that these long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or discontinued operations. This statement is effective beginning for fiscal years after December 15, 2001, with earlier application encouraged. The Company adopted SFAS 144 and does not believe that the adoption will have a material impact on the financial statements of the Company at December 31, 2001. 37 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Accounting Pronouncements (Continued) - ------------------------------------- In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" (SFAS No. 143). SFAS No. 143 establishes guidelines related to the retirement of tangible long-lived assets of the Company and the associated retirement costs. This statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived assets. This statement is effective for financial statements issued for the fiscal years beginning after June 15, 2002 and with earlier application encouraged. The Company adopted SFAS No. 143 and does not believe that the adoption will have a material impact on the financial statements of the Company at December 31, 2001. In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 provides for the elimination of the pooling-of-interests method of accounting for business combinations with an acquisition date of July 1, 2001 or later. SFAS No. 142 prohibits the amortization of goodwill and other intangible assets with indefinite lives and requires periodic reassessment of the underlying value of such assets for impairment. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. An early adoption provision exists for companies with fiscal years beginning after March 15, 2001. On January 1, 2002, the Company adopted SFAS No. 142. Application of the nonamortization provision of SFAS No. 142 is expected to result in an increase in net income of approximately $283,000 in fiscal 2002. The Company is currently evaluating the impact of the transitional provisions of the statement. In September 2000, the FASB issued SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities and also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS No. 140 is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000, and is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The Company believes that the adoption of this standard will not have a material effect on the Company's results of operations or financial position. NOTE 3 - INVENTORIES Inventories at December 31, 2001 and 2000 consist of the following: 38 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 3 - INVENTORIES (Continued) December 31, December 31, 2001 2000 ------------ ------------ Raw Materials $ 32,813 $ 26,171 Finished Goods 76,519 97,804 ------------ ------------ Total $ 109,332 $ 123,975 ============ ============ NOTE 4 - INVESTMENT IN EPA LABELS The Company has acquired five product registrations ("labels") approved by the U.S. Environmental Protection Agency granting federal clearance to manufacture, market and sell specified insecticide products. Included are: No. 42850-1 for use against flies, roaches, ants, etc., in and around homes and commercial buildings; No. 42850-2 for use in grain storage; No. 42850-3 for use against fleas, ticks and lice on pets; No. 42850-4 for use against over 60 insects on over 130 edible crops and plants; and No. 42850-5 (approved November 23, 1999) for use in the organic market to control all major pest problems. NOTE 5 - NOTES PAYABLE All of the Company's notes payable are considered short-term. At December 31, 2001 and 2000, notes payable consisted of the following: Creditor and Conditions 2001 2000 - ----------------------- ---------- ---------- Jeffrey Linabery, unsecured, interest at 14%, due on demand. $ 7,500 $ 7,500 David Russell (a shareholder of the Company), unsecured, interest at 10%, due on demand. 15,000 15,000 David Russell, (a shareholder of the Company), unsecured, interest at 8%, due on demand. 25,000 25,000 Danny Wirken (a shareholder of the Company), unsecured, interest at 8%, dated December 31, 1993 due on demand. (See Notes 7 and 17.) - 386,581 Subtotal (carried forward) $ 47,500 $ 434,081 ---------- ---------- 39 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 5 - NOTES PAYABLE (Continued) Creditor and Conditions (Continued) 2001 2000 - ----------------------- ---------- ---------- Subtotal (carried forward) $ 47,500 $ 434,081 Max Burdick, unsecured, interest at 18%, dated November 6, 1996, due February 15, 1997, delinquent. - 40,000 David J. Black, (a shareholder of the Company), unsecured, interest at 10%, dated August 5, 1997, due on demand. 