SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-KSB

[X] ANNUAL  REPORT UNDER SECTION 13 OR 15(D) OF THE  SECURITIES  EXCHANGE ACT OF
    1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997

[ ] TRANSITION  REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES  EXCHANGE ACT
    OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _________

                           Commission File No. 0-19844
                                               -------

                                PARACELSIAN, INC.
                 ----------------------------------------------
                 (Name of small business issuer in its charter)


              Delaware                                       16-1399565
              --------                                       ----------
  (State or other jurisdiction of                          (I.R.S. Employer
  incorporation or organization)                           Identification No.)


222 Langmuir Laboratories, Cornell Technology Park, Ithaca, New York     14850
--------------------------------------------------------------------     -----
               (Address of principal executive offices)                 Zip Code


                    Issuer's telephone number: (607) 257-4224
                                               --------------

           Securities registered under Section 12(b) of the Act: None

              Securities registered under Section 12(g) of the Act:

                          Common Stock, $.01 par value
                          ----------------------------
                                (Title of class)

                    Redeemable Common Stock Purchase Warrants
                    -----------------------------------------
                                (Title of class)

Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Securities  Exchange  Act  during the past 12 months (or for
such shorter period that the registrant was required to file such reports),  and
(2) has been subject to such filing requirements for the past 90 days.

                                 Yes [X] No [ ]

Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation  S-B is not  contained  in  this  form,  and no  disclosure  will  be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]

Issuer's revenues for its most recent fiscal year were $ 6,146.

The  aggregate  market value of the voting stock (based on the closing  price of
such stock on NASDAQ) held by  non-affiliates  of the Registrant at December 22,
1997 was approximately $2,800,000.

There were  12,004,867  shares of Common Stock and 4,632,773  Redeemable  Common
Stock Purchase Warrants outstanding at December 22, 1997.


<PAGE>
ITEM 1.        BUSINESS

               Paracelsian,  Inc., (the  "Company") is a development  stage drug
discovery  and  discovery  and  research   service  company  that  utilizes  its
proprietary  screening  technology to identify novel therapeutic  compounds from
herbal  sources and to define the  biological  mechanisms  through  which herbal
medicines affect cellular function.  The Screening Technology has been developed
by the Company to identify  potential  products  that  regulate  the  biological
signals  generated by targeted  cells that result in controlled or  uncontrolled
cell growth and  division.  The  Company's  Screening  Technology  evaluates the
effects of herbal  products  on  intracellular  signals  referred  to as "Signal
Transduction Technology."

               Cellular  signaling  is one of the basic  steps in biology and is
necessary for normal growth of tissues to support life. The Company's technology
enables  researchers to observe signal  transduction  and measure the effects of
chemicals contained in synthetic or natural compounds,  such as herbal extracts,
on  cellular  processes.  In the  course  of  these  studies,  the  Company  can
distinguish the effects of such chemicals on targeted cells,  thereby  screening
compounds  to identify  those with  promising  therapeutic  effects of herbs and
herbal extracts. This proprietary technology, including the components, methods,
procedures  and  know-how  employed in this  screening  process,  is referred to
herein as the "Screening Technology".

               The Company  believes  that the results of its research  coincide
with the need for  sound  scientific  understanding  of  herbal  medicines.  The
Company's  technology  provides  tools  for the  definition  of solid  and valid
scientific  bases for the  beneficial  health  effects of herbal  medicines  and
dietary  supplements.  In addition,  the Company has utilized its  technology to
screen  and  identify  active   substances   contained  within  its  library  of
traditional Chinese medicines.

