Item 5 and Item 8 are subjects of a Form 12b-25



                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549
                             ----------------------
                                    FORM 10-K

                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1997

                        Commission File Number: 2-93277-D



         MEDIZONE INTERNATIONAL, INC. (originally Madison Funding, Inc.)
       ----------------------------------------------------------------
          (Exact name of Registrant as stated in its corporate charter)

        Nevada                              87-0412648
-----------------------------------------------------------------------
(State of incorporation)         (I.R.S. Employer I.D. Number)

4505 South Wasatch Boulevard, Suite 210, Salt Lake City, Utah   84124
-----------------------------------------------------------------------
(Address of principal executive offices)                     (Zip code)

Registrant's telephone number:        (801) 274-8400
                              
Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to Section 12(g) of the Act:  None
The Registrant has (1) has filed all reports  required to be filed by Section 13
or 15(d) of the  Securities  Exchange Act of 1934 during the preceding 12 months
(or for such  shorter  period  that the  Registrant  was  required  to file such
reports),  and (2) has been subject to such filing  requirements for the past 90
days.
  Yes   X        No

Disclosure  of  delinquent  filers  pursuant  to Item 405 of  Regulation  S-K is
contained  herein,  and will be contained  in  definitive  proxy or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment hereto. Yes No X

The aggregate market value of voting common stock held by  non-affiliates of the
Registrant was $_______ on March ___,  1998,  based on the average bid and asked
prices of such stock as  reported in the NASD OTC  Bulletin  Board and the "pink
sheets" of the National Daily Quotation Bureau.

According to information received from Registrant's  transfer agent, as of March
17, 1998,  Registrant had 138,609,519  shares  outstanding (of which  41,490,125
were restricted).

DOCUMENTS INCORPORATED BY REFERENCE:  None

SUPPLEMENTAL  INFORMATION:  The Registrant  intends to furnish its  shareholders
with an annual report for 1997 and a proxy statement subsequent to the filing of
the 10-K.


<PAGE>

                                TABLE OF CONTENTS

                                     PART I
                                      Page

Item 1.  Business..........................................................3

Item 2.  Properties.......................................................10

Item 3.  Legal Proceedings................................................10

Item 4.  Submission of Matters
                  to a Vote of Security Holders...........................10

                                     PART II

Item 5.  Market for Registrant's Common
                  Equity and Related Stockholder Matters..................11

Item 6.  Selected Financial Data..........................................13

Item 7.  Management's Discussion and Analysis
                  of Financial Condition and Results of
                  Operations..............................................13

Item 8.  Financial Statements and Supplementary
                  Data....................................................15

Item 9.  Changes in and Disagreements with
                  Accountants on Auditing and Financial
                  Disclosure..............................................15

                                    PART III

Item 10. Directors and Executive Officers.................................15

Item 11. Executive Compensation...........................................19

Item 12. Security Ownership of Certain
                  Beneficial Owners and Management........................24

Item 13. Certain Relationships and Related
                  Transactions............................................26

                                     PART IV

Item 14. Exhibits, Financial Statement
                  Schedules, and Reports on Form 8-K......................28

                  Signatures..............................................28

                  Exhibits Index..........................................E-1

                  Financial Statements and Schedules......................F-1

                                       -2-

<PAGE>


                                     PART I

Item 1.  Business
         --------

General

          Medizone  International,  Inc., a Nevada corporation (the "Company" or
the  "Registrant")  organized in 1986,  is a  development  stage  company  whose
objective is to (i) gain regulatory  approval for its drug, a precise mixture of
ozone and oxygen  called  MEDIZONE(R),  and its  process of  inactivating  lipid
enveloped  viruses for the intended purpose of  decontaminating  blood and blood
products and  assisting in the treatment of certain  diseases;  and (ii) develop
the  related  technology  and  equipment  for  the  medical  application  of its
products,  including  its drug  production  and delivery  system (the  "Medizone
Technology").  MEDIZONE(R) is one of two  registered  trademarks of the Company.
Throughout this report,  whether or not the trademark symbol is used, the phrase
"Medizone  (the drug)" is  intended to have the same effect as if the  trademark
symbol had been used.

     Medizone (the drug) is intended to be used as a therapeutic  drug in humans
to  inactivate  certain  viruses,  and thereby  afford a  treatment  for certain
virally-based diseases (including Human Immunodeficiency Virus ["HIV"], the AIDS
related virus, Hepatitis B, Epstein-Barr,  herpes, and cytomegalovirus),  and to
decontaminate blood and blood products, applications which are covered under the
Company's patent (Patent No. 4,632,980).  The Medizone  Technology was developed
for the  production  of  Medizone  (the  drug),  and has  led to the  design  of
equipment  for which a patent has been issued in the United  States  (Patent No.
5,052,382).  The Company has obtained  patents based on each of these patents in
various foreign countries. See "Patents".


Patents

     The  proprietary  scope of the  Company  is covered  under a United  States
process patent (U.S. Patent No. 4,632,980) entitled,  "Ozone  Decontamination of
Blood and Blood  Products" (the "Patent") and a related United States  equipment
patent  (U.S.  Patent  No.  5,052,382)  entitled  "Approaches  for  the  Control
Generation and Administration of Ozone" (the "Equipment Patent").

     The Patent, which covers a procedure for ozone decontamination of blood and
blood  products  through the  treatment  of blood and blood  components,  is the
Company's  principal  asset,  and was  purchased,  together with rights to other
ozone-related inventions, from Immunologics Limited Partnership, L.P. ("ILP") in
1987,  for an aggregate of 6,000,000  shares of the Company's  common stock (the
"Patent  Purchase  Agreement").  John M. Kells,  the general partner of ILP, was
Chairman  of the  Company's  Board  of  Directors  from  November  1992  through
September 1993.

     The Patent Purchase  Agreement requires the Company to pay to ILP an annual
royalty equal to 3% of the net receipts  (i.e.,  net receipts after all credits,
returns and customary  deductions,  and exclusive of all taxes)  received by the
Company  in  connection  with  the  sale of any  product,  device  or  apparatus
embodying the Patent.  The method  covered by the Patent is the principal use of
ozone  under  study  by  the  Company  and  is the  method  incorporated  in its
regulatory  applications.  (See "Governmental  Regulation" below.) In June 1990,
pursuant to the Company's  request for  re-examination  of the Patent,  the U.S.
Patent Office issued a re-examination certificate,  confirming the patentability
of the  claims  covered  by the  Patent.  The  Company's  United  States  patent
protection for the Patent will expire in 2003,  subject to extension  based upon
the length of time  required  to bring the Patent to  commercial  fruition.  The
Company  has been  granted  patents  (based on the  Patent)  in  Canada  and the
European  Patent  Community,  Australia,  Malaysia,  Hong Kong and  Japan,  with
applications pending in Singapore. The foreign patents

                                       -3-

<PAGE>

began to be issued in 1990 and will expire 17 years after their respective dates
of issuance.

     The Equipment Patent, which covers apparatus for the controlled generation,
monitoring and dosage of a precise admixture of ozone and oxygen (Medizone,  the
drug),  was  developed  by a  consultant  engineer to the Company and issued and
assigned to the Company in 1991.  The Equipment  Patent was developed to provide
the  physical  means to deploy the Patent.  The foreign  patent  coverage of the
Equipment Patent parallels the coverage of the Patent.

     In late 1996, the Company became aware that a United States patent had been
issued to a Canadian  corporation which it believes infringes on the Patent. The
Company has  consulted  its patent  counsel and intends to take the  appropriate
steps to protect its rights with respect to the Patent.  However, at the present
time,  the  nature of any  action to be taken by the  Company  has been and will
continue to be limited by its lack of funding.


Research and Development

     The Company does not maintain  laboratories  or other clinical  research or
testing facilities.  The Company's research and development activities have been
conducted by utilizing  contract  laboratories and clinicians.  The research and
development  activities have been directed by the Company's  Scientific Advisory
Board,  whose sole member  since June 1997 has been Dr.  Gerard V.  Sunnen,  the
Company's Director of Science (see "Employees and Consultants").

Pre-clinical Studies

     Pre-clinical  Studies are defined as  non-human  studies.  Since 1988,  the
Company has both  sponsored and been the  beneficiary  of research to determine,
among other  things,  (i) whether the use of ozone,  either  alone or with other
modalities,  is  efficacious  in the  treatment of certain  diseases and (ii) to
establish  additional  scientific  evidence  that ozone,  through the use of the
patents and/or applications of scientific  methodologies of a similar nature can
decontaminate  blood  of  lipid  enveloped  viruses  and  thereby  significantly
diminish the degree of transfusion related disease.

     Pre-clinical projects sponsored by the Company to date include: (1) studies
to test ozone's ability to inactivate HIV,  conducted at the State University of
New York ("SUNY") Health Science Center at Syracuse; (2) a pilot animal study of
the  potential  toxicity  of ozone,  conducted  by the  Arnold & Marie  Schwartz
College of  Pharmacy  and  Health  Science at Long  Island  University;  and (3)
studies investigating the effects of ozone/oxygen admixtures on human peripheral
blood,  including whole blood, serum and plasma,  conducted by the Blood Bank of
Mt. Sinai Medical Center, New York City.

     In 1990, the Canadian Blood Forces Program (under the aegis of the Canadian
Department of Defense and Agriculture and the Canadian Red Cross) requested that
the Company add the  Medizone  Technology  to the other  proprietary  technology
being investigated as an experimental arm of an ozone- based blood sterilization
investigative  program.  The  program  was an attempt  to  develop an  effective
technology for sterilizing whole blood and blood products.  This program,  which
was to study the Medizone Technology as it relates to the inactivation of Simian
Immunodeficiency  Virus  ("SIV"),  included a live  primate  model.  The program
continued until 1994,  completing two out of the three proposed stages, when the
funding  arm of the  Canadian  Blood  Forces  Program  discontinued  funding the
program. The Company's current management learned in late 1997 that the program,
as it  involves  the  Medizone  Technology,  was  stopped  primarily  due  to an
equipment  failure and the  generation  of erroneous  data due to the  equipment
failure.  The  third  stage of the study was  resumed  in May 1996,  but did not
utilize the Medizone Technology.

                                       -4-
<PAGE>



Governmental Regulation

     Medizone  (the drug),  the  Medizone  Technology  and any related  products
derived  therefrom are regulated  under the Federal Food,  Drug and Cosmetic Act
and the regulations  promulgated thereunder (the "FDC Act") and are regulated by
the Food and Drug  Administration  (the  "FDA").  The FDA  exercises  broad  and
extensive  authority in regulating  the  development,  production,  importation,
distribution and promotion of "new drug" products and "investigational  devices"
pursuant to the FDC.

     Because  ozone-generation  for the purposes of  interfacing  with blood and
blood  products  is  regarded  as a new drug  delivery  system,  the  Company is
precluded  from  selling or  distributing  Medizone  (the drug) or the  Medizone
Technology  until after FDA  approval has been  granted.  In order to obtain FDA
approval, the Company will be required to submit medical and scientific evidence
sufficient to demonstrate  that Medizone (the drug) and the Medizone  Technology
has been successfully used in pre- clinical studies followed by  well-controlled
clinical studies using human volunteer  subjects.  The FDA will not grant an NDA
unless it  contains  sufficient  medical  evidence  and data to permit a body of
qualified  and  experienced  scientists to conclude that the new drug product is
safe and effective for its recommended and proposed medical uses.  Historically,
the FDA has held a strong bias against  treating humans with ozone, due largerly
to issues of safety.

     In order to initiate  the first  phase  (i.e.,  Phase I) of human  clinical
studies  required  as part of an NDA,  an  applicant  must  submit to the FDA an
application for an Investigational  New Drug Exemption  ("IND"),  which contains
adequate  information  to satisfy  the FDA that human  clinical  studies  can be
conducted  without exposing the volunteer human subjects to an unreasonable risk
of illness or injury.  The Compay submitted an IND application  (assigned to the
Registrant by its former president) to the FDA on October 6, 1985, and requested
FDA approval to commence human clinical trials using ozone- oxygen to inactivate
HIV.  The FDA deemed the IND  application  to be  incomplete,  and  required the
Company to conduct  additional animal studies prior to commencing a large animal
study and human trials.  In September  1994,  after not  receiving  responses to
requests for  information  from the Company,  the FDA  inactivated the Company's
IND. The Company has no present  plans to commence a large animal  study,  which
would require,  as a precursor,  additional  small animal and  laboratory  work.
Accordingly,  there can be no assurance that the Company's IND application  will
ever be  re-opened.  Until an NDA has been  granted to the  Company,  it may not
distribute  ozone-generating  devices, except to researchers who agree to follow
FDA  guidelines,  and  provided  the devices are labeled as  "Investiga-  tional
Devices."

     Because  ozone  has been used to treat  humans  in  Europe  for at least 30
years,  the European Union (the "EU") is more accepting of human clinical trials
of ozone  therapies  being  conducted  than is the United  States.  Accordingly,
Management  believes  that the Company  should  pursue the option of  conducting
human clinical  trials in Europe,  using  stringent  protocols that will meet EU
standards,  with a view to utilizing  the results of such trials in an effort to
obtain EU approval and to re-open the Company's FDA file.


Clinical Studies

     Overview

     To date the Company has not performed any human clinical studies.

     The Italian Initiative


                                       -5-
<PAGE>



     In late 1992, the Italian  Ministry of Health suspended the clinical use of
ozone until such time as sufficient scientific evidence was available to support
its use as a human therapeutic  treatment.  In this regard, the Italian Ministry
of Health designated the Italian Scientific Society for Ozone-Oxygen  Therapy in
Bergamo,  Italy  ("ISSOT")  as the agency to select  those  treatment  protocols
utilizing ozone as worthy of investigation and to provide those protocols to the
Italian  Ministry of Health for review and approval.  By letter  agreement dated
March 23, 1993, with ISSOT, the Company entered into a collaborative arrangement
to research and examine the efficacy of the Medizone Technology in the treatment
of various  blood-related  human  diseases.  The research is to be supervised by
ISSOT in Italy, under the direction of a research group assembled by the Italian
Ministry of Health. The research is to be conducted in accordance with protocols
that will meet EU Standards  for human  clinical  trials (to be furnished by the
Company) at University  based  hospitals,  which will enter into agreements with
the Company on a site by site basis.  The ISSOT  letter  agreement  requires the
Company to furnish ozone-generating instruments for use in the trials and to pay
for laboratory tests performed by each testing  institution that are outside the
scope  of the  normal  realm  of  clinical  analyses  performed  by the  testing
institutions.  There can be no assurance that any of the data generated from the
ISSOT  research will be permitted to be utilized in connection  with the Company
efforts to re-open the FDA IND (see "Governmental Regulation").

     On May 16, 1994,  the Company  announced that human trials were to commence
at the University of Naples ("Naples"). However, after the termination of Joseph
S.  Latino's  employment  with the  Company's,  the  Company's  inquiry into the
conduct of its operations during Dr. Latino's tenure as its Chairman,  President
and Chief of Research disclosed that human trials of the Company's ozone therapy
on patients  infected with either Acquired  Immunodeficiency  Syndrome (AIDS) or
Hepatitis B (chronic  active) has not been  authorized by Naples or commenced at
that  institution.  The Company also learned that the Italian Ministry of Health
had not issued  approvals for human clinical trials to commence at certain sites
as  previously  disclosed.  While the ethics  committees  at certain  university
hospitals have stated their approval for the Company to conduct Phase II trials,
they would require the Company to have either completed a large animal study and
Phase I trials or to have  these  requirements  waived.  The  Company  has never
performed a large animal  study or Phase I clinical  trials and does not possess
the necessary data with respect to its ozone therapy to commence Phase II study.
However,  there  does  exist a broad  use and  understanding  of  ozone  therapy
throughout Europe and there have been numerous  scientific articles published in
European medical journals describing the use of ozone on humans. The Company has
held  discussions with an Italian Contract  Research  Organization  (the "ICRO")
with a view to having the ICRO act as an  intermediary  on behalf of the Company
with the  Italian  Ministry of Health and  prepare a written  submission  to the
Italian  Ministry  of Health  regarding  the data in the public  domain on ozone
therapy  with a view to  having  the  Italian  Ministry  of Health  accept  this
material as proof of safety,  toxicity and tolerance of the use of the Company's
ozone  technology on humans in lieu of having the Company perform a large annual
study and possibly even a Phase I clinical  study.  The ICRO would also design a
research  program  and  protocols  for  clinical  trials  which  would  meet the
standards of the EU and FDA,  monitor the clinical terms and collect and prepare
analyses of the data  produced by the  trials.  The Company  will not be able to
enter into a formal contract with ICRO unless it obtains additional  funding. If
the Italian Ministry of Health does not accept the published evidence on the use
of ozone  therapy on humans,  the  Company  will be  required to perform its own
Phase I clinical  trials and possibly a large animal  study.  In late 1997,  the
Company  entered into a  discussions  with Italian and Belgium  clinicians  with
regard to them  performing  Phase I  clinical  studies.  However,  assuming  the
Italian Ministry of Health did not grant the Company's  request for a waiver, no
formal  agreements with these  clinicians  would be signed and the studies would
not begin until the Company obtains  additional  funding.  The Company estimates
that it would require an infusion of  approximately  $1.5 million to advance the
above-described research initiatives through the completion of a Phase III study
and submission of the data for approval to the Italian Ministry of Health.

Instrument Development

     On October 17, 1996, the Company  executed an agreement with  Multiossigen,
S.r.L., an Italian corporation located in Bergamo,  Italy (the  "Manufacturer"),
dated as of September  13, 1996 (the  "Equipment  Contract"),  providing for the
manufacture  of ozone  generating  devises to be used in the human  trials to be
commenced  pursuant to the Company's  letter agreement with the ISSOT, as trials
are approved by the Italian Ministry of Health.

                                       -6-

<PAGE>

     Pursuant to the Equipment Contract, the Manufacturer will produce a working
prototype of ozone generating  devices  dedicated to the use of hollow fibers or
similar  gas  exchange   technology   covered  under  the   Company's   patents,
satisfactory to the Company (the "Equipment"),  and will make all data generated
from the use of the Equipment  available to the Company.  The Equipment Contract
calls for the  Manufacturer  to manufacture  twenty pieces of the Equipment at a
purchase  price of $9,000 per unit,  for an aggregate  of  $180,000,  payable as
follows:

     (a)  $25,000, paid upon approval of the prototype;  
     (b)  $55,000,  payable in  fifteen  installments  of $3,667  with five such
          installments  ($18,335)  being paid on each  delivery of five units of
          the Equipment; and
     (c)  one  million  shares  of  the  Company's   common  stock,   bearing  a
          restrictive  legend,  500,000  shares of which were issued on the date
          the Equipment Agreement was executed with the remaining 500,000 shares
          issued on March 16, 1997.

     Pursuant  to  the  Equipment   Agreement,   the  Company   granted  to  the
Manufacturer  a license to use the Company's  patents in Europe,  subject to the
regulations of all documents necessary to protect the Company's rights in and to
the  patents,   and  appointed  the  Manufacturer  as  the  Company's  exclusive
manufacturer  and  distributor of the Equipment in Europe.  Notwithstanding  the
forgoing,  the present  distribution of the Equipment shall be limited to Italy,
but such  distribution  will be  expanded  to the rest of Europe upon the mutual
agreement of the parties.

     The  Equipment   Agreement   (together  with  its  grants  of  license  and
distribution  described  above) will  terminate on September 13, 1998 and may be
renewed by mutual  agreement  of the  partners at least thirty days prior to the
end of its term.

     Units of  Equipment  shall be  delivered in lots of five units and shall be
deliverable  to the  appropriate  hospital  site  within 60 days of the  written
request by the Company,  based upon such hospital's  ethics  committee  granting
approval to committee trials at a particular site.