20,000 20,000 Greg Cloward, (a shareholder of the Company), unsecured, interest at 15%, dated January 6, 1997, due on demand. 251,000 251,000 David N. Sim, (a shareholder of the Company), unsecured, interest at 15%, dated October 1, 1999, due on December 31, 1999, delinquent. 6,500 6,500 Shining Star Investment, Inc., a Nevada corporation, (a shareholder of the Company), unsecured, interest at 14%, dated July 14, 1995, due December 31, 1995, delinquent. 5,239 5,239 Hopper Asset Management Company, conditionally secured by 50,000 shares Diatect International Corporation common stock, interest at 15%, dated May 22, 1998, due May 5, 1999, delinquent. 10,000 25,000 Jack S. Stites, (a shareholder of the Company), unsecured, interest at 15%, dated September 1, 1999, due on December 31, 1999, delinquent. 8,800 8,800 Hopper Asset Management Company, unsecured Interest at 15%, dated June 19, 1999, due on December 31, 1999, delinquent. 50,000 50,000 ---------- ---------- Subtotal (carried forward) $ 399,039 $ 840,620 ---------- ---------- 40 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 5 - NOTES PAYABLE (Continued) Creditor and Conditions (Continued) 2001 2000 - ----------------------- ---------- ---------- Subtotal (brought forward) $ 399,039 $ 840,620 D. N. Sim, (a shareholder of the Company) unsecured, interest at 10%, dated January 4, 2000, due on May 4, 2000, delinquent. 2,500 2,500 George H. Henderson, (a shareholder of the Company), unsecured, interest at 10%, dated April 14, 2000, due on December 31, 2000, delinquent. 50,000 72,957 Robert L. Drake and Sandra K Drake, (shareholders of the Company), secured by sale of inventory, interest at 12%, dated July 12, 2000, due on July 12, 2001, delinquent. 62,445 110,000 Johnny and Jack Stites, (a shareholder of the Company) unsecured , interest at 10%, dated February 25, 2000, due on May 1, 2000, delinquent. 20,000 20,000 Futura Title Corporation dba Alliance Title & Escrow, former shareholders of White Mountain Mining and Manufacturing, Inc., monthly payments of $18,000, 18% interest with a one-time compounding of interest effective June 21, 1995, secured by mining property, (later foreclosed) due September 1994. Delinquent. (See Note 7). - 209,444 K & R "Stuff" LC, unsecured, interest at 12%, dated August 22, 2000, due on August 22, 2001, renewed on November 22, 2001, convertible to 232,000 shares of the Company's common stock on demand, due on August 22, 2002. 58,000 50,000 ---------- ---------- Subtotal (carried forward) $ 591,984 $ 1,305,521 ---------- ---------- 41 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 5 - NOTES PAYABLE (Continued) Creditor and Conditions (Continued) 2001 2000 - ----------------------- ---------- ---------- Subtotal (brought forward) $ 591,984 $ 1,305,521 Joseph E. Pigg, Jr., unsecured, interest at 10%, dated September 8, 2000, due on September 8, 2001. - 10,000 Joseph E. Pigg, Jr., unsecured, interest at 10%, dated September 25, 2000, due on September 25, 2001, delinquent. 10,000 10,000 Robert B. Crouch, (shareholder of the Company), unsecured, interest at 12%, dated November 7, 2000, due on demand. - 1,000 Robert B. Crouch, (officer and shareholder of the Company), unsecured, interest at 12%, dated November 16, 2000, due on demand. 2,610 4,000 John Runft (an officer and shareholder of the Company) unsecured, interest at 10%, Dated April 12, 2000, due on demand. - 37,457 George H. Henderson, (shareholder of the Company), unsecured, interest at 12%, dated October 1, 2000, due on October 1, 2001. - 42,590 Jack Stites, (shareholder of the Company), unsecured, interest at 12%, dated December 22, 2000, due on demand. 3,000 3,000 Venture Creations, Inc. (shareholders of the Company), unsecured, interest at 10%, dated September 20, 2001, due on October 1, 2003. 50,000 - Gary Hanson (shareholder of the Company), unsecured, interest at 12%, dated July 24, 2001, due on October 24, 2001, delinquent. 20,000 - ---------- ---------- Subtotal (carried forward) $ 677,594 $ 1,413,568 ---------- ---------- 42 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 5 - NOTES PAYABLE (Continued) Creditor and Conditions (Continued) 2001 2000 - ----------------------- ---------- ---------- Subtotal (brought forward) $ 677,594 $ 1,413,568 RCK, LLC, (a shareholder of the Company) unsecured, interest at 12%, dated September 28, 2001, due on demand 600,000 - Ed L. Shannon, Jr. and Bruce L Shannon, (shareholders of the Company), unsecured, interest at 12%, dated August 1, 2001, due on August 1, 2002. 