               The Company's  research and product  development  activities  are
focused in four (4) principal areas:

               SCREENING  TECHNOLOGY.  The  Company  continues  to  improve  its
Screening  Technology  by the  creation  of new  enzymatic,  cellular  and other
testing  methodologies in order to identify efficiently the favorable effects of
active herbal  extracts and chemical  compounds.  This work,  which  consists of
laboratory-based  experiments  on  living  cells,  is  expected  to  be  ongoing
throughout  fiscal 1998 and thereafter.  The focus of this work is the expansion
of the data collection from the initial screens  performed by the Company with a
series of  incremental  screens  aimed at further  specifying  the  utility of a
particular  product  candidate either as a  pharmaceutical  product or a defined
herbal  product.  The Company has developed a series of  proprietary  cell lines
used to evaluate the  effectiveness  of candidate  extracts and  compounds.  The
Company also utilizes a series of cell lines  acquired  under a license with the
National Cancer Institute as well as commercially  available cell lines for such
screening.  The ultimate  objective of the  Screening  Technology is to identify
potential products and their precise mechanism of action. The Company' Screening
Technology has improved  during 1997, as the Company is now capable of screening
compounds for effect faster for a broad  spectrum of biological  mechanisms  and
with greater  precision.  The Company  continues to refine,  enhance and further
specify its Screening Technology.

               SCREENING  ACTIVITIES.  The compounds under  investigation by the
Company are derived from its current  inventory of over 2,700  extracts of herbs
used in traditional Chinese medicine ("TCM"). The Company has screened it entire
inventory of extracts.  The results of these screens have identified a number of
extracts for further  development  based on (1) the Company's  assessment of the
chemical composition, (2) relative bioavailability and toxicity data and (3) the
documented historical use of the herbs in TCM.

               In addition to the evaluation of herbal extracts from its own TCM
library,  the Company  markets its Screening  Technology on a contract  basis to
other companies in the herbal and dietary supplement markets.

               PRODUCT  DEVELOPMENT.  The third focus of the Company's  research
and development is product  development,  in which the Company further evaluates
selected extracts that have shown promising results in the screening assays. The
primary  objective  of this  research is to identify  the precise  chemical  and
biological  activities  (the  "Mechanism of Action") that produce  desirable and
predictable results.  Studies of this nature are used to provide quality control
for  herbal  products  and  critical   information  on  pharmaceutical   product
candidates.

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<PAGE>

               The Company intends to license the rights to particular compounds
at various points in the course of product development.  The Company may license
extracts as early as upon successful  completion of initial screening,  however,
generally,  the Company intends to license rights to extracts and compounds that
have shown  promising  therapeutic  effects  in the  initial  screens,  once the
Mechanism of Action has been identified and verified.  The Company expects to be
able to charge  licensing  and royalty fees for licenses of such  compounds  and
additional  licensing  and royalty fees if the product is cleared by the US Food
and Drug Administration (the "FDA").  There can be no assurance that the Company
will be able to  enter  into any of such  licenses  on  terms  favorable  to the
Company or at all.

               In 1996, the Company commenced development of products containing
extracts of  ANDROGRAPHIS  PANICULATA,  an herb from China and India. In January
1997,  the FDA informed  the Company that  AndroCar(TM)  and  AndroVir(TM),  two
products being developed for the treatment of cancer and  HIV-positive  patients
respectively,  were classified as  pharmaceutical  products and did not meet the
requirements  for sale as  dietary  supplements.  The  launch  of  AndroCar  and
AndroVir as dietary supplements has been suspended indefinitely.

               The cost to develop a  pharmaceutical  product has been estimated
by the Pharmaceutical  Research and Manufacturers  Association  (PhRMA) to be in
excess  of  $250,000,000.   With  the  limited  financial  and  human  resources
available,  the Company decided to seek a pharmaceutical partner for the further
development and marketing of these products.  The Company is currently seeking a
licensee.

               DIAGNOSTIC  TOOLS AND ASSAYS.  The fourth focus of the Company is
the development,  manufacturing  and marketing of diagnostic tools and assays to
detect  cancer and chemical  carcinogens.  The Company has developed and sells a
line of research  reagents  for  scientists  performing  cellular  proliferation
studies. In addition, the Company has identified a potential serum biomarker for
detection  of cancer in humans and  companion  animals.  The Company is actively
seeking  licensees  for these  products.  The  Company  also has  developed  the
Ah-IMMUNOASSAY(TM),  an IN VITRO  bio-immunoassay  that  detects  the  amount of
potentially   toxic  chemicals  in  the  environment  from  several  classes  of
compounds,  including dioxins and polychlorinated  biphenyls (PCBs). The Company
has  licensed  non-exclusive  rights  to  this  assay  to Dow  Environmental,  a
subsidiary  of Dow Chemical Co.; the Company is currently in  negotiations  with
Dow for the reacquisition of all the rights to the  Ah-IMMUNOASSAY.  The Company
has  also  licensed  rights  to  its  veterinary   cancer  diagnostic  to  IDEXX
Laboratories.  The Company  intends to license  certain rights to several of its
products  so that it can  concentrate  its  product  development  and  financial
resources on the efforts described above.