     Since  its   organization,   the  Company  has  attributed   $2,202,685  as
expenditures for research and development, including $25,000 in 1996.

International Activities

     Medizone Canada Limited
     -----------------------

     In order to maximize both research  opportunities  and the potential market
for its  products,  the Company  intends to establish  subsidiary  or affiliated
corporations  in other  countries.  The  organization of such  subsidiaries  may
initially require the Company to incur significant expenses;  thereafter,  it is
intended that the  subsidiaries  would be responsible  for  organizing  research
programs and/or generating possible sources of financing, from which the Company
would benefit  directly or indirectly.  It is anticipated that the Company would
also enter into license agreements with all subsidiary companies.

     Registrant owns  approximately  two-thirds of the equity of Medizone Canada
Limited, a publicly-owned Utah corporation ("MCL"), which is engaged in the same
business as the Registrant in Canada through its  wholly-owned  subsidiary,  MCL
Medizone  Canada  Ltd.   ("MedCan")  As  described  above  under  "Research  and
Development",  MedCan was a participant in the Canadian  Blood Forces  Program's
SIV Study.

     Four million redeemable common stock purchase warrants, each exercisable to
purchase one share of the common stock of MCL for $.125, are publicly-held.  The
MCL warrants  originally had a nine month exercise  period.  The expiration date
was extended numerous times (but expired on December 31, 1997.)

                                       -7-
<PAGE>

     Medizone New Zealand Limited
     ----------------------------

     On  June  22,  1995,  the  Company  entered  into  a  series  of  contracts
(collectively the "Transaction  Documents") which resulted in the formation of a
joint  venture  subsidiary  incorporated  in New  Zealand,  Medizone New Zealand
Limited ("MNZ").  MNZ, a privately held corporation equally owned by the Company
and Solwin Investments Limited ("Solwin"), a New Zealand corporation which is an
affiliate  of  Richard G.  Solomon  ("Solomon"),  who  became a director  of the
Company on January  16,  1996,  but later  resigned on February  27,  1997,  was
organized on June 22, 1995 and is a research and development stage company whose
objective is to obtain regulatory approval for the distribution of the Company's
patented  technology  in New Zealand,  Australia,  South East Asia and the South
Pacific Islands.

     Pursuant to the Transaction  Documents,  the Company  purchased one hundred
percent of MNZ from  Solomon,  who had caused the  formation  of MNZ on June 22,
1995. Contemporaneously with this transaction, the Company sold fifty percent of
MNZ to Solwin,  a  corporation  owned by Solomon,  for U.S.  $150,000,  of which
$50,000 was thereupon loaned by the Company to MNZ on a demand basis,  which was
repaid on October 26, 1995. On October 26, 1995,  the Company loaned MNZ $50,000
on a demand basis,  which has not been repaid as of the date of this report. The
Directors  of MNZ, as of  September  1997,  are Solomon  and Milton  Adair,  the
Company's President.

     Contemporaneous with the creation of the above share structure, the Company
and MNZ entered into a Licensing  Agreement (the  "Licensing  Agreement")  and a
Managing Agent Agreement (the "Managing Agent Agreement") with MNZ.

     Pursuant  to the  Licensing  Agreement,  the Company  granted an  exclusive
license to MNZ for its  process  and  equipment  patents  and  trademark  in New
Zealand.  MNZ has agreed to apply for corresponding  patent protection for these
patents in New Zealand and to use its best effort to exploit the rights  granted
in the  agreement.  The License  Agreement  shall  terminate  on the date of the
expiration of the last to expire of any patent  obtained in New Zealand,  or, if
no such  patents are  obtained,  on June 22,  2010.  The Company is to receive a
guaranteed minimum royalty (the "Guaranteed  Minimum Royalty"),  in an amount to
be agreed to by the  Company  and MNZ,  commencing  in the third  year after all
necessary  regulatory approvals requisite to the license, use or distribution of
the Company's  proprietary  technology have been obtained in New Zealand. If the
Company  and MNZ are unable to agree upon the amount of the  Guaranteed  Minimum
Royalty,  the  Company  may  terminate  the  license  on  thirty  days'  notice.
Commencing on the first sale to a user by MNZ, the Company shall receive a sales
royalty in an amount  equal to ten percent of MNZ's gross annual sales under the
License Agreement.

     Pursuant to the Managing  Agent  Agreement,  MNZ will act as the  Company's
agent in the finding of other  licensees of the Company's  patents and trademark
in the following countries: Australia (including Australia and New Zealand), the
South Pacific Islands and South East Asia (including the Philippines,  Indonesia
and  Vietnam).  Licensing  fees  obtained  as a  result  of the  Managing  Agent
Agreement shall be divided between the Company and MNZ on a sliding scale as set
forth below:

                                        The Company                        MNZ
                                        -----------                        ---
Initial license                         50%                                50%

Subsequent license
fees up to $500,000                     50%                                50%

Subsequent license
fees between $500,000
and $750,000                            75%                                25%

Subsequent license
fees in excess of
$750,000                                85%                                 15%


                                      -8-
<PAGE>



     MNZ and the Company will also divide any net royalties  paid to the Company
pursuant to any license obtained pursuant to the Managing Agent Agreement,  with
MNZ being paid 10% of the net royalties and the Company receiving 90% of the net
royalties.

     The Managing Agent  Agreement shall expire on the termination or expiration
of the last of the  licenses  obtained  pursuant  thereto,  subject  to  earlier
termination by the Company upon an occurrence of certain events.


Competition

     The  area  in  which  the  Company   seeks  to  do  business  is  extremely
competitive.  The Company is aware of a number of domestic  companies  that have
commenced  research  into the use of ozone as a virucide in the treatment of HIV
and other diseases,  or have announced the intention to do so. Other  companies,
foundations,  research  laboratories  or  institutions  may  also be  conducting
similar investigations into the use of ozone as a virucide or as a decontaminant
for blood or blood products.  The Company is also aware that another company has
provided  ozone-generating  equipment to departments of the Canadian  government
conducting studies in Canada for the purposes of comparison of technologies.  In
addition,  as reported in  scientific  journals and  newspapers,  there are many
commercial,  not-for-profit  and governmental  agencies  investigating  possible
treatments  for  HIV  and  other  viral  diseases,  as  well  as  a  variety  of
methodologies aimed toward blood fractionate decontamination.


Employees and Consultants

     The Company has three employees,  its President,  its Vice  President/Chief
Financial  Officer and a Vice-President  of Operations (who is not an officer of
the Company).

     The Company has established a Scientific  Advisory Board which suggests and
formulates avenues of research and reviews research in progress.  As of December
31, 1996, the Scientific Advisory Board was comprised of two members,  Joseph S.
Latino,  Ph.D., the Company's  President and Chief Executive Officer and Bernard
J. Poiesz, M.D., Head, Regional Oncology Center, S.U.N.Y. at Syracuse, Syracuse,
New York. The Scientific  Advisory Board met three times in 1996. Dr. Poiesz was
not  compensated by the Company for his services on the Company's has Scientific
Advisory  Board,  although he has applied for research grants in connection with
the Company's  research and development  efforts.  Dr. Poiesz became a member of
the Scientific  Advisory Board in 1987. From 1989 to 1995, Fred Quimby,  D.V.M.,
Ph.D.,   Chairman,   Animal  Research  Institute,   New  York  State  School  of
Veterinarian  Medicine,  Cornell  University,  was a  member  of the  Scientific
Advisory Board, but resigned when he became the sole principal  investigator for
the SIV Study being  conducted  under the auspices of the Canadian  Blood Forces
Program. See "Research and Development".

     In June 1997, the Scientific  Advisory Board was reorganized.  It currently
has one member,  Dr. Gerard V. Sunnen,  who serves as the Company's  Director of
Science.

     The Company retains CTC, Inc. ("CTC"),  of Cincinnati,  Ohio, to act as the
Company's liaison with the brokerage community. The agreement is for a period of
one year,  but may be extended by the parties for  additional  one year periods.
CTC receives a monthly payment of $2000, plus expenses.


Insurance

     The Company presently has no product liability insurance, since none of its
products  are in  clinical  use. It  presently  has no  officers  and  directors
liability insurance.

                                       -9-

<PAGE>

Certain Business Risks Associated with the Company

     Development Stage Company/Net Losses
     ------------------------------------

     Although  the  Company  was  incorporated  in  1986,  it is  still  in  the
development  stage and has not yet commenced full operations,  nor has it earned
any revenues.  No assurance can be given that its business  activities will ever
generate revenues.  As indicated in the Company's financial  statements,  it has
experienced  substantial  losses  throughout  its  history.  Such  losses can be
expected to continue for the foreseeable future.

     No Revenues/Need for Additional Financing
     -----------------------------------------

     The Company has  generated  no  revenues,  has had no source of funds other
than  through  the  sale  of its  common  stock  and  will  require  substantial
additional  capital,  which will most  likely be obtained  through  sales of its
common stock, in order continue the research  program  outlined  above,  pay its
administrative   and  operating   expenses,   meet  its  filing  and  disclosure
obligations as a public company, and repay certain outstanding indebtedness.  No
assurances  can be given  that the  Company  will be able to  obtain  sufficient
additional  capital  for it to  continue  its  research  program,  or  that  any
additional financing will be sufficient to satisfy the Company's  administrative
and operating expenses for any significant period of time.

     Status of the Company's Research
     --------------------------------

     As described  above,  the Company's  research has not progressed to a point
where it would be appropriate to predict when, if ever,  Medizone (the drug) and
the Medizone Technology would have commercial application or be marketable.

Forward-Looking Information May Prove Inaccurate

     This Form 10K/A contains  forward-looking  statements and information  that
are based on management's beliefs as well as assumptions made by and information
currently  available  to  management.  When  used in this  document,  the  words
"anticipate,"  "believe,"  "estimate," and "expert," and similar expressions are
intended to identify  forward-looking  statements.  Such statements  reflect the
Company's current views with respect to future events and are subject to certain
risks,  uncertainties  and  assumptions,  including  the  specific  risk factors
described above. Should one or more of these risks or uncertainties materialize,
or should  underlying  assumptions  prove  incorrect,  actual  results  may vary
materially from those anticipated,  believed, estimated or expected. The Company
does not intend to update these forward-looking statements and information.

Item 2.  Properties
         ----------

     As  of  January  1997,   Registrant  leased  from  an  unaffiliated   party
approximately 900 square feet of office space at 123 East 54th Street, Suite 7B,
New York, NY 10022,  under a two-year lease expiring on February 28, 1998, at an
annual  rental of $20,940.  The Company  terminated  this lease in June 1997 and
paid  $4,598.96 to the landlord in settlement of any claim for unpaid rent under
the lease.  On September 23, 1997, the Company  entered into a three-year  lease
with an  unaffiliated  third party for its present offices at 4505 South Wasatch
Boulevard,  comprising  approximately  1400 square feet,  at an annual rental of
$22,984.56.  The office space is used for executive  offices and  administrative
purposes.

Item 3.  Legal Proceedings
         -----------------

     In November 1992, the Company consented to the entry of a final judgment of
permanent  injunction  (S.E.C.  v. Medizone  International,  Inc.,  Civil Action
93-2761,  D.D.C.),  pursuant to which the Company was permanently  enjoined from
failing  to  timely  file  the  reports  required  to be filed  pursuant  to the
Securities Exchange Act of 1934.

                                      -10-
<PAGE>

Item 4.  Submission  of Matters to a Vote of Security  Holders.  No matters
         -----------------------------------------------------
         were submitted to a vote of

     No matters were submitted to a vote of securities holders during the fourth
quarter of the fiscal year ending December 31, 1997.


                                     Part II

Item 5.  Market for Registrant's Common Equity and Related
         Stockholder Matters.
         -------------------------------------------------

Prices/Trading Market Information

     The Company's shares are traded in the over-the-counter  market, with price
quotes listed on the NASD  Electronic  Bulletin  Board under the trading  symbol
"MZEI," and in the "pink sheets" published by the National Quotation Bureau.

     On March , 1998,  according to the NQB Non-NASDQ Price Report  furnished by
the National  Quotation  Bureau,  there were  approximately  marketmakers in the
Company's shares,  with a high bid for the shares of $ and a low bid of $ . Such
prices reflect interdealer prices without retail markup, markdown or commission;
are not necessarily  representative of actual  transactions,  or of the value of
the  Company's  securities;  and are,  in all  likelihood,  not  based  upon any
recognized  criteria of securities  valuation as used in the investment  banking
community.

     Shown below is  information  obtained from the National  Quotation  Bureau,
indicating  the high bid and low bid prices for a share of the Company's  common
stock at the end of each of the four calendar  quarters of fiscal 1996 and 1997,
representing prices between dealers which do not include retail markup, markdown
or commission. They do not reflect actual transactions.

                                    Bid Price
                                    ---------
                           Calendar Period           High               Low
                           ---------------           ----               ---

         1996              First Quarter             .10               .075
                           Second Quarter            .17               .11
                           Third Quarter             .15               .10
                           Fourth Quarter            .125              .075

         1997              First Quarter
                           Second Quarter
                           Third Quarter
                           Fourth Quarter

Number of Holders

     On March 18, 1998,  according to the Company's  transfer agent,  there were
3891 holders of record of the Company's par value $.001 common stock.


Dividends

     The Company has never paid cash  dividends on its common stock.  Payment of
cash  dividends is subject to the  discretion  of the Board of Directors  and is
dependent upon various factors,  including the Company's earnings, capital needs
and general  financial  condition.  The Company does not believe that it has any
immediate  prospect of earnings.  However,  the Company  anticipates that in the
foreseeable  future, it will follow a policy of retaining  earnings,  if any, in
order to finance research and development.


                                      -11-
<PAGE>

Private Sales of Shares

     In June 1997,  the Company  issued  warrants to  purchase an  aggregate  of
73,333,333  shares  of its  common  stock to The  Sand  Dollar  Solution  ("Sand
Dollar"),  a California limited  partnership,  whose general partner is Edwin G.
Marshall,  the Chairman of the  Company's  Board of Directors  (the "Sand Dollar
Warrants").  No  consideration  was  paid to the  Company  for the  Sand  Dollar
Warrants.

     The Sand Dollar Warrants have the following  exercise prices and expiration
dates:

Shares                Exercise Price              Termination Dates
------                --------------              -----------------

15,000,000            $.07 per share              Originally
                                                  September 7, 1997, then
                                                  extended until ten
                                                  days after the Company
                                                  becomes current in its
                                                  filings with
                                                  Securities and
                                                  Exchange Commission,
                                                  now extended to May 31, 1998

33,333,333            $.15 per share              June 9, 1998

25,000,000            $.20 per share              June 9, 1999

     On  September  23,  1997,  Sand Dollar  purchased  5,714,285  shares of the
Company's common stock pursuant to the Sand Dollar Warrant, paying $.07 a share,
or  aggregate  consideration  of  $400,000,  which  shares were  authorized  for
issuance in December 1997. In March 1998, Sand Dollar  purchased  857,143 shares
of the Company's common stock pursuant to the Sand Dollar Warrant, paying $.07 a
share,  or $60,000.  The Company relied on the private  offering  exemption from
registration  under the Securities Act of 1933 (the "Securities Act") in issuing
the Sand Dollar  Warrants and for the sale of shares pursuant to the exercise of
the Sand Dollar Warrants.

     In March and May 1997, the Company issued an aggregate of 2,716,600  shares
of its common stock to Kenneth  Gropper  (500,000  shares),  Arthur P.  Bergeron
(500,000  shares),  George Handel (750,000  shares),  counsel to the Company (an
aggregate  of 666,666  shares),  an  employee  (50,000  shares),  and its public
relations firm (250,000 shares) in consideration of services  rendered,  relying
on the private  offering  exemption  under the Securities Act. In December 1997,
the Company  authorized  the  issuance of 100,000  shares of common stock to Dr.
Gerard  Sunnen in  consideration  of his services as the  Company's  Director of
Science. The Company issued 103,200 shares of its common stock to an employee of
its New Zealand  subsidiary,  pursuant to  Regulation  S  promulgated  under the
Securities Act, as consideration for services rendered.

                                      -12-
<PAGE>

Item 6.  Selected Financial Data.

<TABLE>
<CAPTION>
                                                                                     Year Ended
                                                                                    December 31,
                             1997           1996            1995            1994           1993
                             ----           ----            ----            ----           ----

Operations Data:

<S>                      <C>            <C>              <C>             <C>            <C>  
Revenues                    $ -0-          $ -0-            $ -0-           $ -0-          $ -0-

  Net income               (775,559)     (1,329,395)      (1,081,027)     (1,126,315)    (1,598,342)
   (loss) before
   minority interest

Net income (loss)          (775,559)     (1,329,395)      (1,081,027)     (1,126,315)    (1,598,342)

Net income (loss)            (.01)          (.01)            (.01)           (.01)          (.02)
   per common share

Weighted average         133,568,000     118,022,000      111,306,000      98,292,000     93,384,000
   common shares
   outstanding

Balance Data
   Sheet:

Working capital            (945,859)       (949,254)        (538,102)       (576,101)    (2,844,085)
   (deficiency)

Total assets                 307,019          74,368          124,653          87,230         81,705

Long-term                      -0-             -0-              -0-             -0-            -0-
   liabilities

Accumulated             (13,217,678)    (12,442,119)     (11,112,724)    (10,103,503)    (9,196,610)
   (deficit)

Stockholders'              (886,167)       (885,241)        (432,880)       (558,679)    (2,825,458)
   equity
   deficiency
</TABLE>



Item 7.  Management's Discussion and Analysis of
         Financial Condition and Results of Operations.
         ----------------------------------------------

Results of Operations

     General
     -------

     From its  organization  in January 1986,  Registrant has been a development
stage company primarily engaged in retaining research consultants and sponsoring
research to investigate the medical uses of ozone. Registrant has not generated,
and cannot predict when or if it will generate, sufficient cash flow to fund its
continuing  operations.  Since  its  organization,   Registrant  has  attributed
$2,319,635 as expenditures for research and development,  including  $111,950 in
1997.

Restatements

     Registrant  has restated each of its quarterly  reports for 1992 to account
properly for the proceeds from the Company's sale of a portion of its holding of
Medizone Canada Limited ("MCL") as equity transactions.

                                      -13-
<PAGE>

     During the first  quarter of 1992,  Registrant  sold 250,000  shares of MCL
common stock at  per-share  prices  ranging  from $.093 to $.10,  and during the
third quarter of 1992, an additional  150,000 shares were sold through a broker.
Aggregate  proceeds  from the  transactions  were  $24,555  (first  quarter) and
$24,470 (third quarter), respectively.

     Because  the  Company's  investment  in MCL was only $2,  the  $24,555  and
$24,470 was reported as a gain in the Company's statement of operations for each
respective  period.  In  the  restated  reports,   the  transactions  have  been
characterized as equity transactions.

     The  restatements  result in an increase in the first  quarter  loss in the
amount of $24,555,  and an increase in the third  quarter  loss in the amount of
$24,470.

     Additionally,  the Company sold  100,000  shares of MCL common stock during
1991 through a broker for $5,000, at a per-share price of $.05. This transaction
was also  restated  in 1992,  as an  equity  transaction,  which  results  in an
increase in the 1991 loss of $5,000.

     The restatements do not affect  previously  reported loss per share because
of rounding.

     Years Ended December 31, 1997, and December 31, 1996.

     There were no sales during  either year.  Sales  commenced in May 1986 and,
except for incidental items, ceased in October 1987.

     Expenditures  for research and  development,  including  work  performed by
independent contractors was $116,950 in 1997 and $25,000 in 1996.

     General  and  administrative   were  $633,187  in  1997  as  compared  with
$1,291,082 in 1996. These expenses include professional fees, payroll, insurance
costs and travel expenses.

     Notes  payable  in 1997 of  $354,115  and 1996 of  $332,315  have  interest
accruing at rates averaging from 6.07% to 8%.