200,000 - Robinson Family, LLC, (shareholders of the Company), unsecured, interest at 12%, dated April 1, 2001, due on April 1, 2002. 106,000 - Ronald Davis, (a shareholder of the Company), unsecured, interest at 12%, dated December 28, 2001, due on June 28, 2002. 25,000 - Kyle Baird, (a shareholder of the Company), unsecured, interest at 12%, dated November 26, 2001, due on March 26, 2002 25,000 - Max Burdick, (a shareholder of the Company), unsecured, interest at 12%, dated November 26, 2001, due on March 1, 2002 30,000 - Jay Downs (an officer and shareholder of the Company), unsecured, non-interest bearing, dated October 15, 2001, due on October 15, 2002, convertible to common stock at $0.35 per share 30,320 - Richard Humphries, (a shareholder of the (Company), unsecured, interest at 12%, dated October 1, 2001, due on April 1, 2002 10,000 - ---------- ---------- Totals $ 1,703,914 $ 1,413,568 ========== ========== 43 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 6 - LINE OF CREDIT At December 31, 2001 and 2000, the Company had $97,000 borrowed on an outstanding line of credit. The line of credit was extended to the Company by a director utilizing his personal line of credit. This credit facility is unsecured, has no stated maturity, and bears interest at 12%. NOTE 7 - LITIGATION Sloan, Listrom, Eisenbarth, Sloan & Glassman, LLC - ------------------------------------------------- In November 1999, the Company's former legal counsel was awarded a default judgment against the Company in the amount of $42,166 plus post-judgment interest. This judgment remains outstanding and unpaid and is included as a liability on the Company's balance sheet in commitments and contingencies at December 31, 2000. During the period ended December 31, 2001, the Company reclassified this amount to settlement payable in the amount of $40,166. Ogilvy, Adams & Rinehart - ------------------------ Ogilvy, Adams & Rinehart (Ogilvy) obtained a judgment against Diatect on November 1, 1995 in the sum of $24,346. The entire judgment amount plus attorney's fees and interest thereon is approximately $36,000 and has been included on the Company's balance sheet in commitments and contingencies at December 31, 2000. During the year ended December 31, 2001, the Company reclassified this amount to settlements payable. Since mid-1996, there has been no communication with the plaintiff or its attorneys, nor has the plaintiff made any attempt to satisfy or settle this case. L. Craig Hunt - ------------- L. Craig Hunt brought action on January 14, 1998 against Diatect for damages and breach of contract on a promissory note for the sum of $42,750 plus interest, penalties and attorney's fees. Judgment against Diatect International Corp. was rendered on February 1, 1999 in the sum of $61,543. This judgment is presently outstanding and unpaid. At December 31, 2000, $60,543 is included in commitments and contingencies in these financial statements. During the year ended December 31, 2001, the Company reclassified this amount to settlements payable. To date, plaintiffs have made no attempt to collect on this judgment. Mid-America Venture Capital Fund, Inc. - -------------------------------------- Mid-America Venture Capital Funds, Inc. brought action on July 23, 1997 against the Company for failure to pay loans on two promissory notes totaling $35,000. Judgment was awarded on August 4, 1997 for a total of $39,336 including principal, interest, and attorney's fees and costs. Since that time, Diatect has paid a total of $6,000 and is currently in arrears on the payment schedule. The balance owing is included in commitments and contingencies in these financial statements at December 31, 2000. During the year ended December 31, 2001, the Company reclassified this amount to settlements payable. 