               In  addition to the  foregoing,  the  Company  has  utilized  its
experience in Signal Transduction Technology and its knowledge of the testing of
herbal extracts as the bases for a contract research business to other companies
in the herbal  medicine  and  dietary  supplement  markets.  Toward that end the
Company  recently  performed  contract  research  for  PharmaPrint,   a  dietary
supplement  company, in which one of the Company's assays was used to define the
functional activity of two herbal products.  The Company intends to continue and
expand this  activity and offer its  services to other  companies in the dietary
supplement market.


SIGNAL TRANSDUCTION AND DRUG DISCOVERY

SCIENTIFIC BACKGROUND

               Over the past few years  cell  biologists  have  made  remarkable
progress in identifying  the molecules that drive the cell cycle:  the carefully
choreographed  series of events that  culminates in cell  division.  In doing so
they  have  not  only  provided  a  better  understanding  of one  of  the  most
fundamental of the cell's activities,  they have also opened a new direction for
research aimed at  pinpointing  the mechanism of  carcinogenesis,  angiogenesis,
restenosis,  AIDS  and  a  variety  of  viral  diseases.  The  reason  for  this
convergence is the accumulation of evidence by the Company and others indicating
that  derrangements  in  the  cell  cycle  Signal  Transduction   processes  may
contribute to pathology of a number of apparently unrelated diseases.

               The cell  division  cycle can be broken  down into five  distinct
stages; G0 (Gap-0) or the resting state;  G1-phase (Gap-1),  defined as the time
period between mitosis and DNA synthesis;  S-phase, defined as the time in which
the cell's DNA is  replicated;  G2  (Gap-2),  defined  as the time  between  DNA
synthesis  and  mitosis;  and  M-phase  (mitosis),  the time  period  in which a
daughter cell forms. Upon receipt of proliferative stimulation, a quiescent cell

                                       3
<PAGE>
proceeds from G0 to G1-phase. If the proliferative  stimulus persists,  the cell
continues  through  the cell cycle and upon  completion  of  mitosis  may either
re-enter the G0 state or continue into G1-phase.

               Progression  though  the cell  cycle is a  complex  process  that
involves an orchestra of cellular proteins that can be divided into four general
categories that include positive  regulators  (proto-oncogenes),  enzymes termed
cyclin  dependent  kinases (CDKs),  cyclin  proteins,  and cell cycle inhibitory
proteins (tumor suppressor genes).

               At  the  core  of  cell   cycle   regulation   is  a  family   of
serine/threonine protein kinases (enzymes) that are activated only when bound to
a cyclin protein;  it is for this reason this family of enzymes is called cyclin
dependent  kinases (CDKs).  CDK-cyclin  complexes  initiate signal  transduction
cascades  that  control and  coordinate  the  processes  of cell  division.  The
signaling  events  initiated via these  interactions  either permit or halt cell
cycle  progression.  Kinase  activity and substrate  specificity of the CDKs are
controlled  by various  mechanisms  that  include:  transcriptional  regulation,
complexing   with   cyclin   and  CDK   inhibitory   proteins,   and  cycles  of
phosphorylation and dephosphorylation of threonine and tyrosine residues.