Years Ended December 31, 1996, and December 31, 1995

     There were no sales during  either year.  Sales  commenced in May 1986 and,
except for incidental items, ceased in October 1987.

     Expenditures  for  research and  development  including  work  performed by
independent contractors were $25,000 in 1996. There were no such expenditures in
1995.

     General and administrative  expenses were $1,291,082 in 1996 as compared to
$1,170,119 in 1995. These expenses include professional fees, payroll, insurance
costs and travel expenses.

     Notes  payable  in 1996 of  $332,315  and  $147,815  in 1995 have  interest
accruing at rates ranging from 8% to 10%.


Liquidity and Capital Resources

     At December 31, 1997, the Registrant  had a working  capital  deficiency of
$945,859 and a stockholders' deficiency of $886,167.

     At December  31,  1996,  Registrant  had a working  capital  deficiency  of
$949,254 and a stockholders' deficiency of $885,241.

                                      -14-
<PAGE>

     During 1987,  excluding  options  exercised and shares issued for services,
Registrant  sold an aggregate  of 950,000  shares to  unrelated  individuals  at
prices ranging from $.10 to $.25 for aggregate proceeds of $150,000 and borrowed
$150,000 which, in 1989, was exchanged for 1,500,000 shares.

     During 1988,  excluding  options  exercised and shares issued for services,
Registrant sold 1,000,000  shares to an unrelated  individual at $.08 per share,
and  borrowed an  aggregate  of  $166,700  which,  in 1989,  was  exchanged  for
1,834,000 shares.

     During 1989,  excluding options exercised and other issuances not for cash,
Registrant  sold an aggregate of 5,790,000  shares to unrelated  individuals  at
prices  ranging  from  $.03-1/3  to $.10 per share,  for  aggregate  proceeds of
$291,500.

     During 1990, excluding issuances to settle outstanding  obligations and for
services,  Registrant  sold  an  aggregate  of  4,250,000  shares  to  unrelated
individuals at prices ranging from $.03 to $.05 per share for aggregate proceeds
of $179,500.

     During 1991,  excluding  options  exercised  and  issuances  for  services,
Registrant  sold an aggregate of 4,366,667  shares to unrelated  individuals  at
prices ranging from $.036 to $.20 per share, for aggregate proceeds of $310,000.

     During  1992,  excluding  options  exercised  and  issuance  of shares  for
services,  Registrant  sold  an  aggregate  of  2,702,335  shares  to  unrelated
individuals at prices ranging from $.15 to $.20 per share for aggregate proceeds
of $430,350.

     During 1993, excluding issuance of shares for services,  Registrant sold an
aggregate of 1,471,766  shares to unrelated  individuals  at prices ranging from
$.15 to $.20 per share for  aggregate  proceeds  of  $271,000.  Registrant  also
received proceeds from stock subscriptions totaling $261,915.

     During 1994, excluding issuance of shares for services,  Registrant sold an
aggregate of 9,552,340  shares to  unrelated  individuals  at $.10 per share for
aggregate proceeds of $955 234.

     During 1995, excluding issuance of shares for services,  Registrant sold an
aggregate of 8,984,450  shares to  unrelated  individuals  at $.10 per share for
aggregate proceeds of $898,445.

     During 1996, excluding issuance of shares for services,  Registrant sold an
aggregate of 7,254,470  shares to  unrelated  individuals  at $.10 per share for
aggregate proceeds of $725,447.

     During 1997,  excluding  issuance of shares for services,  Registrant  sold
5,714,285 shares to The Sand Dollar Solution,  a California limited partnership,
and an affiliate of the  Registrant,  at $.07 a share for aggregate  proceeds of
$400,000.

     In connection with certain of the foregoing  transactions,  the Company has
paid or accrued finders' fees.

     Registrant will continue to require additional funding to enable it to fund
research necessary to make the appropriate  regulatory  application and continue
operations.

Item 8.  Financial Statements and Supplementary Data.
         -------------------------------------------

     The financial statements and supplementary data are listed under Item 14 in
this Annual Report and commence on page F-1.

Item 9.  Changes in and Disagreements with Accountants
         on Accounting and Financial Disclosure.
         ---------------------------------------------

         None.

                                      -15-
<PAGE>

                                    PART III

Item 10.  Directors and Executive Officers of Registrant.
          ----------------------------------------------

     On July 7, 1996, at the Company's annual meeting,  Joseph S. Latino, George
Handel,  Kenneth Gropper,  John D. Pealor and Richard G. Solomon were elected to
the  Company's  Board of  Directors.  On July 31,  1996,  Lawrence I. Sosnow and
Howard L. Feinsand  were  appointed to the  Company's  Board of  Directors.  Mr.
Sosnow  resigned and Mr.  Feinsand  resigned as Directors on October 1, 1996 and
March 26,  1997,  respectively.  Richard G.  Solomon  resigned  as a Director on
February 27, 1997.

     On May 14, 1997, the Company's Board of Directors terminated the employment
of Joseph L. Latino ("Latino") as the Company's President and Chairman after the
discovery of a pattern of unaccounted for  expenditures of the Company's  funds.
The  Company  is  investigating   the  purposes,   nature  and  extent  of  such
expenditures. Dr. Latino remained a Director of the Company until he resigned in
August 1997.  George  Handel  ("Handel")  was named  President  and Chairman and
served as such until May 19, 1997 when Kenneth Gropper ("Gropper") assumed these
positions.

     Contemporaneously  with the above events, the Company was notified that The
Sand Dollar Solution,  a California limited  partnership ("Sand Dollar"),  whose
general partner is Edwin G. Marshall  ("Marshall"),  was soliciting  shareholder
proxies to vote for Marshall, Milton G. Adair ("Adair"),  Gerard V. Sunnen, M.D.
("Sunnen") and William M. Hitt, Ph.D., M.D. ("Hitt") as Directors.

     On June 12, 1997,  the  Company's  Board of Directors  appointed  Marshall,
Adair,  Sunnen and Hitt, to the Registrant's  Board of Directors,  with Marshall
being named Chairman. Contemporaneously thereto, John Pealer ("Pealer") resigned
as a Director,  and Gropper resigned as President.  The Board thereupon made the
following appointments to the following positions:

                           President and    -        Adair
                           Chief Executive
                           Officer

                           Chief Operating
                           Officer          -        Gropper

                           Secretary        -        Sunnen

The Board  also named an  Executive  Committee,  composed  of  Marshall,  Adair,
Gropper,  Sunnen and Hitt.  The  remaining  Directors  were  Latino and  Handel;
however,  during the Board meeting,  Handel  resigned from the Board,  effective
June 13, 1997 and Latino  subsequently  resigned  from the Board in August 1997.
The Board  abolished the position of Chief Executive  Officer -  Administration,
which had been established on April 30, 1997. The holder of the position, Arthur
P. Bergeron,  remains Vice President,  Treasurer and Chief Financial  Officer of
the  Registrant.  In November  1997,  the Board  abolished the position of Chief
Operating Officer, held by Gropper, who remains a Director.  The following table
sets  forth  certain  information  concerning  the  Registrant's  directors  and
officers, as of December 31, 1997.

                          Director  Officer   Positions with
Name                Age    Since     Since    Registrant
----                ---   --------  -------   --------------

Edwin G. Marshall   55     1997               Chairman of the Board

Milton G. Adair     65     1997       1997    President, Chief Executive Officer
                                              and Director

Gerard V. Sunnen    55     1997       1997    Secretary and Director

                                      -16-
<PAGE>


Arthur P. Bergeron  47     1992               Vice President, Chief Financial
                                              Officer

William M. Hitt     71     1997               Director

Kenneth Gropper     55     1995               Director


     Edwin G. Marshall  became the Company's  Chairman in June 1997. He attended
Santa Rosa  Junior  College and the College of Marin,  in  California,  studying
Business and Fire  Science.  Marshall  served for 17 years in the fire  service,
rising to become Captain of the Richmond,  California Fire  Department.  He left
the fire service in 1979 to enter the real estate  business.  He participated in
the real estate business as the owner of Smith, Smith & Associates,  in Truckee,
California,  from 1979 to 1984,  and as a broker with TRI  Realtors,  in the San
Francisco  Bay  Area,  from  1987 to  1990.  Marshall  was  employed  by  Future
Technology Marketing,  Inc., of Truckee,  California, in sales and training from
1985 to 1987. In 1989, Marshall  co-founded The Marin Car Company,  which was in
the  automobile  and truck sales and leasing  business,  in Novato and Petaluma,
California.  In 1992,  Marshall  left The Marin  Car  Company.  He is  currently
employed as a private investor and is also the general partner of Sand Dollar.


     Milton G. Adair became the Company's President, Chief Executive Officer and
a Director  in June 1997.  He  received a Bachelor  of Arts  degree in  Business
Administration  and  Psychology  from The College of the Pacific in 1955.  After
employment  by Shell Oil Company and  Pittsburgh  Des Moines  Steel from 1955 to
1963, Mr. Adair was employed by Pfizer Incorporated from 1963 to 1978 in several
capacities,  culminating  in his  position  as  Director of Sales for the Pfizer
Diagnostics  division.  From  1978 to  1979,  Mr.  Adair  was  employed  as Vice
President-Sales/Marketing for the Becton Dickinson Immunodiagnostics division of
Becton Dickinson Corporation ("BD") in Orangeburg,  New York. Thereafter,  until
1983, he was  Vice-President  and General Manager of Becton Dickinson  Automated
Immunochemistry  division of BD in Salt Late City,  Utah. From 1983 to 1984, Mr.
Adair was  President of Orbit  Medical  Systems,  Inc., a Salt Lake City venture
capital company in the  immunochemistry  field.  Mr. Adair was President,  Chief
Executive  Officer  and a Director  of  Mountain  Medical  Equipment,  Inc.,  in
Littleton,  Colorado, whose stock was traded on the American Trade Exchange (the
"AMEX"),  from 1984 to 1991.  In 1991, he became  President and Chief  Executive
Officer of Gull Laboratories,  Inc. ("Gull Labs"), in Salt Lake, and whose stock
trades on the AMEX,  and which is in the business of supplying  diagnostic  kits
and automated  equipment in the infectious  disease and autoimmune  markets.  He
remained at Gull Labs until 1995 and became  President  and  Director of Biomune
Systems,  Inc.  ("Biomune")  until 1997.  Biomune,  whose stock is traded on the
NASDAC system,  is a  bio-technology  company that is developing  pharmaceutical
products for the treatment of cryptosporidioses and E. Coli.

     Gerard V. Sunnen,  M.D.  became  Secretary and a Director of the Company in
June 1997.  He graduated  from Rutgers  University  in 1963 and from the medical
school of the State University of New York,  Downstate,  in 1967. Dr. Sunnen has
practiced  psychiatric medicine since his graduation from medical school and has
taught  clinical  psychiatry at New York  University  Medical Center since 1977,
where he is now an Associate Clinical Professor of Psychiatry. He is currently a
consultant to several  organizations and companies,  including the Institute for
Behavior Therapy and the Training  Institute for Mental Health  Practitioners in
New York. He is a member of the American Psychiatric  Association,  the American
Society  of  Clinical  Hypnosis,  the  International  Association  of  Emergency
Psychiatry,  of  which  he is  Honorary  President,  and the  World  Psychiatric
Association,  where he is currently  Vice President of the Section for Emergency
Psychiatry.  He  received  the  Chevalier  de l'Ordre du Merite  from the French
government in 1990 for his work in assisting  members of the French community in
New York.  Dr.  Sunnen has  written  and  lectured  extensively  on  psychiatric
medicine and medical hypnosis.  He have also written on the medical applications
of ozone.


                                      -17-

<PAGE>

     William M. Hitt became a Director of the Company in June 1997.  He received
a Bachelor's of Science degree from the University of Denver in 1946 and a Ph.D.
from  Colorado A&M  University  in 1948.  He received a medical  degree from the
University  of  Colorado  in 1952 and did  post-medical  school  studies at Duke
University and Washington University School of Medicine. Dr. Hitt has taught and
conducted  research  at several  institutions  in the United  States and Mexico,
culminating  with his work at the World Health  Organization in Mexico City from
1989 to 1994.  He was the  recipient  of the Eli Lily  Award  from the  National
Institute  of Health  in 1953;  the  Leovenhoek  Award in 1960,  the  Cientifico
Destacado in 1990 and 1992,  and the Bioethics  International  Award of Merit in
1993.  Dr. Hitt was a member of the Board of  Directors  of  Physicians  Against
Nuclear War, which  organization  was awarded the Nobel Peace Prize in 1985. Dr.
Hitt is  currently  the  Director of the William  Hitt  Center,  which  conducts
clinical immunology and addiction recovery programs, has operated since 1986 and
now has seven  locations  in Central and South  America,  with  headquarters  in
Tijuana, Mexico.

     Kenneth  Gropper  became a director of the Company in September  1995.  Mr.
Gropper is the President and Chief  Executive  Officer of Management  Consulting
Group, Inc. of Woburn, Massachusetts,  which serves as a consultant to physician
group practices,  medical centers,  pharmaceutical  companies and medical device
manufacturers on regulatory, legislative,  administrative,  sales, marketing and
other management issues. Mr. Gropper joined Management Consulting Group, Inc. in
1977. Mr. Gropper was a member of the Board of Trustees of the Massachusetts Eye
and Ear Infirmary  from 1989 to 1994.  Mr.  Gropper  received a Bachelor of Arts
degree in Economics  from Long Island  University in 1964 and attended  Columbia
University's Graduate School of Business Administration.

         Arthur P. Bergeron became Vice President, Treasurer and Chief Financial
Officer of the  Company in 1992.  He holds  these same  positions  with MCL.  He
received a Bachelor of Science in  Accounting  from Bentley  College in Waltham,
Massachusetts  in 1973 and a Master of Science in Taxation from Bentley  College
in 1980. Mr. Bergeron is a certified  public  accountant and is the principal of
Arthur P. Bergeron & Co., P.C., in Wellesley, Massachusetts, a public accounting
firm which he founded in 1978.  He does not devote his full time to the  affairs
of the Company.


Item 11.  Executive Compensation.
          ----------------------

Directors Compensation

     None of the directors  received any  compensation for serving as a director
in 1997.

Executive Compensation

     The following table sets forth the compensation paid by the Company for the
1995, 1996 fiscal years to Joseph S. Latino,  the Company's  President and Chief
Executive Officer, in 1997 to Milton G. Adair, the Company's President and Chief
Executive  Officer,  and to  Arthur  Bergeron,  the  Company's  Vice  President,
Treasurer  and Chief  Financial  Officer,  and to  certain  others who served as
officers during these periods.

                           Summary Compensation Table
                           --------------------------
                                                                      Long Term
                                        Annual Compensation         Compensation
                                        -------------------         ------------
Name and                                              Other
Principal                                             Annual
Position                       Year  Salary    Bonus  Compensation   Options #
--------                       ----  ------    -----  ------------   ---------
                  


                                      -18-
<PAGE>

Joseph S. Latino, Ph.D, Pres-  1996  $180,000   - 0 -      (1)
ident and Chief Executive      1995  $180,000   - 0 -      (1)        3,000,000
Officer

Milton G. Adair,               1997  $200,000   - 0 -     - 0 -       3,000,0002
President and
Chief Executive Officer

Arthur P. Bergeron, Vice       1997  $72,000(3) - 0 -      (4)
President, Treasurer and       1996  $72,000(3) - 0 -                  1,500,000
Chief Financial Officer        1995  $72,000    - 0 -

Dr. Gerard V. Sunnen,          1997   - 0 -     - 0 -      (5)
Secretary, and Director of
Science

Kenneth Gropper, Chief         1997   - 0 -     - 0 -      (6)
Operating Officer

George Handel                  1997   -0-       - 0 -      (7)
Secretary

Employment Agreements

-------------------------------
                                                                               
    (1)   In 1995 and 1996 Dr.  Latino was  reimbursed  for  certain  automobile
          expenses and other  business  expenses,  in the amounts of $33,222 and
          $45,642 respectively. In 1995 and 1996 the Company provided Dr. Latino
          with health  insurance,  paying  premiums in the amounts of $9,438 and
          $10,380, respectively.
             
    (2)   On  December  16,  1997,  Mr.  Adair was  granted  options to purchase
          3,000,000  shares  of  the  Company's  Common  Stock  pursuant  to the
          Company's 1997 Qualified  Stock Option Plan (the "Option  Plan").  The
          options vest at the rate of 500,00  shares every six months and,  once
          vested,  may be exercised  over a period of ten years at a price equal
          to the Common  Stock's  market value at the date of grant ($.06).  The
          Option Plan will be submitted to a  shareholder  vote at the Company's
          1997 annual meeting.6


    (3)   In  1996,  due to the  Company's  financial  condition,  Mr.  Bergeron
          received  only $36,000 to his salary.  He has not received  payment of
          his salary in 1997.
                                                                             
    (4)   In 1995,  1996 and 1997 the Company  provided Mr. Bergeron with health
          insurance,  paying  premiums  in the  respective  amounts  of  $9,438,
          $10,380 and $2,595  (until April 18, 1997,  when the  Company's  group
          health plan was cancelled).
                                                                                
    (5)   Dr. Sunnen received a grant of (i) options to purchase  300,000 shares
          of the Company's  common stock pursuant to the Option Plan for serving
          as the Company's  Secretary  and as its Director of Science;  and (ii)
          100,000  shares of the Company's  common stock for serving as Director
          of Science.
                                                                             
    (6)   Mr. Groper received an award of 500,000 shares of the Company's Common
          Stock  and a grant of an  option  to  purchase  100,000  shares of the
          Company's  Common Stock pursuant to the Option Plan for serving as the
          Company's Chief Operating Officer during part of 1997.
                                                                                
    (7)   George  Handel  received an income of 750,000  shares by the Company's
          Common Stock for serving as the Company's  Secretary in 1994, 1995 and
          1996.

                                      -19-
<PAGE>

     The Company  and Joseph S. Latino  entered  into an  employment  agreement,
effective  January 1, 1995,  pursuant to which the Company  agreed to employ Dr.
Latino as its Chief Executive  Officer and Director of Research,  at a salary of
$180,000  per  annum,  for a one  year  period;  provided,  however,  that  this
agreement  shall remain in effect until  terminated  by either of the parties in
accordance  with  its  terms.  Dr.  Latino  received  certain  fringe  benefits,
including  the use of an automobile  and health and life  insurance and was been
granted an option to purchase  3,000,000  shares of the Company's  common stock,
par value $.001,  at a per share price of $.20.  These options  vested in annual
increments of 1,000,000 shares, on and after January 1 of each of 1996, 1997 and
1998, provided that Dr. Latino is still employed by the Company at the time. The
Agreement continued in effect in 1996 but was terminated for cause in May 1997.

     The Company agreed to employ Arthur P. Bergeron, effective January 1, 1995,
as its Chief Financial  Officer,  at a salary of $72,000 per annum, plus monthly
expenses,  for a one year period;  provided,  however, that this agreement shall
remain in effect until  terminated by either party in accordance with its terms.
The Agreement continued in effect in 1996 and 1997. Mr. Bergeron's salary may be
increased in the discretion of the Board of Directors.  Mr.  Bergeron is also to
serve  as the  Chief  Financial  Officer  of  Medizone  Canada  Limited  without
additional  compensation.  Pursuant to this agreement, Mr. Bergeron is permitted
to continue his private  accounting  practice.  Mr.  Bergeron  will also receive
health  insurance  from the Company  and has been  granted an option to purchase
1,500,000  shares of the Company's common stock, par value $.001, at a per share
price of $.20. These options vest in annual  increments of 500,000 shares on and
after January 1 of each of 1996,  1997 and 1998,  provided that Mr.  Bergeron is
still  employed by the Company at that time.  The  agreement  also  provides for
certain bonuses to be paid if the Company achieves certain financial results.