44 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 7 - LITIGATION (Continued) Mike Glazer - ----------- A consultant rendered services to a Company subsidiary during 1996 in the amount of $17,230 and has brought action for this amount. The Company has chosen not to contest this case. Settlement efforts are expected to be undertaken after entry of judgment and demonstration that the assets of the subsidiary, Diatect International, Inc., are fully encumbered. The amount of $17,230 is included in commitments and contingencies in these financial statements at December 31, 2000 and was paid in full during the year ended December 31, 2001. Danny Wirken - ------------ The Company is considering litigation against Danny Wirkin, (one of the brokers involved in the selling of Diatect stock, which gave rise to certain litigation for stock manipulation) with the objective of obtaining a judgment for damages and foreclosing on the Company's obligation under its note to Mr. Wirkin. This note is reflected at December 31, 2000 in the principal amount of $386,581, with accrued interest included in interest payable for the amount of $216,570. During June 2001, the Company declared this note and the interest accrued thereon as invalid and void. Legal counsel for the Company further asserted that the obligation has passed the statute of limitations for collection thereon. This resulted in a gain from termination of debt, which is reflected in the financial statements at December 31, 2001 as an extraordinary item. (See Notes 5, and 17.) Toxikon, Inc. - ------------- Toxikon, Inc. filed suit in 1999 to collect on an unpaid trade account in the amount of $21,260 plus accrued interest. The debt was paid in full in March 2000 and the case was dismissed. Terrance Dunne - -------------- Terrance Dunne, the Company's former auditor, initiated action against the Company for payment of unpaid fees. In response to the allegations, the Company has countersued for reimbursement of fees paid for work not performed. The outcome of this action is uncertain and, accordingly, no amounts have been accrued in these financial statements. George Brink - ------------ During December 2000, George Brink was awarded a default judgment in the total amount of $44,648, including interest and legal fees, for the balance due on a promissory note. At this time, active collection on the judgment has not been pursued. The outstanding and unpaid amount is included as a liability on the Company's balance sheet in commitments and contingencies at December 31, 2000. During the year ended December 31, 2001, the Company reclassified this amount to settlements payable. 45 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 7 - LITIGATION (Continued) Creditors' Judgments - -------------------- During 1994 and 1995, the Company was sued by a number of creditors, whose lawsuits were allowed to go to judgment. These judgments were a result of the inability of the Company to fund operations and payments to the Company's creditors. The collection judgments, which are substantially unpaid at December 31, 2001 and 2000, total approximately $90,000 and $52,000, and are included in the Company's accounts payable and other obligations. A settlement has been approved whereby this liability is scheduled to be paid in full on or before March 31, 2002. Environmental Protection Agency - ------------------------------- During October 2000, the Company joined other plaintiffs represented by a public interest law firm in filing action against the Environmental Protection Agency (EPA). The action seeks relief from the EPA's practice of using certain guidelines as a basis for hazard classification and risk assessments pursuant to the Federal Insecticide, Fungicide and Rodenticide Act. Plaintiffs and the EPA worked out a stipulation for the dismissal of the case whereby the EPA must use final guidelines promulgated for such reviews. The case was dismissed during March 2002 pursuant to this stipulation. Former Officers and Consultant - ------------------------------ In September 2000, the Company received notice from two former officers and a former consultant that they intend to bring action for nonpayment of back wages. During May 2001, the Company issued 188,000 shares of its common stock to one former officer valued at $47,000 ($0.25 per share) in full settlement. This amount is included in executive compensation in the attached financial statement. During August 2001, the Company paid $5,000 to another former officer for settlement with mutual release of his claim for nonpayment of back wages in the amount of $38,500. The remaining amount in dispute totals $25,745. Because the Company plans to contest the related claim which it does not expect to pay, the amount disputed is not recorded in the accompanying financial statements. Other Litigation - ---------------- The Company is not aware of any other filed litigation against it or its subsidiaries. However, there remains a possibility of litigation against Diatect and its subsidiaries by creditors. NOTE 8 - COMMON STOCK In February 2000, the