               In yeast, CDK1 (p34cdc2), in conjunction with cyclin A and cyclin
B, is the sole CDK  responsible  for the execution of DNA synthesis and mitosis.
Higher  eukaryotes  have  developed  more  intricate  cell cycle pathways by the
evolution of a series of CDK1  homologues and  corresponding  cyclin proteins to
partner with the additional CDK family members.  CDK1 in conjunction  with other
CDK family members is a recognized mediator for progression through the G1-phase
and entry into S phase. In higher eukaryotes,  as in yeast, CDK1 is the sole CDK
implicated in the progression through the G2/M phases of the cell cycle.

               Physical injury (wound healing), growth factors, viral infection,
and xenobiotic (nongenotoxic  carcinogen) exposure can modulate CDK1 expression.
Furthermore,  in  quiescent  cells and tissue  (liver,  kidney,  and brain) CDK1
expression is low to  undetectable.  In contrast,  CDK1  expression was found in
very high levels  (over-expressed)  in all clinical gastric and colon carcinomas
examined,  in 40 out of 40 human cancer cell lines grown in the laboratory,  and
in 90% of breast tumor cells. Furthermore, CDK1 expression has been proposed for
diagnostic  purposes to distinguish benign from malignant breast lesions.  These
studies  have  established  the  importance  of CDK1 in cancer  cell  growth and
therefore support the premise of assaying for small molecule drugs that modulate
CDK1  expression as therapy for human and  veterinary  disorders such as cancer,
psoriasis,   viral   infection   including  HIV,   restenosis,   glaucoma,   and
inflammation.

               Cellular  signaling  is one of the basic  steps in biology and is
necessary for normal growth of tissues to support life. The Company's technology
enables  researchers to observe Signal  Transduction  and measure the effects of
chemicals contained in synthetic or natural compounds,  such as herbal extracts,
on cell growth and  division.  In the course of these  studies,  the Company can
distinguish the effects of such chemicals on targeted cells,  thereby  screening
compounds to identify those with promising therapeutic effects.

EXTRACT SCREENING AND PRODUCT DISCOVERY

               As of August 1997,  Paracelsian  scientists completed the initial
screening  of its on-hand  herbal  library of 2764  extracts.  Each  extract was
tested in all four of the  Company's  core assays to begin  characterization  of
these herbs' activities at the cellular level. The Company utilizes cellular and
biochemical test systems to identify  extracts that have potent activity against
signal  transduction  targets.  Extracts that produced a positive  response were
subject to a  thorough  literature  review  and  evaluation  of  historical  use
pattern. The next step in the development process for the active herbal extracts
is the  identification  of the active  principles  responsible  for the activity
found in the initial screening.

               To determine the activity of TCM extracts at the cellular  level,
Company scientists  employed four core test systems to assay each extract in its
library of herbal medicines.  These assays include two biochemical targets found
within cells, tyrosine kinases and the Ah receptor, and two "cell-based" assays,
termed CDK1 and Cell Fusion. "Cell-based" test systems evaluate effects on whole
cells,  not just a single protein or enzyme as in the biochemical  test systems.
In contrast to direct  biochemical  target assays, if activity is detected using
"cell-based"  methodologies  the exact mechanism  causing that biological effect
requires   additional   study.   However,   cell-based  tests  provide  valuable
information  concerning potential  cytotoxicity and potency. For example, a very
potent tyrosine kinase active extract may not produce a biological effect if the
active principle does not enter the cell.

               A description of the test systems  employed to screen the library
follows: 

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<PAGE>

TYROSINE KINASE ASSAY

               The  Tyrosine  Kinase  test system  determines  if an extract can
block phosphorylation of tyrosine residues by cellular tyrosine kinases.  Signal
Transduction via phosphorylation of the amino acid tyrosine is a rare event, and
often is an indication of altered cellular  behavior in a broad range of medical
conditions that include inflammation, cancer, viral infections, atherosclerosis,
psoriasis,  immune  system  function/dysfunction.  Thus testing for factors that
modulate  activity  of these  enzymes  provides  specificity  of  action  of the
material being tested.