     The Company  does not have a written  employment  agreement  with Milton G.
Adair.


Compensation Committee Interlocks and Insider Participation

     The Company does not have a compensation committee.  Matters concerning the
compensation  of executive  officers are  determined by the  Company's  Board of
Directors.  Until his termination,  Dr. Latino,  who was an executive officer of
the  Company,  was  also a  member  of the  Company's  Board  of  Directors  and
participated in deliberations concerning executive officer compensation, but did
not vote on his own individual compensation.  However, his participation in such
deliberations  gave rise to a conflict of interest which could have affected his
compensation.  Mr. Adair,  who is an executive  officer of the Company is also a
member of the Company's Board of Directors and will participate in deliberations
concerning executive offer compensation, but will not vote in his own individual
compensation.  However,  his participation in such deliberations gives rise to a
conflict of interest which could affect his compensation.

     Option Grants in Last Year Pursuant to Employment Agreement
     -----------------------------------------------------------

     The  following  table  sets  forth  information  as of  December  31,  1997
regarding the outstanding options under the Company's employment agreements with
its executive officers.

<TABLE>
<CAPTION>
                                              Potential realizable value at Assumed
                                              Annual Rates of Stock Price Appreciation
                                              for Option.

                              Percent of Total
                              Options granted
           Number of          under
           Securities Under   Employment       Exercise      Expiration
Name       Option(1)          Agreements       Price ($/sh)  Date        5%($)  10%($)
----       ------             ----------       ------------  ----        -----  ------
<S>          <C>                  <C>              <C>         <C>           <C>    <C>

Joseph S.  3,000,000             66.66%          $.20         (1)         (1)    (1)
Latino

Arthur P.  1,500,000             33.33%          $.20         (1)         (1)    (1)
Bergeron
</TABLE>

                                                      -20-
<PAGE>

     (1)  Options  were  granted on January 1, 1995  pursuant  to the  Company's
     employment  agreements  with  each of Dr.  Latino  (options  for  3,000,000
     shares) and Mr. Bergeron (options for 1,500,000 shares). The exercise price
     of the  option  is $.20.  They  vest  fully on  January  1,  1998  over the
     following vesting schedule,  33% on January 1, 1996, 33% on January 1, 1997
     and 33% on January 1, 1998. They may be exercised for as long as Dr. Latino
     and Mr.  Bergeron remain employed by the Company and for one year after the
     termination  of Dr.  Latino's  and/or Mr.  Bergeron's  employment  with the
     Company. As of January 1, 1995 (the date of grant), the average of the high
     and low bid price for the Company's common stock was approximately $.14. As
     of  March ,  1998,  the  average  of the  high  and low bid  price  for the
     Company's common stock was approximately $. .


                 Aggregate Option Exercises in Last Fiscal Year
                        and Fiscal Year-End Option Values
                        ---------------------------------

     The  following  table  provides  information  on the value of the Company's
named  executive  officers'  unexercised  options  to  purchase  shares  of  the
Company's common stock as of December 31, 1997.

<TABLE>
<CAPTION>
                                    Number of Unexercised    Value of Unexercised
                                    Options at December 31,  in-the-money option at
                                    1997                     December 31, 1997 ($)(1)

            Shares                                                      Unex-
            Acquired on   Value     Exer-       Unexer-      Exerci-    erci-
Name        Exercise      Realized  cisable     cisable      sable      sable
----        -----------   --------  -------     -------      -------    ------

<S>         <C>           <C>       <C>         <C>          <C>        <C>
Joseph S.
Latino(2)    -0-           -0-      2,000,000   1,000,000     -0-        -0-

Arthur P.
Bergeron     -0-           -0-      1,000,000     500,000     -0-        -0-
</TABLE>
(1)  Fiscal year ended  December 31,  1997.  The average high and low bid of the
     Company's common stock at March __, 1998 was $_____.

(2)  Dr. Latino was terminated for cause on May 14, 1997.

                               BOARD OF DIRECTORS
                               ------------------
                                Edwin G. Marshall
                                  Milton Adair
                              Dr. Gerard V. Sunnen
                               Dr. William M. Hitt
                                 Kenneth Gropper

     Mr. Adair,  an executive  officer is a member of the Board of Directors and
participates in deliberations  concerning  executive officer  compensation,  but
does not vote on his own individual compensation.  However, his participation in
these deliberations may give rise to a conflict of interest.

                                      -21-

<PAGE>


Item 12.  Security Ownership of Certain Beneficial Owners and Management.
          ---------------------------------------------------------------

     The following  table sets forth certain  information as of January 8, 1998,
pertaining to the beneficial  ownership of Common Stock, by (i) persons known to
the  Company  to own 5% or more  of the  outstanding  Common  Stock,  (ii)  each
director  and  executive  officer of the  Company as of  December  31,  1996 and
December 31, 1997,  and (iii) present  directors  and executive  officers of the
Company as a group.

                             Number of Shares     Percentage of
Name and Address             Beneficially Owned   Total Outstanding
----------------             ------------------   -----------------


Arthur P. Bergeron               3,830,334(1)           2.76%
40 Grove Street
Wellesley, MA 02181

Kenneth Gropper                   660,0002              0.48%
129 Eagle's Nest Road
Lincoln, NH  03251

Edwin G. Marshall              74,098,3333             36.08%
P.O. Box 342
Stinson Beach, CA 94970

Milton G. Adair                    - 0 -(4)             - 0 -
2401 SouthFoot Hill Drive
Salt Lake City, Utah 04109

Dr. Gerard V. Sunnen            1,500,0005              1.08%
200 East 23rd Street
New York, NY 10016

------------------

(1)  Includes (i) 544,167 shares held through the Bergeron  Profit Sharing Plan;
     and (ii) 1,000,000 shares obtainable upon exercise of the option granted in
     Mr.  Bergeron's  employment  agreement  which  vested  on  January  1, 1996
     (500,000 shares) and January 1, 1997 (500,000  shares).  

(2)  Includes  500,000  shares  registered in the name of his wife, but excludes
     options to purchase  100,000  shares of the Company's  Common Stock granted
     pursuant to the  Company's  Option Plan which will be cancelled if the plan
     is not approved by the Company's shareholders. 

(3)  Includes:  (i) an aggregate of 351,000 shares owned by Mr. Marshall's wife,
     son and mother;  (ii) 6,571,428  shares owned by Sand Dollar,  of which Mr.
     Marshall is the general partner;  and (iii) options to purchase  66,761,905
     shares  owned  by Sand  Dollar.  

(4)  Does not include  options to  purchase  3,000,000  shares of the  Company's
     common stock granted  pursuant to the Company's  Option Plan, which will be
     cancelled  if the  Option  Plan  is not  approved  by the  shareholders.  

(5)  Includes  100,000 shares awarded as compensation for serving as Director of
     Science  which were  unissued at December  31,  1997,  but does not include
     options to purchase  300,000  shares of the Company's  common stock granted
     pursuant to the  Company's  Option  Plan,  which will be  cancelled  if the
     Option Plan is not approved by the shareholders.

                                      -22-

<PAGE>

                             Number of Shares     Percentage of
Name and Address             Beneficially Owned   Total Outstanding
----------------             ------------------   -----------------

Dr. William M. Hitt                - 0 -                - 0 -
4248 Palm Avenue
San Diego, CA 92154

All present directors            80,088,667             38.97%
and executive officers
as a group (6 persons)


Item 13. Certain Relationships and Related Transactions.
         -----------------------------------------------

Loans from Directors

     On August 22, 1994,  the Company  borrowed  $18,000 from George  Handel and
$10,000 from John Pealer, two of the Company's directors, and $9,000 from Samuel
Handel, the brother of George Handel.  Each of these loans was payable on August
23, 1995 and bears  interest at an annual rate of 8%, payable on the maturity of
the loans.  The  maturity  date on these  loans has been  extended to August 23,
1997. Each of the lenders has the right to require that payment of principal and
interest due on his loan be made in shares of the Company's  common stock,  at a
per share price equal to that charged by the Company in the most recent  private
transaction prior to the maturity of the loans.

     On June 4 and June 8, 1995, the Company borrowed $25,000 from George Handel
and $25,000 from Samuel Handel,  respectively,  payable in June 1996, which date
has been  extended to June 1997.  These loans bear interest at an annual rate of
9% and have the same conversion terms as the 1994 loans from these individuals.

     In February  1996,  the Company  borrowed  $25,000 from Richard G. Solomon,
$12,000 from George Handel and $10,000 from John Pealer,  three of the Company's
directors. These loans were payable on June 15, 1996, but payment was thereafter
extended to June 15, 1997.  In August 1996,  the Company  borrowed  $32,500 from
George  Handel,  $15,000 from Samuel  Handel and $10,000  from Richard  Solomon,
payable in one year. In September 1996, the Company borrowed $10,000 from Howard
Feinsand, at the time a director,  payable in ninety days. In November 1996, the
Company  borrowed  $10,000 from each of John Pealer,  George  Handel and Richard
Solomon,  payable in November  1997.  The 1996 loans bear  interest at an annual
rate of 8%,  payable on the  maturity of the loan.  The Company has the right to
make  payments  of  principal  and  interest  on these  loans in  shares  of the
Company's  common  stock,  at a per share  price  equal to that  charged  by the
Company in its most  recent  private  transaction  prior to the  maturity of the
loan.

     On or about  January  31,  1997,  the Company  borrowed  $1,800 from George
Handel.  The loan bears  interest at 8% per annum and is payable in one year and
has the same conversion terms as the 1996 loans.

     In June 1997, in connection  with their  appointment to the Board,  Messrs.
Marshall,  Adair, Sunnen and Hitt  (collectively,  the "New Directors") and Sand
Dollar  entered into an agreement in principal  (the  "Agreement")  with Messrs.
Gropper, Handel and Pealer (collectively, the "Old Directors") pursuant to which
the parties agreed, inter alia,

               (a)  that Messrs. Pealer and Handel resign as Directors;

               (b)  to  cause  the   election  of  the  New   Directors  to  the
                    Registrant's Board of Directors and to cause the appointment
                    of Mr.  Marshall as Chairman,  Mr. Adair as  President,  Mr.
                    Gropper  as  Chief  Operating  Officer  and  Dr.  Sunnen  as
                    Secretary;

                                      -23-
<PAGE>

               (c)  to  cause  the  Registrant  to  enter  into  indemnification
                    agreements with each of the New Directors and Old Directors;

               (d)  that the New Directors  shall not commence or participate in
                    any legal proceedings,  including class actions, against the
                    Old  Directors   arising  out  of  the   operations  of  the
                    Registrant;

               (e)  to release and hold each other harmless against any claim or
                    liability of any kind (with the exception of any obligations
                    under the Agreement); and

               (f)  to cause the issuance to Sand Dollar of warrants to purchase
                    an aggregate of 73,333,333 shares of the Registrant's common
                    stock as described above.


Issuance of Securities

     In May 1997,  the Company  issued  500,000  shares of the Company's  common
stock to each of Arthur P.  Bergeron  and Kenneth  Gropper in  consideration  of
their  services as  officers  of the  Company  and  750,000 to George  Handel in
consideration of his services as the Company's Secretary.  In December 1997, the
Company   awarded  Dr.  Gerard  Sunnen   100,000   shares  of  common  stock  in
consideration of his services as the Company's Director of Science.  In December
1997, the Board of Directors voted to establish the Option Plan,  which is to be
submitted for shareholders approval at the 1997 annual meeting.  Pursuant to the
Option  Plan,  options to purchase  shares of the  Company's  common  stock were
granted to Milton G. Adair (3,000,000 shares), Gerard V. Sunnen (300,000 shares)
and Kenneth Gropper (100,000), which grants will be cancelled if the Option Plan
is not  approved  by the  shareholders.  On  September  23,  1997,  Sand  Dollar
purchased  5,714,285  shares of the Company's  common stock pursuant to the Sand
Dollar Warrant, at a per share price of $.07, an aggregate of $400,000. On March
___, 1998, Sand Dollar purchased an additional 857,143 shares for $60,000.

                                      -24-

<PAGE>

                                     PART IV

Item 14.  Exhibits, Financial Statement Schedules,
          Reports on Form 8-K                    
          ----------------------------------------

               (a)  See Index to Consolidated Financial Statements and Schedules
                    on Page F-1.

               (b)  See Index to Exhibits on page E-1.

               (c)  None.

                                   SIGNATURES
                                   ----------


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

                          MEDIZONE INTERNATIONAL, INC.


                     By: s\Milton G. Adair
                         -------------------------------------
                         Milton G. Adair
                         President and Chief Executive Officer

Date:  January 28, 1998


     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange Act of 1934,  this Annual Report has been signed below by the following
persons  on  behalf  of the  Company,  in the  capacities  shown and on the date
indicated:



Date:  March 30, 1998        s/Milton G. Adair
                             ------------------------------------
                             Milton G. Adair, President
                             Chief Executive Officer and Director


Date:  March 30, 1998        s/Arthur P. Bergeron
                             ------------------------------------
                             Arthur P. Bergeron,
                             Vice President, Treasurer and
                             Chief Financial Officer


Date:  March 30, 1998        s/Edwin G. Marshall
                             ------------------------------------
                             Edwin G. Marshall, Director


Date:  March 30, 1998        s/Gerard V. Sunnen
                             ------------------------------------
                             Gerard V. Sunnen, Director


Date:  March 30, 1998        s/Kenneth Gropper
                             ------------------------------------
                             Kenneth Gropper, Director


Date:  March 30, 1998        s/William M. Hitt
                             ------------------------------------
                             William M. Hitt, Director


                                      -25-

<PAGE>

Exhibits and Financial Statement  Schedules.  The following Exhibits form a part
of this Annual Report on Form 10-K.

Exhibit
Number    Description of Exhibit
------    ----------------------

2         Agreement and Plan of Reorganization dated March 12, 1986.(2)

3(a)      Articles of Incorporation of Registrant.(2)

3(b)      By-laws of Registrant.(2)

3(c)      Articles of Amendment to Registrant's Articles of Incorporation.(3)

10(a)     Patent Agreement, dated February 26, 1987.

10(b)     Assignment of Distributor Agreement by Terrence O. McGrath to Medizone
          Delaware,  dated February 4, 1986, and Distributor  Agreement  between
          Terrence O.  McGrath and Dr. J.  Hansler  GmbH,  dated  September  25,
          1985.(3)

10(c)     Letter  confirmation  and Protocol,  dated June 2, 1986, by Registrant
          with regard to research to be conducted by the State University of New
          York at Syracuse.(2)

10(d)     Consulting  Agreement  between  P.J.  Watrous  &  Co.,  Inc.  and  the
          Registrant.(2)

10(f)     Consulting   Agreement   between   Jeffrey  Freed,   MD,  PC  and  the
          Registrant.(2)

10(g)     Consulting Agreement between Joseph Latino, PhD and the Registrant.(2)

10(h)     Consulting Agreement between Susan Golden, RN and the Registrant.(2)

10(i)     Stock Option of Joseph Latino.(2)

10(j)     Stock Option of Jeffrey Freed.(2)

10(k)     Stock Option of Susan Golden.(2)

10(l)     Stock Option of Hubert Weinberg.(2)

10(m)     Agreement dated June 16, 1987, between Registrant and Oliver Grace.(5)

10(n)     Agreement dated June 26, 1987, between Registrant and John Grace.(5)

10(o)     Agreement dated June 26, 1987, between Registrant and Oliver Grace.(5)

10(p)     Agreement dated June 30, 1987, by and among Registrant and John C.
          Black, Dr. Gerard V. Sunnen and Dr. Priyakant S. Doshi.(5)

10(q)     License Agreement with MCL Medizone Canada Ltd. dated November 18,
          1987.(5)

10(r)     Agreement dated October 1988 by and among Immunologics, Limited
          Partnership, John M. Kells, Y. C. Zee, David C. Bolton and Medizone
          International, Inc.(6)

10(s)     Form of Stock Purchase  Agreement between  Registrant and individuals
          who purchased Shares from Registrant.(7)

10(t)     Letter agreement between Registrant and Rebus Oil Co., Ltd. dated
          July 28, 1992.(8)

10(u)     Letter  of  understanding  between  Registrant  and the RMB  Group of
          Boston dated August 10, 1992.(8)

                                      E-1

<PAGE>




10(v)     Agreement between Registrant and Rebus Oil Company,  Ltd., dated as of
          October 20, 1992.(9)

10(w)     Letter agreement among Messrs. McGrath,  Watrous, Melera, Chou, Kells,
          Handel and Pealer, dated as of November 10, 1992.(9)

10(x)     Loan agreement  with Messrs.  McGrath and Watrous dated as of November
          16, 1992.(9)

10(y)     Settlement   agreement  with  former  consultant  dated  February  12,
          1993.(9)

10(z)     Consulting  Agreement  with  Joseph S.  Latino  dated as of January 1,
          1993.(9)

10(aa)    Consulting  Agreement  with Arthur P. Bergeron  dated as of January 1,
          1993.(9)

10(bb)    Employment  Agreement with Katherine M. Kalinowski dated as of January
          1, 1993.(9)

10(cc)    Consulting  Agreement  with  Roger  Shelley  dated  as of  January  1,
          1993.(9)

10(dd)    Consulting  Agreement with Jeannette  Arsenault dated as of January 1,
          1993.(9)

10(ee)    Loan Agreements between  Registrant and John Kells,  George Handel and
          John Pealer, executed as of June 11, 1993 (and promissory notes).(9)

10(ff)    Promissory  Note to Joseph S. Latino  dated as of October 26, 1993 and
          Acceptance Form dated as of November 26, 1993.(9)

10(gg)    Letter  Agreement  dated March 23,  1993  between  Registrant  and the
          Italian Scientific Society.(10)

10(hh)    Contract between Registrant and Capmed USA.(10)

10(ii)    Agreement made as of May 18, 1994, among Medizone International, Inc.,
          Medizone  Canada  Ltd.,  John M. Kells,  George  Handel,  John Pealer,
          Joseph S. Latino, Terrence O. McGrath and Philip J. Watrous.(11)

10(jj)    Agreement made as of January 1, 1995, between Medizone  International,
          Inc. and Joseph S. Latino.(11)

10(kk)    Agreement made as of January 1, 1995 between  Medizone  International,
          Inc. and Arthur P. Bergeron.(11)

10(ll)    Agreement made as of January 1, 1995 between  Medizone  International,
          Inc. and Giacomo C. DiGiorgio, M.D.(11)

10(mm)    Lease  Agreement  between  Medizone  International,  Inc.  and  Benabi
          Realty, made on September 27, 1991, as extended, January 17, 1995.(11)

10(nn)    Agreement  for Sale and  Purchase  of Shares in  Medizone  New Zealand
          Limited between Richard G. Solomon and Medizone  International,  Inc.,
          dated June 22, 1995.(12)

10(oo)    Shareholders'  Agreement  relating  to Medizone  New  Zealand  Limited
          between and among Solwin Investments Limited,  Medizone International,
          Inc. and Medizone New Zealand Limited, dated June 22, 1995.(12)

10(pp)    Licensing Agreement between Medizone International,  Inc. and Medizone
          New Zealand Limited, dated June 22, 1995.(12)

10(qq)    Managing Agent  Agreement  between  Medizone  International,  Inc. and
          Medizone New Zealand Limited, dated June 22, 1995.(12)

10(rr)    Lease Agreement between Medizone International,  Inc. and Linmar L.P.,
          dated January 17, 1996.(13)

                                       E-2

<PAGE>




10(ss)    Agreement  between  Medizone  International,   Inc.  and  Multiossigen
          S.r.l., dated as of September 13, 1996.(14)

10(tt)    Agreement  between Medizone  International,  Inc. and JRH Biosciences,
          Inc., dated April 17, 1997.(15)

10(uu)    Lease  Agreement  between  Medizone   International   Inc.  and  Eagle
          Overlook, L.C., made on September 23, 1997.(16)

16        Letters re: change in certifying accountants.(11)

--------------------

(1)       Filed herewith.