Company increased its authorized capital to 50,000,000 shares of common stock. During the year ended December 31, 2000, the Company issued 500,000 shares of its common stock valued at $50,000 for the guarantee of a line of credit, 472,500 shares of its common stock valued at $80,625 for forbearance on notes payable, 200,000 shares of its common stock valued at $20,000 for purchase of all outstanding stock of Magic International, Inc. 400,000 shares of its common stock valued at $40,000 for partial purchase of National Diatect, Inc. and 110,000 shares of its common stock valued at $11,000 for rights to EPA labels at $0.10 per share. The Company also issued 46 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 8 - COMMON STOCK (Continued) 1,399,591 shares of its common stock valued at $342,398 for services and 4,291,084 shares of its common stock valued at $1,072,712 for debt at $0.25 per share. The stock was valued at its market value on the date of issuance. Two officers also exercised options to purchase 1,517,667 shares of the Company's common stock valued at $91,049 at $0.06 per share for partial payment of accrued consulting and legal fees. During the year ended December 31, 2001, the Company issued 2,107,500 shares of its common stock valued at $196,550 in consideration for a note payable, 1,716,590 shares of its common stock valued at $374,505 for debt, 188,000 shares of its common stock valued at $47,000 to a former officer for back wages (Note 7), 1,300,000 shares of its common stock valued at $97,500 for services to officers and others, 500,000 shares of its common stock valued at $37,500 in settlement of a distributor agreement, 500,000 shares of its common stock valued at $37,500 as a severance bonus to the Company's former president and 200,000 shares of its common stock valued at $41,035 in payment of a vendor account. The shares were valued at their fair market value on the date of issuance. The Company also sold 1,200,000 shares of its common stock at prices ranging from $0.10 to $0.25 per share for cash and a receivable. An officer, to whom options with a fair market value of $55,534 had been previously issued, exercised the options and purchased 499,998 shares of common stock. The exercise price of the stock of $30,000 was exchanged for accrued legal fees. NOTE 9 - COMMON STOCK SUBSCRIBED In 1996, the Company agreed to convert outstanding debts to certain individuals into common stock. This common stock was not issued until August 2000 and was treated as common stock subscribed but not issued. The following individuals were owed common stock to satisfy the amount of these debts: Ross S. Wolfley $ 22,500 G. Reeve 163,738 ---------- Total $ 186,238 ========== During August 2000, the Company issued 200,000 shares of its common stock to G. Reeve and 90,000 shares of its common stock to Ross S. Wolfley, in full payment of the above subscriptions. During the year ended December 31, 2001, the Company sold stock valued at $170,000 and received $100,000. The remaining $70,000 is reflected in the attached financial statements as stock subscription receivable. See Note 8. 47 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 10 - STOCK OPTIONS The Company has a 1995 Stock Option Plan, which was initiated in order to aid the Company in maintaining and developing a management team, attracting qualified officers and employees. A total of 3,000,000 shares of stock may be subject to, or issued pursuant to the terms of the plan. Following is a summary of the status of these performance-based options during the years ended December 31, 2001 and 2000: Weighted Average Number of Shares Price per Share ---------------- ---------------- Outstanding at December 31, 1999 894,636 $0.06 Granted 1,122,335 0.06 Exercised (1,517,667) 0.06 Expired or forfeited - - ---------------- ---------------- Outstanding at December 31, 2000 499,304 $0.06 ================ ================ Options exercisable at December 31, 2000 499,304 $0.06 ================ ================ Weighted average fair value of options granted during 2000 $0.05 ================ Outstanding at December 31, 2000 499,304 $0.06 Granted 1,100,000 0.18 Exercised (499,304) 0.06 Expired or forfeited - - ---------------- ---------------- Outstanding at December 31, 2001 1,100,000 $0.18 ================ ================ Options exercisable at December 31, 2001 1,100,000 $0.18 ================ ================ Weighted average fair value of options granted during 2001 $0.08 ================ Weighted Average Exercise Date Number of Shares Price per Share ---------------- ---------------- On or before February 1, 2002 600,000 $0.25 On or before December 31, 2004 500,000 $0.10 48 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 10 - STOCK OPTIONS (Continued) SFAS No. 123 requires the Company to provide pro forma information regarding net loss and loss per share as if compensation cost for the Company's stock option plan had been determined in accordance with the fair value based method prescribed by SFAS No. 123. The Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option- pricing model with the following weighted-average assumptions used: dividend yield of zero percent; expected volatility of thirty percent; risk-free interest rate of six percent. The weighted average fair value at date of grant for options granted to employees and stockholders in the years ended December 31, 2001 and 2000 was $0.08 and $0.05 per option, respectively. Compensation cost charged to operations was $18,890 and $51,370 during the years ended December 31, 2001 and December 31, 2000, respectively. Finance fees charged to other expenses was $66,010 and legal fees charged to operations was $3,985 during the year ended December 31, 2001. NOTE 11 - CONCENTRATION OF RISK Credit - ------ The Company is a wholesale supplier of products and grants credit to its customers, a substantial portion of which are retailers of agricultural products throughout the country. NOTE 12 - COMMITMENTS AND CONTINGENCIES The Company is obligated to pay certain notes and settlements under judgments awarded to outside parties. (Note 7.) These amounts, included in commitments and contingencies as December 31, 2000, are as follows: December 31, 2001 2000 ---------- ---------- Futura Title Corporation dba Alliance Title & Escrow $ 461,605 $ - L. Craig Hunt - 61,543 Mid-America Venture Capital Fund, Inc. - 37,336 Sloan, Listrom, Eisenbarth, Sloan & Glassman, LLC - 40,166 Ogilvy, Adams & Rinehart - 36,000 Mike Glazer - 17,230 George Brink - 44,648 ---------- ---------- $ 461,605 $ 236,923 ========== ========== In the year ending December 31, 2001, the Company reclassified $214,693 in commitments as outstanding settlements payable. The $17,230 owed to Mike Glazer was paid in full during the year ended December 31, 2001. 49 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 12 - COMMITMENTS AND CONTINGENCIES (Continued) Futura Title Corporation - ------------------------ During the year ended December 31, 2001, the Company reclassified a note payable to Futura Title Corporation dba Alliance Title & Escrow plus interest accrued thereon to commitments and contingencies in the total amount of $461,605. The Company is currently negotiating a settlement agreement on this liability. Although the outcome is uncertain, the Company expects to settle for considerably less. National Diatect, Inc. - ---------------------- In July 2000, the Company signed a letter of intent to purchase National Diatect, Inc. The agreement is subject to ratification by the board of directors and has not been finalized as of the date of these financial statements. See Note 1. Lease Commitments - ----------------- The Company leased office facilities in Boise, Idaho from an individual through March 2000. The lease was a month-to-month handshake agreement, with payments of $550. In April 2000, the Company entered into a lease agreement for new office facilities in Boise. The agreement called a three-year lease with monthly payments of $820 during the first year, $838 during the second year and $857 during the third year. The Company occupied these facilities from May 1, 2000 through October 1, 2001. The Company negotiated a settlement on the remaining lease in the amount of $2,089. The Company leased operating facilities in Smith Center, Kansas from an individual through July 2001. The lease was a month-to-month handshake agreement, with monthly payments of $273. Other Contingencies - ------------------- The production of pesticides is subject to complex environmental regulations. As of the date of these financial statements and the date of this report, the Company is unaware of any pending environmentally related litigation or of any specific past or prospective matters involving environmental concerns which could impair the marketing of its products. On November 14, 2001, Diatect entered into an agreement with IX Group, Inc. (hereinafter "IXG") whereby Diatect would sell to IXG all of the common stock of a subsidiary, Magic International, Inc. (hereinafter "Magic"), in exchange for approximately 5% of the common stock of Magic after IXG's merger with and into Magic and the post-merger payment of cash. The transaction, if consummated, would be a related party event because IXG's president and principal shareholder is also a shareholder of Diatect. At December 31, 2001, Magic had no assets or liabilities. 