               The Tyrosine  Kinase  Assay is a  non-radioactive  ELISA  (enzyme
linked  immunosorbant  assay)  based  method.  A  defined  biotinylated  peptide
sequence is first added to NeutrAvidin-coated  wells to which it binds. Addition
of  cellular  tyrosine  kinases  results  in  the  phosphorylation  of  tyrosine
residue(s) within the peptide. An antibody specific for phosphorylated  tyrosine
conjugated  to a  color-developing  enzyme is added for  specific  detection  of
phosphotyrosine residues. The tyrosine kinase activity is then determined by the
addition of a soluble substrate to the well.

               Paracelsian's  screening  of  its  TCM  library  has  led  to the
identification  of  twenty-six   potent  extracts  that  represent   twenty-five
different  herbs.  Of these  twenty-five  plant  species  twelve  have been well
studied  whereas,  the  remaining  thirteen  appear  have been given very little
study.

AH IMMUNOASSAY

               The Ah-Immunoassay measures the ligand-induced  transformation of
the Ah receptor,  a cellular protein complex,  to a DNA binding form. Ligands of
the  Ah  receptor  can  either  promote  transformation  (agonists)  or  inhibit
transformation  (antagonists).  Agonists  of the Ah receptor  (ligands  with the
ability to  transform  the Ah  receptor  to the DNA  binding  conformation)  are
associated with multiple toxic endpoints, immunosuppression,  promotion of liver
cancer, and anti-estrogenic  activity including inhibition of breast cancer cell
growth.   Antagonists   (ligands   that  bind  to  the   receptor   and  inhibit
transformation to a DNA binding form) also act as anti-estrogens and inhibit the
toxic  endpoints  of Ah receptor  agonists.  Certain  plant  materials  (notably
broccoli) contain Ah receptor ligands and are associated with cancer prevention.

               Thirty-five  extracts of the  Paracelsian  TCM  library  acted as
strong Ah receptor  antagonists  and three  extracts  strongly  promoted  the Ah
receptor DNA binding. The identity of the components that interacted with the Ah
receptor  has not been  investigated  to date.  Literature  available  on active
extracts  showed that these plants commonly  contained  flavones and isoflavones
(quercetin,  hesperidin  and  formononetin),   berbines  (berberine,  palmatine,
columbamine,  coptisine,  jatrorrhizine),   anthroquinones  (emodin),  aporphine
(corytuberine,    magnoflorine)   or   furoquinolines   (fagarine,    dictamine,
skimmianine) as major components.

CDK1 ASSAY

               The  CDK1  Assay  is  a  "cell-based"   test  that  measures  the
concentration of Cyclin Dependent  Kinase 1 (CDK1,  p34cdc2 kinase),  a key cell
division  control  enzyme.  CDK1 has been shown to be  overexpressed  in tumors,
cancer cell lines and virally  infected cells.  Because CDK1 is an integral cell
cycle regulator,  preparations  that can lower the levels of CDK1 are capable of
inhibiting  cell growth and thus are candidates for inhibitors of  proliferative
based disorders such as cancer, viral infections, psoriasis, restenosis, etc.

               In the primary screening, 132 active extracts were identified via
the  CDK1  ELISA.  These  extracts  were  then  retested  under  more  stringent
conditions on the primary screen cell line as well as two human prostate and two
human breast cancer cell lines and assayed for viability/growth inhibition. This
process led to the selection of thirty-seven  TCM extracts meeting the specified
criteria for further study. Of these thirty-seven, fifteen extracts appear to be
good candidates for the pharmaceutical development pathway.

                                       5
<PAGE>

CELL FUSION ASSAY

               The  second   "cell-based"  assay,  the  Cell  Fusion  assay,  is
performed by  co-culturing  of CD4+ T cell lines with a T cell line (HIVenv 2-8)
that expresses three HIV-1 genes, Tat, Rev, and Env. The HIVenv 2-8 cell line is
capable  of  processing/cutting   the  HIV-1  envelope  gene  (gp160)  from  the
approximately 160 kDa precursor protein into 120 and 41 kDa subunits (gp120/41).
The  processing  mimics the  presentation  of  gp120/41  on the surface of viral
particles that infect CD4+ cells as well as their presentation on infected cells
that are producing  virus.  During  progressive HIV infection the interaction of
infected cells (presenting  gp120/41 on their cell surface) with uninfected CD4+
T lymphocytes can cause a cytopathic  interaction  (fusion) in which one or both
of the cells die, a process called apoptosis. This HIV-induced cytopathic Signal
Transduction  event is  mimicked  by this in vitro  system  without the need for
"real" virus particles.