(2)       Incorporated by reference to the Registrant's  registration  statement
          on Form S-18 (Registration No. 2-93277-D), effective May 14, 1985.

(3)       Incorporated  by reference to the  Registrant's  annual report on Form
          10-K for the period ended December 31, 1986.

(4)       Incorporated by reference to the  Registrant's  current report on Form
          8-K, filed March 13, 1987.

(5)       Incorporated  by reference to the  Registrant's  annual report on Form
          10-K for the period ended December 31, 1987.

(6)       Incorporated  by reference to the  Registrant's  annual report on Form
          10-K for the period ended December 31, 1988.

(7)       Incorporated  by reference to the  Registrant's  annual report on Form
          10-K for the period ended December 31, 1989.

(8)       Incorporated  by reference to the  Registrant's  annual report on Form
          10-K for the period ended December 31, 1990.

(9)       Incorporated  by reference to the  Registrant's  annual report on Form
          10-K for the period ended December 31, 1992.

(10)      Incorporated by reference to the Registrant's current annual report on
          Form 8-K dated September 8, 1993.

(11)      Incorporated  by reference to the  Registrant's  annual report on Form
          10-K for the period ended December 31, 1994.

(12)      Incorporated by reference to the Registrant's current annual report on
          Form 8-K, dated June 22, 1995.

(13)      Incorporated  by reference to the  Registrant's  annual report on Form
          10-K for the period ended December 31, 1995.

(14)      Incorporated by reference to the  Registrant's  current report on Form
          8-K, dated October 17, 1996.

(15)      Incorporated by reference to the  Registrant's  current report on Form
          8-K, dated May 5, 1997.

(16)      Incorporated by reference to the  Registrant's  current report on Form
          8-K dated September 24, 1997.

                                       E-3

<PAGE>

                  MEDIZONE INTERNATIONAL, INC., AND SUBSIDIARY
                          (A Development Stage Company)

            INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES

                 for the years ended December 31, 1996 and 1995
                                     -------


                                   Page Number

Report of Andersen Andersen and Strong, L.C.,                                
  Independent Accountants

Consolidated Balance Sheets                                         F-3

Consolidated Statements of Operations                               F-4

Consolidated Statements of Changes in Stockholders' Equity          F-5

Consolidated Statements of Cash Flows                               F-12

Notes to Consolidated Financial Statements                          F-14

                                       F-1

<PAGE>

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

The Board of Directors and Stockholders
  Medizone International, Inc.

We have audited the consolidated balance sheets of Medizone International,  Inc.
and subsidiaries (a development stage company) as of December 31, 1996 and 1995,
and the related  statements of operations,  stockholders'  equity and cash flows
for the years ended December 31, 1996, 1995 and 1994, and the period January 31,
1986 (date of inception)  through December 31, 1996. These financial  statements
are the  responsibility of the Company's  management.  Our  responsibility is to
express an opinion on these financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards. Those standards require that we plan and perform the audits 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  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 above present fairly, in
all material respects,  the financial position of Medizone  International,  Inc.
and  subsidiaries  as of December  31,  1996 and 1995,  and the results of their
operations and their cash flows for the years ended December 31, 1996,  1995 and
1994, and the period January 31, 1986 (date of inception)  through  December 31,
1996, in conformity with generally accepted accounting principles.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company  will  continue  as a  going  concern.  As  discussed  in  Note 3 to the
financial statements,  the Company has suffered recurring losses from operations
and has a net capital  deficiency that raise substantial doubt about its ability
to continue as a going  concern.  Management's  plans in regard to these matters
are also  described  in Note 3. The  financial  statements  do not  include  any
adjustments that might result from the outcome of this uncertainty.



Salt Lake City, Utah
January 7, 1998                             s\ANDERSEN ANDERSEN AND STRONG, L.C.


                                       F-2

<PAGE>


                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
                           CONSOLIDATED BALANCE SHEETS
                           December 31, 1996 and 1995


                                     ASSETS

<TABLE>
<CAPTION>
                                                                            1996              1995
                                                                           ------            ------
<S>                                                             <C>                   <C>    
CURRENT ASSETS
   Cash and cash equivalents                                     $          3,579     $        -
   Prepaid expenses and advances                                            6,776             19,431
                                                                  ---------------         ----------

         Total Current Assets                                              10,355             19,431
                                                                  ---------------         ----------

FIXED ASSETS
   Office equipment                                                        14,665              4,663
   Furniture and fixtures                                                   2,711              2,711
                                                                 ----------------         ----------
                                                                           17,376              7,374
   Less accumulated depreciation                                            8,308              5,401
                                                                 ----------------         ----------
                                                                            9,068              1,973
                                                                 ----------------         ----------
OTHER ASSETS
   Investment in affiliate (Note 1)                                        -                   -
   Receivable from affiliate (Note 1)                                      48,947             48,947
   License agreement (Note 5)                                              -                   -
   Organization costs (net of accumulated amortization
      of $5,520)                                                           -                   -
   Deposits (Note 6)                                                        5,998              54,302
                                                                 ----------------          ----------
                                                                 $         74,368       $     124,653
                                                                 ================       =============


                    LIABILITIES AND STOCKHOLDERS' DEFICIENCY

CURRENT LIABILITIES
   Checks issued in excess of deposits                                     -            $      1,760
   Accounts payable                                                       455,885            315,972
   Accrued liabilities                                                    171,409             91,986
   Notes payable (Note 10)                                                332,315            147,815
                                                                    -------------         ----------
         Total Current Liabilities                                  $     959,609       $    557,533
                                                                     ------------         ----------

COMMITMENTS AND CONTINGENCIES (Notes 2, 3, 6 and 13)                        -           $       -

REDEEMABLE COMMON STOCK (Note 13)                                           -                   -
                                                                    -------------       ------------

MINORITY INTEREST (Note 9)                                                  -                 -

STOCKHOLDERS'  DEFICIENCY  (Notes  1,  2,  3,
   7,  8, 9 and  11)  Common  stock,
   authorized 250,000,000 shares, par value
      $.001 per share; issued and outstanding 130,051,613
      and 120,123,359 shares for 1996 and 1995, respectively        $     130,052       $    120,123
   Common stock subscribed                                                  3,090              5,047
   Additional paid-in capital                                          11,423,736         10,554,674
   Deficit accumulated during development stage                       (12,442,119)       (11,112,724)
                                                                      -----------        -----------

         Total Stockholders' Deficiency                                  (885,241)          (432,880)
                                                                    -------------        -----------
                                                                    $      74,368       $    124,653
                                                                    =============        ===========
</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                       F-3
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
                      CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                                                             From the Date
                                                                                                             of Inception
                                                                                                             (January 31,
                                                                                                            1986) through
                                                                 For the Years Ended December 31             December 31,
                                                            1996              1995              1994             1996
                                                           ------            ------            ------           ------
                                                                                                              (restated)


<S>                                                    <C>                <C>               <C>            <C>            
SALES                                                  $          -       $      -          $     -        $       133,349
                                                        -------------      ------------      -----------    --------------

COSTS AND EXPENSES

   Cost of sales                                              -                  -                -                103,790
   Research and development expenses                           25,000            -                -              2,202,685
   General and administrative expenses                      1,291,082         1,170,119        1,118,246         9,084,534
   Compensation under stock options
      (Note 8)                                                -                  -                -                872,894
   Interest expense                                            13,313            10,908            8,075           744,902
   Other (income) and expense, net                            -                  -                      (6)         16,018)
                                                        -------------      ------------      -----------    --------------

                                                            1,329,395         1,181,027        1,126,315        12,992,787
                                                        -------------      ------------      -----------    --------------

Net loss before extraordinary gain and                     (1,329,395)       (1,181,027)      (1,126,315)      (12,859,438)
   minority interest
Extraordinary gain on  sale of investment in
   subsidiary (Note 1)                                        -                 100,000             -              100,000
                                                        -------------      ------------      -----------    --------------
Net loss before minority interest                          (1,329,395)       (1,081,027)      (1,126,315)      (12,759,438)
Minority interest in loss                                     -                  -                  -               26,091
Prior period adjustment (Note 11)                             -                  -                  -              291,228
                                                        -------------      ------------      -----------    --------------

Net loss                                                $  (1,329,395)      $(1,081,027)    $( 1,126,315)     $(12,442,119)
                                                        -------------      ------------      -----------    --------------

Weighted average number of shares outstanding             118,022,000       111,306,000       98,292,000        80,003,000
                                                        =============      ============     ============    ==============

Net loss per share                                      $       (0.01)$           (0.01)    $      (0.01)   $        (0.16)
                                                        =============      ============      ===========     =============
</TABLE>


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       F-4

<PAGE>



                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
            CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
     From the Date of Inception (January 31, 1986) through December 31, 1996


<TABLE>
<CAPTION>
                                                                                                          Deficit
                                                                                                        Accumulated
                                                                                  Additional  Accrued      During
                                                             Common Stock          Paid-in  Stock Option Development
                                                   ------------------------------- Capital  Compensation    Stage
                                                     Shares    Amount   Subscribed -------  ------------ -----------
                                                     ------    ------   ----------
<S>                                               <C>          <C>      <C>        <C>       <C>        <C>
Medizone - Delaware
Initial capitalization of Medizone-Delaware (no
   par value), February 1986, ($10.21 per share)   $      882   $  9,000  $   -     $   -     $   -     $   -
Shares of Medizone-Delaware (no par value)
   issued for cash, March 1986 ($22.58 per share)          50      1,129      -         -         -         -
                                                   ----------    -------   -------   -------   -------   -------

                                                          932     10,130  $   -     $   -     $   -     $   -
                                                   ==========    =======   =======   =======   =======   =======
Medizone - Nevada (formerly Madison
   Funding Inc.)
Existing shares of Medizone-Nevada (formerly
   Madison Funding, Inc.) (par value
   $.001 per share)                                 5,500,000   $  5,500      -     $139,998  $   -     $   (310)
Exchange of 932 shares of Medizone-Delaware
    for shares of Medizone-Nevada resulting
    in a reverse merger, March 1986                37,500,000     10,130      -         -         -         -
Reallocation of paid-in capital to par value
   due to recapitalization as a result of
   reverse merger                                        -        27,370      -      (27,370)     -         -
                                                   ----------    -------   -------   -------   -------   -------

Balance after reverse merger, March 1986
   (par value $.001 per share)                     43,000,000     43,000      -      112,628      -         (310)


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.
</TABLE>





                                       F-5

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
               CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
                  EQUITY (Continued) From the Date of Inception
                  (January 31, 1986) through December 31, 1996

<TABLE>
<CAPTION>
                                                                                                          Deficit
                                                                                                        Accumulated
                                                                                  Additional  Accrued      During
                                                             Common Stock          Paid-in  Stock Option Development
                                                   ------------------------------- Capital  Compensation    Stage
                                                     Shares    Amount   Subscribed -------  ------------ -----------
                                                     ------    ------   ----------
<S>                                               <C>          <C>      <C>        <C>       <C>        <C>
Shares issued for services, July 1986
    ($.10 per share)                                 50,000    $    50  $    -     $  4,950  $   -       $    -
Shares issued for warrants, August through
   October 1986 ($.10 per share)                  7,814,600      7,815       -      773,645      -            -
Stock issuance cost in connection
   with shares issued for warrants
Stock option compensation expense (Note 8)                                         (105,312)     -            -  
Net loss for the year ended
   December 31, 1986                                   -          -          -         -       223,521     (795,758)
                                                 ----------     ------   --------   -------   --------     --------

Balance, December 31, 1986                       50,864,600     50,865       -      785,911    223,521     (796,068)

Shares issued for warrants, January 1987
   ($.10 per share)                                   2,600          2       -          257       -           -
Shares issued for patent, March 1987
   ($.69375 per share)                            1,000,000      1,000       -      692,750       -           -
Shares issued for cash, June 1987
   (from $.10 to $.25 per share)                    950,000        950       -      149,050       -           -
Shares issued for services, June and July 1987
   (from $.10 to $.25 per share)                    203,167        203       -       24,314       -           -
Stock option compensation expense relating to
   option exercised in August 1987                     -          -          -         -       338,551        -
Option exercised, August 1987 ($.001 per share)     250,000        250       -      437,250   (437,250)       -
</TABLE>



The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                       F-6
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
               CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
                  EQUITY (Continued) From the Date of Inception
                  (January 31, 1986) through December 31, 1996

<TABLE>
<CAPTION>
                                                                                                          Deficit
                                                                                                        Accumulated
                                                                                  Additional  Accrued      During
                                                             Common Stock          Paid-in  Stock Option Development
                                                   ------------------------------- Capital  Compensation    Stage
                                                     Shares    Amount   Subscribed -------  ------------ -----------
                                                     ------    ------   ----------
<S>                                               <C>          <C>      <C>        <C>       <C>        <C>
Adjustment to accrued stock option compensation
   (Note 8)                                                    $   -    $   -      $   -     $   -      $   510,527

Net loss for the year ended December 31, 1987          -           -        -          -         -       (2,749,400)
                                                  ----------    -------  ---------  ---------  --------  ----------
Balance, December 31, 1987                        53,270,367     53,270     -       2,089,532   685,349  (3,545,468)

Options exercised, January 1988
   ($.001 per share)                                 200,000        200     -          99,800   (99,800)       -
Shares issued for cash, September 1988
   ($.08 per share)                                1,000,000      1,000     -          79,000      -           -
Shares issued for services
   (from $.10 to $.25 per share)                      35,000         35     -           7,965      -           -
Adjustment to accrued stock option
   compensation (Note 8)                                -          -        -            -     (584,599)       -
Issuances of shares by subsidiaries                     -          -        -         174,126      -           -
Net loss for the year ended December 31, 1988            -         -        -            -         -       (714,347)
                                                  ----------    -------  ---------  ---------  --------  ----------

Balance, December 31, 1988                        54,505,367     54,505     -       2,450,423       950  (4,259,815)

Shares issued for services
   (from $.10 to $.19 per share)                     261,889        262     -          46,363      -          -
</TABLE>


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       F-7
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
               CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
                  EQUITY (Continued) From the Date of Inception
                  (January 31, 1986) through December 31, 1996


<TABLE>
<CAPTION>
                                                                                                          Deficit
                                                                                                        Accumulated
                                                                                  Additional  Accrued      During
                                                             Common Stock          Paid-in  Stock Option Development
                                                   ------------------------------- Capital  Compensation    Stage
                                                     Shares    Amount   Subscribed -------  ------------ -----------
                                                     ------    ------   ----------
<S>                                               <C>          <C>      <C>        <C>       <C>        <C>
Shares issued for cash
   (from $.03 to $.10 per share)                  5,790,000    $  5,790 $   -      $  285,710 $   -     $     -
Shares issued for notes, accrued liabilities and
   services (from $.06 to $.24 per share)         4,749,532       4,750     -         578,978     -           -
Options exercised ($.16 per share)                  375,000         375     -          59,125 (59,125)        -
Adjustment to accrued stock option compensation        -           -        -            -     58,175         -
Net loss for the year ended December 31, 1989           -          -        -            -        -        (862,051)
                                                  ----------    -------  ---------  ---------  --------  ----------
Balance, December 31, 1989                        65,681,788     65,682     -       3,420,599     -      (5,121,866)


Shares issued for services ($.10 share)              880,000        880     -          87,120     -           -
Shares issued for cash
   (from $.03 to $.05 per share)                   4,250,000      4,250     -         175,250     -           -
Shares issued for notes and accrued liabilities
   (from $.055 to $.10 per share (Note 7)          2,422,727      2,423     -         137,577     -           -
Adjustment to accrued stock option compensation         -          -        -            -      6,000         -
Issuance of shares by subsidiaries (Note 9)             -          -        -         100,000     -           -
Net loss for the year ended December 31, 1990           -          -        -            -        -        (606,309)
                                                  ----------    -------  ---------  ---------  --------  ----------

Balance, December 31, 1990                        73,234,515     73,235     -       3,920,546   6,000    (5,728,175)

Shares issued for services
   (from $.15 to $.20 per share)                     425,000        425     -          72,075     -           -
Shares issued for cash
   (from $.036 to $.20 per share)                  4,366,667      4,366     -         305,634     -           -
</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       F-8

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
               CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
                  EQUITY (Continued) From the Date of Inception
                  (January 31, 1986) through December 31, 1996

<TABLE>
<CAPTION>
                                                                                                          Deficit
                                                                                                        Accumulated
                                                                                  Additional  Accrued      During
                                                             Common Stock          Paid-in  Stock Option Development
                                                   ------------------------------- Capital  Compensation    Stage
                                                     Shares    Amount   Subscribed -------  ------------ -----------
                                                     ------    ------   ----------
<S>                                               <C>          <C>      <C>        <C>        <C>        <C>
Options exercised
   (from $.22 per share to $.93 per share)           450,000   $    450  $   -     $  204,050 $(204,050) $     -
Adjustment to accrued stock option compensation         -                    -           -      324,800        -
Sale of subsidiary's stock (Note 9)                     -                    -           -        5,000        -
Net loss for the year ended December 31, 1991           -                    -           -         -     (1,220,152)
                                                  ----------    -------  ---------  ---------  --------  ----------

Balance, December 31, 1991                        78,476,182     78,476      -      4,507,305   126,750  (6,948,327)

Shares issued for services ($.20 per share)          151,500        152      -         30,148      -           -
Shares issued for accrued liabilities
   ($.15 per share)                                  250,000        250      -         37,250      -           -
Shares issued for cash(from $.15-$.20 per share)  $2,702,335      2,702      -        427,648      -           -
Shares in settlement of advances from and amounts
   due to stockholder ($.10 per share)            13,118,619     13,119      -        800,248      -           -
Options exercised ($.50 per share)                   250,000        250      -        124,750  (124,750)       -
Adjustment to accrued stock option compensation         -          -         -           -       (2,000)       -
Sale of subsidiary's stock (Note 9)                     -          -         -         81,100      -           -
Net loss for the year ended December 31, 1992           -          -         -           -         -       (649,941)
                                                  ----------    -------  ---------  ---------  --------  ----------

Balance, December 31, 1992                        94,948,636     94,949      -      6,008,449      -     (7,598,268)

Cancellation of shares previously issued in
   settlement of advances from and amounts
   due to stockholder ($.062 per share)          (13,118,619)   (13,119)     -       (800,248)     -           -
</TABLE>



The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


                                       F-9
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
               CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
                  EQUITY (Continued) From the Date of Inception
                  (January 31, 1986) through December 31, 1996

<TABLE>
<CAPTION>
                                                                                                          Deficit
                                                                                                        Accumulated
                                                                                  Additional  Accrued      During
                                                             Common Stock          Paid-in  Stock Option Development
                                                   ------------------------------- Capital  Compensation    Stage
                                                     Shares    Amount   Subscribed -------  ------------ -----------
                                                     ------    ------   ----------
<S>                                               <C>          <C>      <C>        <C>        <C>        <C>
Shares issued for services
   (from $.10 to $.46 per share)                    5,347,219  $  5,347 $   -      $  542,859 $    -     $     -
Shares issued for cash
   (from $.15 to $.20 per share)                    1,471,666     1,472     -         269,528      -           -
Shares subscribed ($.10 per share)                       -         -       2,619      259,296      -           -
Net loss for the year ended December 31, 1993            -         -        -            -                (1,598,342)
                                                   ----------   ------- ---------  ----------  --------    ----------

Balance, December 31, 1993                         88,648,902    88,649    2,619    6,279,884      -      (9,196,610)

Shares issued for services ($.10 per share)         1,431,590     1,431     -         141,727      -            -
Shares subscribed ($.10 per share)                       -         -       9,552      945,682      -            -
   indebtedness ($.10 per share)                         -         -         417       41,234      -            -
Shares subscribed for cancellation of
   indebtedness to former management
    ($.18 per share) (Note 2)                            -         -      11,250    2,022,379      -            -
Issuance of subscribed stock                       10,384,900    10,385  (10,385)        -         -            -
Issuance of shares to certain prior purchasers
   of common stock in recognition of disparity
   in purchase price in contemporaneous offering    1,125,834     1,126     -          (1,126)     -            -

Prior period adjustment (Note 11)                        -          -       -            -         -            -

Net loss for the  year ended December 31, 1994           -          -       -            -         -            -
                                                   ----------   -------  ---------  ---------  --------   ----------

Balance, December 31, 1994                        101,591,226   101,591   13,453    9,429,780      -     (10,103,503)
</TABLE>


The accompanying notes are an integral part of these financial statements.