50 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 13 - RELATED PARTY TRANSACTIONS Diatect International Corp. has notes payable to twenty-four shareholders and one officer totaling $1,528,714 and $1,086,624 as of December 31, 2001 and 2000, respectively. See Note 5. The Company's secretary performs services as the Company's main legal counsel. Legal services performed by this officer totaled $45,226 and $42,640 for the years ended December 31, 2001 and 2000, respectively, of which $28,167 are included in accounts payable - related party at December 31, 2000. The Company's former president performed consulting services for the Company during the first quarter of 2000. Consulting services preformed by this former officer totaled $20,560 for the year ending December 31, 2000. Included in accounts payable - related party is $2,628 at December 31, 2000. No consulting services were preformed by the Company's former president during the year ending December 31, 2001. The Company has employment contracts to pay the Company's president and vice-president of operations annual compensation in the amounts of $120,000 and $90,000 respectively. During January 2001, the Company's president received a signing bonus of 350,000 options for the purchase of shares of common stock. The Company also had an employment contract to pay the Company's former president annual compensation of $120,000. See Note 10. Executive compensation totaled $409,937 for the year ended December 31, 2001. The Company's president contributed office furniture and equipment valued at $30,320 in exchange for a non-interest bearing convertible note payable. The note was subsequently converted to stock. See Note 18. NOTE 14 - GOING CONCERN As shown in the financial statements, the Company incurred a net loss before extraordinary item of $1,486,498 for the year ended December 31, 2001 and has an accumulated deficit of $13,613,935 at December 31, 2001. The Company has negative equity, negative working capital, unsatisfied collection judgments, and is delinquent in repaying its debt obligations. These factors indicate that the Company may be unable to continue in existence. The financial statements do not include any adjustments related to the recoverability and classification of recorded assets, or the amounts and classification of liabilities that might be necessary in the event the Company cannot continue existence. Management's plans for ensuring the Company's continued viability are as follows: Management's plans are increased product placement and sales and the sale of new stock issuances, which are expected to raise the capital needed to satisfy collection judgments and repay debt obligations. Through the acquisition of Magic International, Inc., management has taken measures to increase product markets. 51 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 15 - MINING PROPERTY The Company formerly owned a majority interest (89.125%) in White Mountain, which had unpatented mining claims located in Malheur County, Oregon. During 1998, the Company lost its controlling interest in White Mountain stock, including the mining claims, which had been pledged as collateral and was foreclosed on by note holders. (Note 7.) During September 2001, the Company was able to reacquire title to these unpatented mining claims by paying the filing fees, which had become delinquent. NOTE 16 - BUSINESS SEGMENT AND GEOGRAPHICAL AREA DATA The Company's operations are classified into two principal reporting segments based upon geographical location. Separate accounting for each segment is required due to varying strategies used by the Company in each location. The table below presents information about the Company's reportable segments: Year Ended December 31, 2001 Kansas Idaho/Utah Eliminations Consolidated ---------- ---------- ------------ ------------ External revenue $ - $ 570,904 $ - $ 570,904 ========== ========== ============ ============ Operating income (loss)$ (20,005) $(1,086,451) $ - $ (1,106,456) ========== ========== ============ Corporate expenses - ------------ Total operating income (loss) $ (1,106,456) ============ Depreciation and Amortization $ 456 $ 295,521 $ - $ 295,977 ========== ========== ============ ============ Interest expense and finance charges $ - $ 278,501 $ - $ 278,501 ========== ========== ============ ============ Identifiable assets $ 160,618 $ 2,850,764 $ (154,924) $ 2,856,458 ========== ========== ============ General corporate assets - Total assets $ 2,856,458 ============ 52 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 16 - BUSINESS SEGMENT AND GEOGRAPHICAL AREA DATA (Continued) Year Ended December 31, 2000 Kansas Idaho Eliminations Consolidated ---------- ---------- ------------ ------------ External revenue $ 158,770 $ 120,772 $ (118,178) $ 161,364 ========== ========== ============ ============ Operating income (loss)$ (6,563) $(1,185,397) $ 118,178 $ (1,073,782) ========== ========== ============ Corporate Expenses (316,685) ------------ Total net income (Loss) $ (1,390,467) ============ Depreciation and Amortization $ 903 $ 315,987 $ - $ 316,890 ========== ========== ============ ============ Interest expense and finance charges $ 1,209 $ 308,688 $ - $ 309,897 ========== ========== ============ ============ Identifiable assets $ 307,295 $ 2,377,645 $ (175,810) $ 2,509,130 ========== ========== ============ General corporate assets - ------------ Total assets $ 2,509,130 ============ Kansas operations, the first reportable segment, performed services including mixing and distribution of pesticide products during 2000. Idaho/Utah operations, the second reportable segment, manufactures product and generates sales revenues. NOTE 17 - EXTRAORDINARY ITEMS In June 2001, a former supplier agreed to write off a balance owed in the amount of $8,100. This is reflected in the financial statement as gain from debt forgiveness. During June 2001, the Company also declared a note payable to Danny Wirken and the interest accrued thereon as invalid and void. Legal counsel for the Company further asserted that the obligation has passed the statute of limitations for collection thereon. This resulted in a gain from termination of debt, which is reflected in the financial statements at December 31, 2001 as an extraordinary item in the amount of $603,152. (See Notes 5, and 12.) During the fourth quarter of the year ended December 31, 2001, the Company experienced extraordinary product returns in the amount of $214,355. The inventory cost of the returned products was $38,179, which resulted in a net loss of $176,176 for the change of distributor relationships. The returns resulted from the Company's efforts to restructure its distribution markets. 53 DIATECT INTERNATIONAL CORP. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001 NOTE 18 - SUBSEQUENT EVENTS Purchase of Facilities - ---------------------- During October 2001, the Company relocated both its office and operating facilities to Heber City, Utah. The Company is currently negotiating the purchase of its new facilities at a cost of $825,000. Under terms of the agreement, the Company may continue occupying the facilities with no charge until closing occurs but not longer than July 2002. Other terms of the agreement call for a down payment of $28,500, escrow deposit in the amount of $384,000 and a letter of credit in the amount of $412,500. The Company paid the down payment of $28,500 during the fourth quarter of the year ended December 31, 2001 and this amount is reflected in the attached financial statements as deposits. During the same period, the Company also secured cash in the amount of $400,000, which is considered restricted and will be used for closing on the building. The Company occupied the facilities on October 10, 2001 and closing is scheduled to occur in July 2002. Note Payable Conversion - ----------------------- Subsequent to the date of these financial statements, the Company's president exercised rights to convert his note payable to 86,629 shares of the Company's common stock at $0.35 per share. See Note 5. NOTE 19 - CORRECTION OF AN ERROR The accompanying financial statements for December 31, 2000 have been restated to correct an error made in understating a related party note payable by $37,457 in the year ended December 31, 2000 and prior years. The restatement had no effect on the net loss for the year ended December 31, 2000. Accumulated deficit has been adjusted for the effects of the restatement on prior years. The Company realized no tax effect from this transaction. See Note 2. -----END PRIVACY-ENHANCED MESSAGE-----