               Screening   of  the  TCM   library   for   inhibition   of  viral
cytopathicity  (cell fusion) has identified  twenty-eight  potent plant extracts
that correspond to twenty-four  different species. Of these twenty-four species,
sixteen have been well studied with the  remaining  eight species not studied in
great detail.

HERBAL PRODUCTS/DRUG DISCOVERY PRODUCTS (ANDROVIR, ANDROCAR)

               In 1997 the Company planned the launch of two dietary  supplement
products,  AndroVir and AndroCar,  to support normal immune function and general
well being in cancer and  HIV-positive  patients,  respectively.  The  Company's
announcements  pertaining to the clinical  trial  results  using these  products
initiated an  investigation by the Food and Drug  Administration  (FDA). The FDA
concluded that,  because the Company intended to sell these products to targeted
disease  groups,  the products were  misbranded as dietary  supplements and were
subject to the Federal  Regulations for as a drug product.  These actions forced
the Company to discontinue the scheduled product launches. The active ingredient
is currently being re-evaluated for clinical pharmaceutical drug development.

CONTRACT LABORATORY TESTING.

               The Company has also  engaged in  contract  research  for outside
companies for validation of their herbal products and is seeking  collaborations
with these companies for further development of the Company's herbal library.

COMPETITION

               There are a number of small biotechnology companies that focus on
drug  discovery.  The Company  competes on the basis of the  combination  of its
therapeutic focus on anti-proliferative diseases, its novel screening technology
and a large library of Chinese extracts with data on historical use. The Company
is not aware of any competitors with a similar drug discovery program.

BUSINESS STRATEGY

               The Company's strategy is to add value to the product development
process  by  concentrating  its  efforts  on  the  highly  specialized  area  of
early-stage  drug   development,   generally   discovery   through   preclinical
toxicology,  pharmacology and Phase I clinical trials.  Industry factors such as
downsizing and the trend toward  outsourcing by major  pharmaceutical  companies
support the strategy of  identifying  chemicals as potential  drugs  without the
intent to develop these discoveries into clinically proven  therapeutics.  There
are a number of  biotechnology  companies  focusing their efforts on early-stage
drug development. By partnering with large pharmaceutical companies at the phase
II/III  stages  of  development  they can  capitalize  on the  synergy  of their
discovery  technology  and the  capital  resources  of the large  pharmaceutical
corporations.   Uncertainty  from  government  health  care  reform  and  rising
competition from the generic sector are forcing pharmaceutical companies to look
for ways of reducing  the high cost of  research  and  development,  but without
harming their ability to develop  innovative  products.  With rising competition
from  generics,  the  development of novel products has become more important to
the success of the pharmaceutical industry.  Thus,  pharmaceutical companies are
increasingly  focusing their capital and human  resources on the  development of
fewer, but higher quality, compounds.

                                       6
<PAGE>

               The Company  has  completed  screening  of extracts of its entire
library of 2764  traditional  Chinese  herbal  medicines  using its  proprietary
screening  methodology.  As a result of this screening  effort,  the Company has
identified   approximately  127  herbal  extracts  that  demonstrate  inhibitory
activity in signal transduction  processes involved in the pathology of AIDS and
proliferative  diseases.  Of these,  approximately 50 extracts appear to possess
significant potential to yield good candidate drugs.

               The Company  plans to supply these and future drug  candidates to
established pharmaceutical and biotechnology companies located in the US, Europe
and  Asia.  In  1993,  member  companies  of  the  Pharmaceutical  Research  and
Manufacturers  Association  ("PhRMA")  spent  approximately  $1.5 billion on the
development of anti-cancer  drugs. Of this,  approximately 30%, or $450 million,
was spent on  synthesis,  extraction  and  screening,  for which the Company has
developed a process which it believes is able to perform similar  screening less
expensively.