                                      F-10
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
               CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
                  EQUITY (Continued) From the Date of Inception
                  (January 31, 1986) through December 31, 1996



Deficit

Accumulated
<TABLE>
<CAPTION>
                                                                                          Additional         Accrued        During
                                                               Common Stock                Paid-In         Stock Option  Development
                                                       Share      Amount    Subscribed     Capital         Compensation     Stage
                                                       -----      ------    ----------    ----------       ------------  -----------
<S>                                                 <C>          <C>       <C>          <C>                <C>           <C>
Redeemable common shares converted to common
   stock (Note 13)                                     200,000   $    200   $   -       $     39,800       $    -        $     -
Shares issued for services ($.10 per share)          2,050,000      2,050       -            202,950            -              -
Issuance of subscribed stock                        17,524,860     17,524    (17,524)           -               -              -
Cancellation of common shares issued to former
   management (Note 7)                              (1,242,727)    (1,242)      -            (70,563)           -              -
Shares subscribed ($.10 per  share)                       -          -         9,118         902,707            -              -
Prior period  adjustment (Note 11)                        -          -          -               -               -            71,806
Sales of stock in subsidiary  (Notes 1 and 7)             -          -          -             50,000            -              -
Net loss for the year ended December 31, 1995             -          -          -               -               -        (1,081,027)
                                                   -----------   --------     ------      ----------        --------    -----------

Balance, December 31, 1995                         120,123,359    120,123      5,047      10,554,674            -       (11,112,724)
Shares issued for cash ($.10 per share)                100,000        100       -              9,900            -              -
Shares issued for services ($.10 per share)          1,415,875      1,416       -            140,171            -              -
Issuance of subscribed stock                         8,412,379      8,413     (8,413)           -               -              -
Shares subscribed ($.11 per share)                        -          -         6,456         718,991            -              -
Net loss for the year ended December 31, 1996             -          -          -               -               -        (1,329,395)
                                                   -----------   --------     ------      ----------        --------    -----------
Balance, December 31, 1996                         130,051,613  $ 130,052    $ 3,090     $11,423,736       $    -      $(12,442,119)
                                                   ===========   ========     ======      ==========        ========    ===========

</TABLE>

The accompanying notes are an integral part of these financial statements.


                                      F-11
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS


                                  From the Date
                                  of Inception
                               (January 31, 1986)


<TABLE>
<CAPTION>
                                                                                         From the Date
                                                                                          of Inception
                                                                                       (January 31, 1986)
                                                  For the Years Ended December 31,           through
                                                 ----------------------------------
                                                  1996           1995          1994     December 31, 1996
                                                 ------          ----          ----     -----------------
                                                                                           (restated)

OPERATING ACTIVITIES

<S>                                            <C>          <C>           <C>            <C>   

   Net loss                                                 $(1,329,395)  $(1,081,027)    $(1,126,315)
$(12,442,119)
   Prior period adjustment                          -                         219,422            -
   Adjustments to reconcile net loss to net
      cash used in operating activities:
      Issuance of stock for services             141,587        205,000       143,158       1,312,893
      Subscription of stock for services            -            13,380          -             13,380
      Compensation - stock options                  -              -             -            924,975
      Write-off of license agreement                -              -             -                  2
      Write off of patent                           -              -             -            693,750
      Depreciation and amortization                2,907          1,148         1,205          21,084
      Minority interest in loss                     -              -             -            (26,091)
   Changes in assets and liabilities:
      Current and other assets                    12,655        (64,138)          160         (55,723)
      Accounts payable                           139,913       (115,474)       11,215         662,074
      Accrued liabilities                         79,423         15,338      (214,189)        228,194
                                               ---------      ---------       -------       ---------

Net Cash Used in Operating Activities           (952,910)    (1,025,773)     (965,344)     (8,667,581)
                                               ---------      ---------       -------       ---------

INVESTMENT ACTIVITIES

   Additions to organization costs               (10,002)          -             -             (8,904)
   Additions to fixed assets                        -              -             -            (21,247)
   Additions to deposits                          48,304           -             -             (5,998)
                                               ---------      ---------   -------------     ---------

Net Cash Provided by (Used in)                    38,302           -             -            (36,149)
                                               ---------      ---------   -------------     ---------
 Investment Activities
FINANCING ACTIVITIES

   Issuance of stock for cash                     10,000           -             -          1,877,977
   Stock issuance cost                              -              -             -           (105,312)
   Exercise of warrants                             -              -             -            781,719
   Exercise of stock options                        -              -             -              1,525
   Sale of stock of subsidiary                      -            50,000          -            421,847
   Proceeds of long-term debt                       -              -             -            191,657
   Proceeds of notes payable                                       -           37,000         283,665
   Payment of notes payable                         -              -          (20,000)       (189,150)
   Redeemable common stock                          -              -             -             40,000
   Increase in minority interest              $     -         $    -       $     -         $   14,470

</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                      F-12
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
                CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

<TABLE>
<CAPTION>
                                                                                         From the Date
                                                                                          of Inception
                                                                                       (January 31, 1986)
                                                  For the Years Ended December 31,           through
                                                 ----------------------------------
                                                  1996           1995          1994     December 31, 1996
                                                 ------          ----          ----     -----------------
                                                                                           (restated)

<S>                                            <C>          <C>           <C>            <C>   

FINANCING ACTIVITIES (continued)-

   Common stock subscribed                     $ 725,447    $  898,445    $  955,234     $4,804,515
   Increase in notes payable                     184,500        50,000          -           584,396
                                                --------     ---------     ---------      ---------

Cash Provided by Financing Activities            919,947       998,445       972,234      8,707,309
                                                --------     ---------     ---------      ---------

INCREASE (DECREASE) IN CASH AND
   CASH EQUIVALENTS                                5,339       (27,328)        6,890          3,579

  Cash and cash equivalents, beginning of        (1,760)       25,568         18,678            -
                                                --------     ---------     ---------      ---------
    year

   Cash and cash equivalents, end of year       $  3,579    $   (1,760)    $  25,568      $   3,579
                                                 =======     =========      ========       ========


SUPPLEMENTAL DISCLOSURE OF CASH
   FLOW INFORMATION

   Cash paid for interest                       $   -       $     -        $   1,397      $  26,483

SUPPLEMENTAL SCHEDULE OF NONCASH
   ACTIVITIES

   Conversion of notes payable to stock         $   -       $     -       $2,075,280     $2,091,980
   Conversion of long-term debt to stock            -             -             -           191,658
   Conversion of accrued liabilities to stock       -             -             -           258,689
   Conversion of accounts payable to stock          -             -             -             4,285
   Conversion of due to stockholders to stock       -             -             -         1,103,263
   Issuance of stock for license agreement          -             -             -                 2
   Issuance of stock for patent                     -             -             -           693,750
   Cancellation of stock for reinstatement of
      due to stockholders                           -             -             -           813,367
   Conversion of redeemable common stock to
      common stock                                  -           40,000          -            40,000
</TABLE>


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.



                                      F-13

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   NATURE OF THE BUSINESS

Background

Medizone  International,  Inc., a Delaware corporation  (Medizone-Delaware)  was
formed on January 31,  1986.  Medizone  International,  Inc.  (the  Company) was
organized  under the laws of the State of Nevada on August  27,  1984 as Madison
Funding,  Inc. (Madison) for the purposes of investing in, acquiring,  operating
and disposing of businesses or assets of any nature. On March 26, 1986,  control
of Madison was acquired by the  stockholders of  Medizone-Delaware,  and Madison
changed  its  name  to  Medizone  International,  Inc.  The  substance  of  this
transaction  was the  acquisition  of the net  monetary  assets  of  Madison  in
exchange for the equity of  Medizone-Delaware.  As a result of this transaction,
the stockholders of Medizone-Delaware acquired 87.2% of Madison.  Therefore, the
transaction was accounted for as a pooling of interests.

On November 18, 1987,  Medizone Canada Ltd. (MedCan) was incorporated  under the
laws of the Province of British  Columbia with authorized  capital of 25,000,000
common  shares  without par value.  Shortly  thereafter,  MedCan  entered into a
license agreement with the Company wherein the Company transferred to MedCan the
licenses and rights  necessary to permit MedCan to hold  substantially  the same
rights  with  respect  to the  medical  applications  of ozone in  Canada as the
Company  does in the United  States.  As  consideration  for the  transfer,  the
Company received 3,000,000 shares of MedCan and, in addition,  purchased 1 share
for the sum of $1.00. Under a separate  agreement among the Company,  MedCan and
Australian  Gold Mines  Corporation  (AGMC),  (which  later  changed its name to
International Blue Sun Resource  Corporation),  a company incorporated under the
laws of the  Province of British  Columbia,  AGMC  purchased  130,000  shares of
MedCan for (U.S.) $100,000.  On December 23, 1988, MedCan was recapitalized in a
transaction in which the majority of its shares were exchanged for shares of KPC
Investments,  a Utah corporation (KPC). Following this transaction,  the Company
owned 25,029,921 shares of KPC,  representing 72% of the outstanding shares. KPC
then changed its named to Medizone  Canada,  Ltd. (MCL).  MedCan acquired all of
the  assets of KPC,  consisting  solely of cash in the  amount of  approximately
$89,000. KPC and its subsidiary MedCan are hereinafter referred to as MCL.

Formation of  Joint Venture Subsidiary
--------------------------------------

On June  22,  1995,  Medizone  International,  Inc.  entered  into a  series  of
contracts  (collectively  the  "Transaction  Documents")  which  resulted in the
formation of a joint venture  subsidiary  incorporated in New Zealand,  Medizone
New Zealand Limited ("MNZ").  MNZ, a privately held corporation equally owned by
the  Company  and  Solwin  Investments   Limited   ("Solwin"),   a  New  Zealand
corporation,  was organized on June 22, 1995, and is a research and  development
stage  company  whose  objective  is  to  obtain  regulatory  approval  for  the
distribution  of the Company's  patented  technology in New Zealand,  Australia,
South East Asia and the South Pacific Islands.

Pursuant to the Transaction Documents, the Company purchased one hundred percent
of MNZ from Richard G. Soloman ("Solomon"),  a New Zealand citizen, who became a
director of the Company in January,  1996 and who caused the formation of MNZ on
June 22, 1995.  Contemporaneously with this transaction,  the Company sold fifty
percent of MNZ to Solwin, a corporation owned by Solomon, for U.S. $150,000,  of
which $50,000 was thereupon  loaned by the Company to MNZ on a demand basis. The
Directors of MNZ are Solomon and Milton Adair, the Company's President and Chief
Executive Officer.

Contemporaneous with the creation of the above share structure,  the Company and
MNZ  entered  into a  Licensing  Agreement  (the  "Licensing  Agreement")  and a
Managing Agent Agreement (the "Managing Agent Agreement) with MNZ.


                                      F-14
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


1.   NATURE OF THE BUSINESS (continued)-

Formation of Joint Venture Subsidiary (continued)
-------------------------------------

Pursuant to the Licensing Agreement, the Company granted an exclusive license to
MNZ for its process and equipment patents and trademark in New Zealand.  MNZ has
agreed to apply for  corresponding  patent  protection  for the  patents  in New
Zealand  and to use its  best  effort  to  exploit  the  rights  granted  in the
agreement.  The License  Agreement shall terminate on the date of the expiration
of the last to expire of any  patent  obtained  in New  Zealand,  or, if no such
patents are obtained,  on June 22, 2010.  The Company is to receive a guaranteed
minimum royalty (the "Guaranteed  Minimum Royalty") in an amount to be agreed to
by the  Company  and MNZ,  commencing  in the third  year  after  all  necessary
regulatory  approvals  requisite  to the  license,  use or  distribution  of the
Company's  proprietary  technology  have been  obtained in New  Zealand.  If the
Company  and MNZ are unable to agree upon the amount of the  Guaranteed  Minimum
Royalty,  the  Company  may  terminate  the  license  on  thirty  days'  notice.
Commencing on the first sale to a user by MNZ, the Company shall receive a sales
royalty in an amount  equal to ten percent of MNZ's gross annual sales under the
License Agreement.

Pursuant to the Managing Agent Agreement, MNZ will act as the Company's agent in
the finding of other  licensees of the  Company's  patents and  trademark in the
following countries: Autralasia (including Australia and New Zealand), the South
Pacific  Islands and South East Asia (including the  Philippines,  Indonesia and
Vietnam).  Licensing fees obtained as a result of the Managing  Agent  Agreement
shall be divided  between the  Company  and MNZ on a sliding  scale as set forth
below:
                                                               Medizone
                                        Medizone              New Zealand
                                   International, Inc.          Limited
                                   -------------------        -----------

Initial license                          50%                      50%

Subsequent license
fees up to $500,000                      50%                      50%

Subsequent license fees
between $500,000 and $750,000            75%                      25%

Subsequent license fees in
excess of $750,000                       85%                      15%

MNZ and the  Company  will also  divide any net  royalties  paid to the  Company
pursuant to any license obtained pursuant to the Managing Agent Agreement,  with
MNZ being paid 10% of the net royalties and the Company receiving 90% of the net
royalties.

The Managing Agent  Agreement  shall expire on the  termination or expiration of
the  last  of  the  licenses  obtained  pursuant  thereto,  subject  to  earlier
termination by the Company upon an occurrence of certain events.

Pursuant  to  Emerging  Issues  Task  Force  Statement  No.  89-7,  the  Company
recognized a $100,000 gain on the sale of MNZ to Solwin.

                                      F-15

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


1.   NATURE OF THE BUSINESS (continued)-

Business Activities
-------------------

The Company's  objective is to gain regulatory  approval for the medical uses of
ozone to  inactivate  certain  viruses and to assist in the treatment of certain
diseases and to develop,  promote and distribute ozone- generating equipment and
related products for medical applications.

By letter agreement with the Italian Scientific Society for Oxygen-Ozone Therapy
(ISSOT) in Bergamo,  Italy,  dated March 23,  1993,  the Company  entered into a
collaborative  arrangement to research and examine the efficacy of ozone therapy
and the Company's  technology in the treatment of various  blood-  related human
diseases. The research is to be conducted by ISSOT in Italy, under the direction
of a research group assembled by the Italian Ministry of Health.

On May 16, 1994, the Company announced that human trials were to commence at the
University of Naples  ("Naples").  However,  after the  termination of Joseph S.
Latino's employment with the Company,  the Company's inquiry into the conduct of
its operations  during Dr. Latino's tenure as its Chairman,  President and Chief
of Research  disclosed that human clinical trials of the Company's ozone therapy
on patients  infected with either Acquired  Immunodeficiency  Syndrome (AIDS) or
Hepatitis B (chronic  active) has not been  authorized by Naples or commenced at
that  institution.  The Company also learned that the Italian Ministry of Health
had not issued  approvals for human clinical trials to commence at certain sites
as  previously  disclosed.  While the ethics  committees  at certain  university
hospitals have stated their approval for the Company to conduct Phase II trials,
they would require the Company to have either completed a large animal study and
Phase I human clinical trials or to have these requirements  waived. The Company
has never  performed a large animal study or Phase I human  clinical  trials and
does not  possess  the  necessary  data with  respect  to its ozone  therapy  to
commence Phase II study. However, there does exist a broad use and understanding
of ozone  therapy  throughout  Europe  and there have been  numerous  scientific
articles  published in European medical journals  describing the use of ozone on
humans.

The Company has held discussions with an Italian Contract Research  Organization
(the "ICRO") with a view to having the ICRO act as an intermediary on behalf the
Company with the Italian Ministry of Health and prepare a written  submission to
the Italian  Ministry of Health regarding the data in the public domain on ozone
therapy  with a view to  having  the  Italian  Ministry  of Health  accept  this
material as proof of safety,  toxicity and tolerance of the use of the Company's
ozone  technology on humans in lieu of having the Company perform a large animal
study and possibly  even a Phase I human  clinical  trials.  The ICRO would also
design a research  program and protocols for human  clinical  trials which would
meet the standards of the European Union ("EU") and Food and Drug Administration
("FDA"), monitor the clinical terms and collect and prepare analyses of the data
produced  by the  trials.  The  Company  will not be able to enter into a formal
contract  with the ICRO  unless it obtains  additional  funding.  If the Italian
Ministry  of Health does not accept the  published  evidence on the use of ozone
therapy on humans, the Company will be required to perform its own Phase I human
clinical  trials and possibly a large animal  study.  In late 1997,  the Company
entered into discussions with Italian and Belgium clinicians with regard to them
performing Phase I human clinical trials. However, assuming the Italian Ministry
of Health did not grant the Company's  request for waiver,  no formal agreements
with these  clinicians would be signed and the studies would not begin until the
Company obtains additional funding.  The Company estimates that it would require
an  infusion  of  approximately  $1.5  million  to advance  the  above-described
research initiatives through the completion of a Phase III human clinical trials
and submission of the data for approval to the Italian Ministry of Health.


                                      F-16
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


2.   CHANGES IN MANAGEMENT CONTROL AND LITIGATION AGAINST FORMER MANAGEMENT

Changes in Control
------------------

In November 1992,  four directors  resigned from the Board of Directors.  Two of
the outgoing directors,  who were the founding shareholders of the company, were
also the Company's  sole  officers  (former  management  or former  officers and
directors), and they resigned from these management positions as well. Three new
directors  were elected by the outgoing  directors  and three new officers  (new
management)  were then appointed on an interim basis,  to serve until the formal
election of directors and  appointment of officers at the next annual meeting of
shareholders.

On July 7, 1996,  at the  Company's  annual  meeting,  Joseph S. Latino,  George
Handel,  Kenneth Gropper,  John D. Pealer and Richard G. Solomon were elected to
the  Company's  Board of  Directors.  On July 31,  1996,  Lawrence I. Sosnow and
Howard L. Feinsand  were  appointed to the  Company's  Board of  Directors.  Mr.
Sosnow and Mr.  Feinsand  resigned as directors on October 1, 1996 and March 26,
1997,  respectively.  Richard G. Solomon  resigned as a director on February 27,
1997.

On May 14, 1997, the Company's  Board of Directors  terminated the employment of
Joseph L. Latino  ("Latino") as the Company's  President and Chairman  after the
discovery of a pattern of unaccounted for  expenditures of the Company's  funds.
The  Company  is  investigating   the  purposes,   nature  and  extent  of  such
expenditures. Dr. Latino remained a director of the Company until he resigned in
August 1997.  George  Handel  ("Handel")  was named  President  and Chairman and
served as such until May 19, 1997 when Kenneth Gropper ("Gropper") assumed these
positions.

Contemporaneously  with the above events, the Company was notified that The Sand
Dollar Solution, a California limited partnership ("Sand Dollar"), whose general
partner is Edwin G. Marshall ("Marshall"), was soliciting shareholder proxies to
vote for Marshall, Milton G. Adair ("Adair"),  Gerard V. Sunnen, M.D. ("Sunnen")
and William M. Hitt, Ph.D., M.D. ("Hitt") as directors.

On June 12, 1997, the Company's Board of Directors  appointed  Marshall,  Adair,
Sunnen and Hitt to the Company's  Board of Directors,  with Marshall being named
Chairman.  Contemporaneously  thereto,  John  Pealer  ("Pealer")  resigned  as a
director,  and Gropper  resigned as President.  George Handel  resigned from the
Board   effective  June  13,  1997.  The  Board  thereupon  made  the  following
appointments to the following positions:

            President and Chief
            Executive Officer                       Milton G. Adair
            Chief Operating Officer                 Kenneth Gropper
            Secretary                               Gerard V. Sunnen, M.D,

On November  5, 1997,  the Board  eliminated  the  position  of Chief  Operating
Officer. Gropper remains as a Director of the Company.

                                      F-17

<PAGE>

                 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


2.  CHANGES IN MANAGEMENT CONTROL AND LITIGATION AGAINST FORMER
    MANAGEMENT (Continued)-

Litigation Against Former Management
------------------------------------

In November 1992, a derivative  action was filed in the U.S.  District Court for
the District of New Jersey by two shareholders of the Company against two of its
former officers and directors.  The Company was named as a nominal  defendant in
the action but in January 1993, the Company  substituted  itself as a real party
plaintiff.  The Company filed an amended complaint seeking damages and equitable
remedies  and  alleging,  among  other  things,  that the  former  officers  and
directors  defrauded  the  Company,   breached  fiduciary  duties  owed  to  the
shareholders, and committed violations of federal securities laws.

In November 1993, the defendants  replied to the  counterclaims  asserted by the
Company.  The reply  contained  additional  counterclaims  seeking  monetary and
injunctive  relief under various  provisions of the federal  securities laws and
the common law. The defendants also asserted a derivative counterclaim on behalf
of the Company against  certain current and former  directors based upon alleged
breaches of a written  agreement  between the defendants and the Company's board
of directors.  Although the claims originally  asserted by the defendants in the
New York action sought only declaratory relief, the newly asserted claims sought
damages in excess of $2.0 million.

On May 18, 1994, the parties reached  agreement in principle to settle all their
litigation.  On September 27, 1994, the parties  stipulated to  discontinue  the
action pending the  finalization  of the  settlement.  On December 28, 1994, the
written settlement  agreement was signed. The settlement  agreement provides (I)
that  Messrs.  McGrath  and  Watrous  will not  challenge  the  validity  of the
Company's  Board of Directors  resolution  to rescind  approximately  13,000,000
shares of the Company's stock previously issued to Mr. McGrath and approximately
1,200,000 shares previously issued to Mr. Watrous and to reinstate the Company's
debt to Messrs.  McGrath and Watrous  that had been  retired by the  issuance of
those shares; and (ii) for the Company to acknowledge the validity of $2,033,628
of debt to Messrs.  McGrath and Watrous. In connection with the settlement,  Mr.
McGrath  assigned his portion of the above mentioned debt to Mr. Watrous,  which
was thereupon  satisfied by the Company's  issuance to Mr. Watrous of 11,250,000
shares of the Company's  common stock  restricted  under the  Securities  Act of
1933.

3. GOING CONCERN

Continuation  of the  Company as a going  concern is  dependent  upon  obtaining
additional capital, obtaining the requisite approvals from the FDA and/or the EU
for the marketing of ozone-related products and equipment, and ultimately,  upon
the  Company's  attaining  profitable  operations.  The Company  will  require a
substantial  amount of  additional  funds to  complete  the  development  of its
products, to establish manufacturing  facilities, to build a sales and marketing
organization  and to fund  additional  losses which the Company expects to incur
over the next several years.

Because  ozone-generation  for the purposes of interfacing  with blood and blood
products is regarded as a new drug  delivery  system,  the Company is  precluded
from selling or distributing  Medizone (the drug) or the Medizone  Technology in
the United States until after FDA approval has been granted.  In order to obtain
FDA  approval,  the Company  will be  required to submit a New Drug  Application
("NDA") for review by the FDA.

                                      F-18

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


3. GOING CONCERN (continued)-

and provide  medical and  scientific  evidence  sufficient to  demonstrate  that
Medizone (the drug) and the Medizone  Technology has been  successfully  used in
pre-clinical  studies  followed  by three  phases of well-  controlled  clinical
studies using human volunteer subjects.  The FDA will not grant an NDA unless it
contains  sufficient medical evidence and data to permit a body of qualified and
experienced  scientists  to  conclude  that  the new  drug  product  is safe and
effective for its recommended and proposed medical uses.  Historically,  the FDA
has held a strong bias against treating humans with ozone, due largely to issues
of safety.

In order to initiate the first phase (i.e.,  Phase I) of human  clinical  trials
required as part of an NDA, an applicant  must submit to the FDA an  application
for an  Investigational  New Drug Exemption  ("IND"),  which  contains  adequate
information  to satisfy  the FDA that  human  clinical  trials can be  conducted
without exposing the volunteer human subjects to an unreasonable risk of illness
or injury. The Company submitted an IND application  (assigned to the Company by
its former  president) to the FDA on October 6, 1985, and requested FDA approval
to commence human clinical trials using  ozone-oxygen to inactivate HIV. The FDA
deemed the IND application to be incomplete, and required the Company to conduct
additional  animal  studies  prior to  commencing a large animal study and human
trials.  In  September  1994,  after not  receiving  responses  to requests  for
information from the Company, the FDA inactivated the Company's IND. The Company
has no present plans to commence a large animal study, which would require, as a
precursor,  additional small animal and laboratory work. Accordingly,  there can
be no assurance that the Company's IND application will ever be re-opened. Until
an NDA has been granted to the Company,  it may not distribute  ozone-generating
devices, except to researchers who agree to follow FDA guidelines,  and provided
the devices are labeled as "Investigational Devices."

Because ozone has been used to treat humans in Europe for at least 30 years, the
EU is more accepting of human clinical trials of ozone therapies being conducted
than is the United  States.  Accordingly,  Management  believes that the Company
should pursue the option of conducting  human clinical  trials in Europe,  using
stringent  protocols  that will meet EU standards,  with a view to utilizing the
results  of such a trial in an  effort  to obtain  EU  approval,  to market  the
product in Europe and to re-open the Company's FDA file.

The management of the Company intends to seek  additional  funding which will be
utilized  to fund  additional  research  and  continue  operations.  The Company
recognizes  that, if it is unable to raise  additional  capital,  it may find it
necessary to substantially reduce or cease operations.

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation
---------------------------

The consolidated financial statements include the accounts of the Company MCL, a
66.6%  owned   subsidiary,   and   Medizone-Delaware   (an  inactive   company).
Intercompany transactions have been eliminated.

Cash and Cash Equivalents
-------------------------

The Company considers all highly liquid instruments purchased with a maturity at
the time of purchase of less than three months to be cash equivalents.

                                      F-19

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)-

Fixed Assets
------------

Fixed  assets  are  stated  at  cost.   Depreciation   is  computed   using  the
straight-line  method  over five  years for office  equipment  and ten years for
furniture  and  fixtures.  Maintenance  and  repairs  are  charged to expense as
incurred.  Upon  retirement  or sale,  the cost of the assets  disposed  and the
related accumulated depreciation are removed from the accounts and any resulting
gain or loss is credited or charged to income.

Other Assets - Organization Costs
---------------------------------

Organization  costs were  deferred  and  amortized  over a 60-month  period on a
straight-line basis.

Loss per Share
--------------

The  computation  of  primary  loss per  share of  common  stock is based on the
weighted average number of shares outstanding during the period.

Stock-Based Compensation
------------------------

In October 1995, the Financial  Accounting  Standards Board issued  Statement of
Financial Accounting Standard No. 123, Accounting for Stock-Based  Compensation.
The Company currently accounts for its stock-based  compensation plans using the
accounting  prescribed by Accounting Principles Board Opinion No. 25, Accounting
for Stock  Issued to  Employees.  Since the Company is not required to adopt the
fair value based  recognition  provisions  prescribed under SFAS No. 123, it has
elected to comply with the disclosure  requirements  set forth in the Statement,
which includes disclosing pro forma net income as if the fair value based method
of accounting had been applied. (See Note 8.)

Estimates and Assumptions
-------------------------

Management uses estimates and assumptions in preparing  financial  statements in
accordance with generally accepted  accounting  principles.  Those estimates and
assumptions  affect  the  reported  amounts  of  assets  and  liabilities,   the
disclosure of contingent  assets and liabilities,  and the reported revenues and
expenses.  Actual  results  could vary from the  estimates  that were assumed in
preparing the financial statements.

5. OTHER ASSETS

Patent
------

In  March  1987,  the  Company  acquired  a  patent  from  Immunologics  Limited
Partnership in exchange for 1,000,000  shares of the Company's  common stock. In
1988,  Immunologics  purchased  for $25,000,  5,000,000  shares of the Company's
common  stock  from the  former  Chairman  and Chief  Executive  Officer  of the
Company.

                                      F-20
<PAGE>


                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


5. OTHER ASSETS (continued)-

Patent (continued)
------

The patent  covers a  procedure  for "ozone  decontamination  of blood and blood
products" through the treatment of stored blood and blood components.  The Board
of Directors assigned a value of approximately $700,000 to the patent based upon
the fair  market  value of the stock on the date of  acquisition  together  with
related legal costs.  The Company charged the cost of the patent to research and
development  expense at  acquisition  because  the  technologies  covered by the
patent have not been approved by the FDA.  Additionally,  the Company  agreed to
pay the seller a royalty  fee equal to 3% of the net  receipts  received  by the
Company in connection  with the sale of any product,  device or apparatus  which
embodies the patent.  The Company's  management  considers the  acquisition  and
retention  of the patent to be material in its  development  and  prospects.  In
1992, the General Partner of Immunologics became chairman of the Company's Board
of Directors and subsequently  resigned from the Company's Board of Directors in
September 1993.

License Agreement
-----------------

On  February 4, 1986,  Medizone,  in  exchange  for shares of its common  stock,
acquired  from a  principal  stockholder  his  interest  in a license  agreement
covering the distribution of ozone-generating  equipment.  The license agreement
was carried at $1.00 through  December 31, 1991;  as that was the  stockholder's
basis, and was written off as of December 31, 1992.

6.  COMMITMENTS AND CONTINGENCIES (See also Notes 7 and 10)

On May 14. 1997, the employment  contract of the Company's  former President and
Chief Operating  Executive Officer was terminated for cause. The Company hired a
new President and Vice President of Operations (who is not a corporate  officer)
at annual  salaries of $200,000 and $65,000  respectively,  The Company does not
have a written  employment  agreement  with its  President or Vice  President of
Operations.  The employment contract of the Company's Vice President,  Treasurer
and Chief  Financial  Officer for an annual  salary of $72,000 plus expenses has
remained unchanged.

In 1996 and 1995,  the Company had employment  contracts with two officers.  The
former President and Chief Operating  Officer was paid $180,000 annually and was
reimbursed  monthly  for  expenses  related  to a  leased  automobile.  The Vice
President,  Treasurer and Chief Financial Officer is paid $72,000 annually, plus
expenses.

The Company retains an investor  relations firm to act as the Company's  liaison
with the brokerage community. The agreement is for a period of one year, but may
be  extended  by the  parties for  additional  one year  periods.  It receives a
monthly payment of $2,000, plus expenses. As additional compensation in 1996, it
received  250,000  shares of the Company's  common stock,  restricted  under the
federal securities laws.

In 1994, the Company had consulting  relations with two officers.  The President
and Chief Operating Officer was paid $72,000 annually and was reimbursed monthly
for expenses related to a leased automobile.  The Vice President,  Treasurer and
Chief Financial Officer was paid $36,000 annually.

                                      F-21

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


6.  COMMITMENTS AND CONTINGENCIES (See also Note 7 and 10) (continued)-

From  November  17, 1992  through  December  31, 1994 the Company  maintained  a
consulting relationship with the Company's Vice President, who is also Treasurer
and Chief Financial  Officer,  whereby the Company was billed in connection with
accounting  services  provided by a private  company owned by the Company's Vice
President.

For the year ended December 31, 1996,  the Company  leased from an  unaffiliated
party, office space in New York City under a two-year lease expiring on February
28, 1998, at an annual rental of approximately  $21,000.  The Company terminated
this lease in June 1997 and paid  $4,599 to the  landlord in  settlement  of any
claim for unpaid  rent under the lease.  On  September  23,  1997,  the  Company
entered into a three-year lease with an unaffiliated third party for its present
offices in Salt Lake City at an annual rent of approximately $23,000. The office
is used for executive offices and administrative purposes. Future minimum rental
commitments pursuant to this lease are as follows:

            Year Ended
            December 31,                            Amount
            ------------                            ------


               1997                               $  5,746
               1998                                 23,214
               1999                                 24,144
               2000                                 18,649

               Total                              $ 71,753

During 1992, a financial  consulting entity agreed to raise equity financing for
Medizone. An agreement was executed requiring the Company to tender $50,000 to a
third party whose obligation was to hold the funds in escrow pending  completion
of the  financing;  however,  these sums were not tendered at that time.  In the
event of completion of the financing,  the $50,000 would be released from escrow
to the  consultant  to defray  legal  fees of the  consultant.  In the event the
financing failed to be completed,  the funds were to be returned to the Company.
In a separate transaction during 1992, the Company sold 250,000 shares of common
stock to five investors for $50,000, and caused the proceeds to be paid directly
to the third party in the pending financing  transaction.  Medizone acknowledged
constructive receipt of the funds by executing stock purchase agreements and the
250,000  shares were  subsequently  issued in 1993.  Since the financing was not
completed  and the funds were not returned to the Company,  the $50,000 has been
expensed in the Company's financial statements.

On or about June 6, 1994,  Maureen Abato,  the Company's former outside counsel,
filed  suit in the  Supreme  Court of the State of New York,  County of New York
entitled Abato V. Medizone International, Inc., Medizone Canada, Ltd. and Joseph
S. Latino. The complaint contains thirteen causes of action. Three of the causes
of action are for breach of  contract,  account  stated and  quantum  meruit for
recovery of unpaid  legal fees  allegedly  due  plaintiff  by the Company in the
amount of $67,864.  The remaining  claims are for fraud,  wrongful  termination,
sexual  discrimination,  defamation,  tortious  interference  with  contract and
intentional  infliction  of  emotional  distress.  With respect to each of these
causes of action,  plaintiff seeks unspecified compensatory damages and punitive
damages of not less than $1 million.

                                      F-22

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


6.  COMMITMENTS AND CONTINGENCIES (See also Note 7 and 10) (continued)-

On October 24,  1994,  the Company  and the other  defendants  moved for partial
summary judgment dismissing all of plaintiff's claims except her legal fee claim
based on quantum  meruit.  By decision and order dated  February  14, 1995,  the
Court dismissed all of the plaintiff's  claims except for breach of contract and
for an account  stated;  however,  the court  limited  plaintiff's  claim to her
actual damages and dismissed her claim for punitive damages on these counts.  In
addition, the court dismissed these claims in their entirety as against Medizone
Canada, Ltd. and Dr. Latino.

A Stipulation of Settlement was executed by the parties, dated October 30, 1995,
whereby the Company  agreed to pay $61,000 in full  settlement  of all remaining
claims, to be paid as follows:

            November 15, 1995                 20,000
            December 15, 1995                  5,000
            January 15, 1996                   5,000
            February 15, 1996                  5,000
            March   15, 1996                   5,000
            April 15, 1996                     5,000
            May 15, 1996                       5,000
            June 15, 1996                      5,000
            July 15, 1996                      6,000

            Total                           $ 61,000
                                             =======

As of the date of this report, all payments have been made in full.

          On  November  10,  1995,  the  plaintiff  executed  a release  against
Medizone International, Inc., Medizone Canada Ltd. and Joseph S. Latino.

7. ISSUANCE OF COMMON STOCK AND WARRANTS

At December 31, 1996,  there were  41,639,323  shares and  88,412,290  shares of
restricted and unrestricted common stock outstanding respectively.

Unless  otherwise  stated,  all  transactions  shown  below were with  unrelated
parties and the securities issued were restricted.

Madison initially issued 1,500,000 shares in a private  transaction for proceeds
of $3,000.

In May 1985, Madison sold in a public offering, 4,000,000 shares of common stock
and  8,000,000  warrants  to  purchase a common  stock at $0.10 per  share.  The
proceeds from the offering to Madison were  $200,000.  The costs of the offering
were offset against paid-in capital.

On  March  26,  1986,   Madison  issued   37,500,000  shares  of  common  stock,
representing  87.2% of the  then  outstanding  shares,  to the  stockholders  of
Medizone,  including  two  officers  and  directors,  in exchange for all of the
shares of Medizone.  The costs of the  transactions  were offset against paid-in
capital.

                                      F-23

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


7. ISSUANCE OF COMMON STOCK AND WARRANTS (continued)-

In July 1986,  the Company  issued 50,000 shares of common stock to  individuals
for services rendered.

During  the  period  from  August  1986  through  October  31,  1986,  the final
expiration  date for exercise,  warrants to purchase  7,814,600  shares together
with cash  totaling  $781,460  were  received by the  Company  which then issued
7,814,600  shares of new common stock.  In January  1987,  an  additional  2,600
shares were issued in exchange for warrants and cash of $259.

In March 1987, the Company issued  1,000,000  shares of common stock in exchange
for a patent (see Note 5).

In June 1987,  the  Company  issued  950,000  shares to  individuals  in private
transactions for aggregate proceeds of $150,000.

During the period from June 1987 through July 1987,  the Company  issued 203,167
shares of common stock to various vendors and individuals for services  rendered
in 1986 and 1987.

On August 26,  1987,  an officer of the  Company  exercised  options to purchase
250,000  shares of common stock.  In January 1988, two holders  exercised  their
options and acquired an aggregate of 200,000 shares of common stock.

On September  26, 1988,  the Company  sold,  in a private  placement,  1,000,000
shares of common stock at $0.08 per share to an individual.

During  1988,  the Company  issued a total of 35,000  shares of common stock for
services.

During  1989,  the  Company  issued  261,889  shares of common  stock to various
vendors and individuals for services rendered in 1988 and 1989.

During 1989,  the Company  issued  5,790,000  shares to  individuals  in private
transactions for aggregate proceeds of $291,500.

Also during 1989,  the Company  satisfied  obligations  for notes payable to and
accrued interest due to unrelated  individuals totaling $377,539 by the issuance
of 3,899,532 shares of common stock. The Company issued 250,000 shares of common
stock to an officer and 600,000  shares of common stock to three advisors to the
Company  as  additional  compensation  for  work  done  for the  Company.  These
issuances  were ascribed  values of $60,650 and $145,539,  respectively,  by the
Company.  Also during 1989, two holders  exercised their options and acquired an
aggregate of 375,000 shares of common stock.

During 1990,  the following  equity  transactions  occurred:  The Company issued
4,250,000 shares to individuals in private  transactions for aggregate  proceeds
of $179,500;  the Company satisfied  obligations totaling $125,000 to the former
vice president, secretary and treasurer as well as director by issuing 2,272,727
shares of common stock at $0.55 per share; the Company  satisfied an outstanding
account payable to an unrelated  individual  totaling $15,000 by the issuance of
150,000 shares of common stock at $0.10 per share;  and the Company issued to an
employee and four other unrelated  persons as compensation or payment a total of
880,000 shares of common stock to which it ascribed a value of $88,000.

                                      F-24
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


7. ISSUANCE OF COMMON STOCK AND WARRANTS (continued)-

During 1991,  the following  equity  transactions  occurred:  The Company issued
4,366,667 shares to individuals in private  transactions for aggregate  proceeds
of $310,000;  the Company  issued a total of 425,000  shares of common stock for
services and accrued  liabilities  of which an aggregate of 100,000  shares were
issued to two directors;  and three holders exercised their options and acquired
an aggregate of 450,000 shares of common stock.

During 1992,  the following  equity  transactions  occurred:  The Company issued
2,702,335 shares to individuals in private  transactions for aggregate  proceeds
of $430,350;  the Company  issued a total of 401,500  shares of common stock for
services  and accrued  liabilities;  holders  exercised  options and acquired an
aggregate of 250,000  shares of common  stock.  Also,  during  1992,  13,118,619
restricted  shares of the Company's stock were issued pursuant to an approval by
the Company's board of directors in December 1989 to the former president, chief
executive  officer and board chairman for the settlement of $813,367 of advances
made to the Company.

During 1993,  the following  equity  transactions  occurred:  The Company issued
1,471,666 shares to individuals in private  transactions for aggregate  proceeds
of $271,000;  the Company issued a total of 5,347,219 shares of common stock for
services;  the Company canceled the 13,118,619  shares of common stock issued in
1992 to the former president,  chief executive officer and board chairman.  As a
result  of this  cancellation  of  shares,  the debt that was  removed  from the
Company books when the shares were issued,  was restored.  The restored debt was
$813,367.  Also,  during  1993,  a total of  $261,915  was  received in cash for
2,619,150  shares  subscribed  as a  result  of  a  private  placement  offering
(Offering).  The Offering  commenced as of November 26, 1993,  with a maximum of
$700,000 to be raised in gross proceeds from the sale of up to 7,000,000 shares.

During 1994, the following equity  transactions  occurred:  The Company issued a
total of 1,431,590  shares of common stock for  services;  the Company  issued a
total of 1,125,834  shares of common stock to certain prior purchasers of common
stock in recognition of disparity in purchase in contemporaneous  Offering. Also
during  1994,  a total of $680,040  was  received in cash for  6,800,499  shares
subscribed  as a  result  of  the  Offering.  Subsequent  to  the  Offering,  an
additional  $316,860 was received in cash from foreign investors  subscribing to
3,168,600  shares of common stock.  On December 28, 1994, the Company  settled a
dispute  regarding  the validity of notes  payable to former  management  in the
amount of $2,033,628 (see Note 2) by agreeing to issue 11,250,000  common shares
(recorded as shares subscribed) in satisfaction of the total amount of the debt.

Also in 1994,  $40,000 of notes  payable (a portion of loans  totaling  $60,000)
together with interest, was satisfied by issuing 416,500 shares of common stock.
(See Note 10.)

During 1995, the following equity  transactions  occurred:  The Company issued a
total of 2,050,000  shares of common stock for  services.  $911,825 was received
from investors  subscribing to 9,118,260 shares of common stock. Also, 7,524,860
common  shares,  previously  recorded as shares  subscribed,  were  issued,  and
1,242,727 were retired in accordance  with the settlement  agreement with former
management  (see  Note 2).  Two  hundred  thousand  of  redeemable  shares  were
converted  into  common  stock.  The  Company  sold  shares  of its New  Zealand
subsidiary for aggregate proceeds of $150,000.

During 1996, the Company received stock subscription agreements for the purchase
of  7,254,470  shares of its  common  stock,  together  with  proceeds  totaling
$725,447 from sales of its securities to non-United States investors, outside of
the United States pursuant to Regulation S promulgated  under the Securities Act
of 1993.

                                      F-25
<PAGE>


                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7. ISSUANCE OF COMMON STOCK AND WARRANTS (continued)-

(the "Securities Act").  Approximately  $635,447 of these proceeds were from the
sale of the  Company's  common  stock at a per  share  price of $.10  (including
$37,500 for 375,000  shares from Richard G.  Solomon,  at the time a director of
the Company).  The remaining  $90,000 were from the sale of 900,000 Units,  each
Unit consisting of one share of the Company's common stock,  $.001 par value, at
a per share  price of $.10 to a director  pursuant  to the  non-public  offering
exemption from  registration  under the Securities Act. In May 1996, the Company
issued 600,000 shares of its common stock to employees and 250,000 shares of its
common stock to its public relations consultant as additional compensation.  The
Company also issued  565,875  shares of its common stock to various  consultants
for services rendered.

8. STOCK OPTIONS

During 1986, the Company  granted  nonqualified  options to a number of persons,
consisting of an officer,  employee and consultants to the Company,  to purchase
an aggregate  of  1,150,000  shares of common stock of the Company at an initial
exercise price of $.25 per share, the estimated fair value at the date of grant.

During 1988,  the Company  granted a  nonqualified  option to a newly  appointed
member of the Board of  Directors  of the Company to purchase  an  aggregate  of
150,000  shares of common stock of the Company at an exercise price of $.001 per
share. The options were exercisable  50,000 shares on each of November 29, 1989,
1990 and 1991 and were to expire on November 29, 1994.  This director  exercised
the option which became exercisable on November 29, 1989 and resigned on January
22, 1990.

During 1989, in consideration  for services rendered over the prior three years,
the Company  granted to a member of it Scientific  Advisory Board a nonqualified
option to purchase  325,000 shares of common stock of the Company at an exercise
price of $.001 per share. This option was exercised in 1989.

During 1990, in consideration  for services  rendered over the prior four years,
the Company granted to a member of its Scientific  Advisory Board a nonqualified
option to purchase  150,000  shares of common stock of the Company at an initial
exercise price of $.10 per share. This option was exercised in 1991.

All options were  exercisable for a period of five years beginning one year from
the date of  grant.  Compensation  expense,  measured  as to the  excess  of the
estimated  fair value over the  exercise  price,  was  accrued  over the service
period. If, on the date of exercise,  the estimated fair value of a share of the
Company's  common  stock  exceeded the exercise  price,  the exercise  price was
decreased by a like amount (but not below the par value of $.001). At the end of
each fiscal period,  total accrued  compensation  was recorded as the difference
between the adjusted  exercise price and the fair market value at the end of the
period for all exercisable  shares. The total accrued  compensation was adjusted
each year for changes in the fair market  value of the  Company's  stock and for
option exercises and cancellations.

The shares issued in connection with the exercise of the options were restricted
shares to be held for investment purposes only.

In 1995, as part the their employment  agreements,  the Company's  president and
chief executive  officer,  and  vice-president  and chief financial  officer and
treasurer, were granted options to purchase an aggregate of 4,500,000.

                                      F-26
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


8. STOCK OPTIONS (continued)-

shares of the  Company's  common  stock at an exercise  price of $.20 per share,
which vest fully on January 1, 1998 over the following vesting schedule;  33% on
January 1, 1996,  33% on January 1, 1997,  and 33% on January 1, 1998.  The fair
value  of  each  option   grant  is   estimated  on  the  grant  date  using  an
option-pricing  model with the following  weighted-average  assumptions used for
grants in 1995: risk-free interest rate of 6%, and expected lives of 3 years for
the options.

The following is a summary of option transactions:

                                                                Weighted Average
Fixed Options                               Shares               Exercise Price

Balance - January 1, 1995                      -                 $      -
Granted - Employees                            -                        -
Exercised                                      -                        -
Forfeited                                      -                        -
                                                                  -----------
Balance - December 31, 1995                    -                        -
Granted - Employees                       4,500,000                     .20
Exercised                                      -                         -
Forfeited                                      -
                                                                  -----------
Balance - December 31, 1996               4,500,000
                                          =========
Exercisable at December 31, 1996          1,500,000
                                          =========
Weighted-average fair value of options
   granted during the year               $     .16
                                          =========

The following table summarizes information about fixed stock options outstanding
at December 31, 1996:

                      Outstanding Options                    Exercisable Options
------------------------------------------------------------ -------------------

                          Weighted                                
                          Average      Weighted                   Weighted
Range of     Number       Remaining    Average   Number           Average
Exercisable  Outstanding  Contractual  Exercise  Exercisable      Exercise
Prices       12/31/96     Life         Price     at 12/31/96      Price
-----------  -----------  -----------  --------  -----------      --------

$.20          4,500,00      3 years      $.20     1,500,000         $.20

If the  Company  had used the fair  value  based  method of  accounting  for its
employee  stock option plan, as prescribed by Statement of Financial  Accounting
Standard No. 123,  compensation cost in net loss for the year ended December 31,
1996 would have  increased by $242,387,  and the Company's net loss and loss per
share would have been reduced to the pro forma amounts indicated below:

                                                      1996
                                                     ------
Net loss                      As reported          $1,329,395
                                Pro forma          $1,571,782
Net loss per share            As reported               $(.01)
                                Pro forma               $(.01)


                                      F-27
<PAGE>

                 MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


9. MINORITY INTEREST

In June 1988, MCL issued 2,000,000 units consisting of one share of common stock
and two  warrants  which allow the holder to purchase  one share of common stock
per warrant.  The warrants are exercisable at $.125 per share.  The net proceeds
of this offering were $84,024.  The warrants were originally scheduled to expire
on December 31, 1992 but were extended to December 31, 1995. In 1988, MCL issued
1,938,000 shares of common stock at $.005 per share to a consultant for services
rendered.  Following  these  transactions,  the  Company's  ownership of MCL was
72.2%.

In 1990,  MCL issued  983,333 shares of common stock at prices ranging from $.05
to $.075 in private  offerings to two individuals  unrelated to MCL for proceeds
of $57,400.  MCL also issued 850,000 shares to five individuals,  550,000 shares
to the three directors of MCL, 50,000 shares to an employee,  and 250,000 shares
to a consultant  for  services  rendered to which MCL assigned the value of $.05
per share  for an  aggregate  of  $42,500.  Following  these  transactions,  the
Company's  ownership of MCL was 68,6%.  These  transactions  had previously been
incorrectly  reported as minority  interest.  Minority  interest should not have
been recorded on the balance sheet because of the magnitude of the stockholders'
deficiency of these  stockholders.  Accordingly,  amounts  previously  stated as
minority interest have been restated to additional paid-in capital.

10.   NOTES PAYABLE

Short-term debt at December 31, 1996 and 1995 consisted of the following:

<TABLE>
<CAPTION>
                                                                                       1996         1995
                                                                                     --------     --------
<S>                                                                                <C>           <C>
Notes payable to ten stockholders, due on demand, plus interest at 10% per annum
   (in arrears).  The Company is obligated to accept the rate at face value plus
   accrued  interest as partial  payment for shares the lender may purchase from
   the Company upon exercise of the lender's option to acquire
   shares from the Company.                                                           $60,815      $60,815

Notes payable to directors  totaling $28,000 and a note payable to a third party
   in the  amount  of  $9,000,  due on April 22,  1995  (principal  and  accrued
   interest in arrears as of report date),  plus interest  ranging from 8% to 9%
   per annum.  Each lender has the right to convert any portion of the principal
   and  interest  into common  stock at a price per share equal to the price per
   share under the most recent private placement transaction.                          37,000       37,000

Notes payable to  directors  and a family  member of a director,  due at various
   dates in 1995, 1996 and 1997 (principal and accrued interest in arrears as of
   report  date),  plus  interest at 8% per annum.  The Company has the right to
   repay  the  loans  with  restricted  stock at $.10 per  share if  alternative
   financings do not occur.                                                           194,500       50,000
</TABLE>



                                      F-28

<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


10.   NOTES PAYABLE (continued)-

<TABLE>
<CAPTION>
<S>                                                                                 <C>           <C>              
   Note payable to  individual,  due on December 2, 1996  (principal and accrued
   interest in arrears as of report date), plus interest at 6.07% per annum. The
   Company has the right,  on or after the  payment due date,  to repay the loan
   with restricted shares valued at $.05 per share.                                    40,000         -
                                                                                     --------     --------

         Total short-term debt                                                      $ 332,315    $ 147,815
                                                                                     ========     ========
</TABLE>


11.   RESTATEMENTS OF PRIOR PERIODS (Unaudited)

Beginning in 1991,  the Company  began  selling off its holdings of MCL to raise
cash for operations. The Company sold 100,000 and 610,000 shares of MCL's common
stock  during  1991 and 1992,  respectively,  through a broker  for  $5,000  and
$81,100  at $.05 per share in 1991 and per share  prices  ranging  from $.093 to
$.179 in 1992.  Because the Company's  investment in MCL was only $2, the entire
$5,000  and  $81,100  were  recorded  as gains  in the  Company's  statement  of
operations  during the fourth  quarter of 1991 and the first  three  quarters of
1992, respectively. During the fourth quarter of 1992, an adjustment was made to
classify these sales as equity transactions.

The effect of these restatements is as follows:

<TABLE>
<CAPTION>
                                             Three Months Ended
------------------------------------------------------------------------------------------------------
               December 31, 1991  March 31, 1992  June 30, 1992  September 30, 1992  December 31, 1992
               -----------------  --------------  -------------  ------------------  -----------------
<S>               <C>              <C>             <C>              <C>                 <C>  
Net loss:
   Previously
   reported       $1,215,200       $ 151,930        $ 173,496        $ 147,905           $  89,510
   Adjustment          5,000          24,555             -              24,470              32,075
                   ---------        --------         --------         --------            --------

As adjusted       $1,220,200       $ 176,485        $ 173,496        $ 172,375           $ 121,585
                   =========        ========         ========         ========            ========
</TABLE>

These  restatements do not affect previously  reported loss per share because of
rounding.

See Note 9 for restatement of minority interest in prior years.

The Company has restated its  financial  statements  to reflect  adjustments  to
write off  liabilities  which were accrued and expensed in years prior to fiscal
1992. These adjustments  increased  previously reported  accumulated deficit and
reduced  previously  reported  results of operations (for the period January 31,
1986,  date of  inception,  through  December 31, 1994) by $219,422.  During the
first quarter of 1995, the Company  recorded a further  reduction to accumulated
deficit  in the  amount  of  $71,806  relating  to the  cancellation  of  shares
previously issued to former management.

                                      F-29
<PAGE>

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES
                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

12.   INCOME TAXES

The components of the provision for income taxes are as follows:

                                                      From the Date of Inception
                                                      (January 31, 1986) through
                                                           December 31, 1996
                             1996           1995           1994     (Cumulative)
                             ----           ----           ----     ------------
Current tax expense     $     -        $     -        $     -       $    -
Deferred tax expense          -              -              -            -
                         ------------   ------------   ----------    ----------

Income tax expense      $     -        $     -        $     -       $    -
                         ============   ============   ==========    ===========

A reconciliation  of the consolidated  income tax expense on income per the U.S.
Federal Statutory rate to reported income tax follows:

                             1996           1995           1994       Cumulative
                             ----           ----           ----       ----------
Taxes at U.S. Federal
Statutory rate          $     -        $     -        $     -        $    -
State income taxes            -              -              -             -
                         ------------   ------------   ----------     ----------

                        $     -        $     -        $     -        $    -
                         ============   ============   ==========     ==========

At December 31, 1996 and 1995,  deferred tax assets  (liabilities)  consisted of
the following:

                                                    1996                 1995
                                                   ------               ------
Current deferred tax liabilities              $      -            $       -
Noncurrent deferred tax liabilities                  -                    -
Current deferred tax assets                      1,651,738            1,470,725
Noncurrent deferred tax assets                       -                    -
Valuation allowance                             (1,651,738)          (1,470,725)
                                                ----------           ----------
                                              $      -            $       -
                                               ===========           ===========

At December 31, 1996,  the Company has a net operating  loss (NOL)  carryforward
totaling  approximately  $10,500,000  that may be offset  against future taxable
income in varying  amounts through 2005 No benefit has been reported in the 1996
or 1995 financial statements,  however, because the Company believes there is at
least a 50% chance that the carryforward  will expire unused.  Accordingly,  the
tax benefit of the loss carryforward has been offset by a valuation allowance of
the same  amount.  The  expected  tax benefit  that would  result from  applying
federal  statutory tax rates to the pretax loss differs from amounts reported in
the financial statements because of the increase in valuation allowance.

Under certain  circumstances,  Section 382 of the Internal  Revenue Code of 1986
restricts a  corporation's  use of its NOL  carryforward.  Due to the  Company's
issuance of additional stock, the Company's use of its existing NOL carryforward
could be limited.  Therefore,  the Company may have to pay federal  income taxes
sooner than if the use of its NOL carryforward were not restricted.

13.   REDEEMABLE COMMON STOCK

On February 12, 1993, per a settlement agreement (Agreement), the Company issued
200,000 shares of restricted  common stock to an unrelated  third party (Party).
According to the Agreement,  if net funds available  specified in the Agreement.

                  MEDIZONE INTERNATIONAL, INC. AND SUBSIDIARIES

                                      F-30

<PAGE>

                          (A Development Stage Company)
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


13.   REDEEMABLE COMMON STOCK (continued)-

If the Company files a registration statement for an offering of its securities,
it must  use its  best  efforts  to  include  such  shares  in the  registration
statement.  If all, or any portion of the shares have not been  purchased by the
Company  pursuant to the exercise of the put option  described above, or all the
shares  have not been  covered by an  effective  registration,  then the Company
shall be required to pay, no later than April 13,  1995,  an amount equal to the
lesser of $50,000 minus the aggregate  purchase  price amount  payable under the
formula set forth in the Agreement,  or $25,000.  In September 1995, the Company
paid $5,000 and issued  200,000  shares of  restricted  common stock in full and
final settlement of the Agreement.

14.   FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying  amounts  reflected in the  consolidated  balance  sheets for cash,
receivable from affiliate,  accounts  payable and notes payable  approximate the
respective values. The estimated fair values have been determined by the Company
using  appropriate  valuation  methodologies  and available market  information.
Considerable  judgment is necessarily  required in  interpreting  market data to
develop the  estimates of fair value,  and,  accordingly,  the estimates are not
necessarily  indicative  of the  amounts  that the  Company  could  realize in a
current market  exchange.  A comparison of the carrying value of those financial
instruments, none of which are held for trading purposes, is as follows:

            Carrying                           Fair
                                              Amount               Value
Assets:
Cash                                      $     3,579          $     3,579
Receivable from affiliate                      48,947               48,947

Liabilities:
Accounts payable and liabilities              627,294              627,294
Short-term debt                               332,315              332,315

Cash receivable from affiliate and accounts payable.  The carrying value of such
items approximates their fair value at December 31, 1996.

Short-term  debt. Fair value of such debt is based on rates currently  available
to the Company for debt of similar terms and remaining maturities.  There are no
quoted prices for the debt or similar debt.

                                      F-31

<PAGE>

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS


To the Board of Directors and Stockholders
  of Medizone Canada Limited

We have audited the  consolidated  balance sheets of Medizone Canada Limited and
subsidiary (a  development  stage company) as of December 31, 1996 and 1995, and
the related  statements of operations,  stockholders'  equity and cash flows for
the years ended December 31, 1996,  1995 and 1994,  and the period  November 18,
1987 (date of inception)  through December 31, 1996. These financial  statements
are the  responsibility of the Company's  management.  Our  responsibility is to
express an opinion on these financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards. Those standards require that we plan and perform the audits 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  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 above present fairly, in
all material  respects,  the financial  position of Medizone  Canada Limited and
subsidiary as of December 31, 1996 and 1995,  and the results of its  operations
and its cash flows for the years ended December 31, 1996, 1995 and 1994, and the
period  November 18, 1987 (date of  inception)  through  December  31, 1996,  in
conformity with generally accepted accounting principles.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company  will  continue  as a  going  concern.  As  discussed  in  Note 2 to the
financial  statements,  since its inception (November 18, 1987), the Company has
been in the development stage and has suffered  recurring losses from operations
and is  dependent  on its  majority  stockholder  to provide  funds to  continue
operations,  the continuation of the majority  stockholder as a going concern is
dependent upon the majority  stockholder  obtaining  additional  capital.  These
factors raise  substantial  doubt about the  Company's  ability to continue as a
going concern.  Management's plans in regard to these matters are also described
in Note 2. The financial  statements do not include any  adjustments  that might
result from the outcome of this uncertainty.


Salt Lake City, Utah
November 14, 1997




                                      F-32