               The Company intends to license compounds in order to maximize the
return from its drug  development  efforts,  while spreading the risk of product
failure over a larger number of drug candidates.






                        [This space intentionally blank]

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<PAGE>

SIGNAL TRANSDUCTION RESEARCH PRODUCTS.

               All of the Company's products and their applications are based on
biochemical  processes  known  as  Signal  Transduction  - how a cell  processes
information  from the  environment.  Two  proteins  involved in separate  signal
transduction  pathways,  CDK1 and the Ah  Receptor,  have been  developed by the
Company into proprietary products.  These products detect potential carcinogenic
proliferative  stimulation (CDK1) by chemical agents, detection of environmental
contaminants  (Ah-Immunoassay  - dioxin like  compounds),  and are useful in the
discovery and development of anti-cancer therapeutics (CDK1 and Ah Immunoassay).
In addition,  the Company has developed  companion  products to CDK1 based on an
established proliferation biomarker,  proliferating cell nuclear antigen (PCNA).
There are a total of eleven research products currently available  consisting of
kits and antibodies.

               Currently  the  Company  has  seven  products  designed  for  the
laboratory  animal  carcinogen  testing and cell culture  markets.  Utilizing an
Enzyme Linked  immunosorbant  Assay ("ELISA")  format,  the IN VIVO product line
(two kits plus a combination kit) allows for the  quantification  of CDK1 in all
human or animal tissues except blood,  for research  purposes only. The IN VITRO
product line (two kits plus a combination kit) permits quantification of CDK1 in
cell cultures.  Visualization of increased CDK1 in specific cells on microscopic
slides is achieved by means of the Company's CDK1 Antibody  Immunohistochemistry
Kit.

               Since several protein biomarkers had established a history of use
in the human and animal solid tissue  markets  before CDK1 was  discovered,  the
Company  offers  ELISA  kits  for the  quantification  of the  most  widely-used
competing  biomarker in this market,  PCNA (proliferating cell nuclear antigen).
The Company's IN VIVO-CDKTM ELISA with  confirmatory PCNA ELISA enables the user
to make a direct comparison of both the CDK1 and PCNA biomarker.

CANCER DIAGNOSTICS.

               The  Company's  strength  and  knowledge  in signal  transduction
pertaining to cell cycle  regulation  and the physiology of cancer cells has led
to the discovery of a potential serum biomarker for human and veterinary  cancer
diagnostics.  Paracelsian  scientists  have found that CDK2,  an enzyme  closely
related to CDK1,  appears to be released by cancer  cells as they  replicate.  A
reliable, high throughput assay design is still in the developmental stage.

               Preliminary  data indicate that the CDK2 biomarker may be able to
identify  individuals with cancer as well as diagnose human patients with benign
prostate  hyperplasia  who may be a  high-risk  for  development  of  metastatic
prostate cancer. Additional work has indicated that it may be used for diagnosis
of canine  osteosarcomas,  lung tumors, and lymphosarcomas.  This biomarker also
has potential in the pharmaceutical drug development market to monitor for tumor
development in  carcinogenicity  bioassay systems.  Because CDK2 is a cell cycle
control protein found in all cell types, the assay could, theoretically, be used
to diagnose cancer patients irrespective of the tumor type.

               Due to the resources  required to perform  regulatory  validation
studies of this type of diagnostic test,  further  development of these products
has been suspended indefinitely.

COMPETITION  -  LABORATORY  ANIMAL  CANCER  DIAGNOSTICS  

               The most  significant  barrier to entry for the cancer  biomarker
test in  rodent  studies  is the  general  aversion  by the  marketplace  to new
technology in toxicology  testing.  Toxicology studies in the pharmaceutical and
agrochemical  industries are performed to assess chemical  safety  (carcinogenic
potential). Ultimately, results of these studies are submitted to the FDA or EPA
as part of drug or chemical  applications.  Although not mandated, the protocols
for data submission  established by these agencies are generally  "recommended".
Although the Company's  published and marketing data  demonstrates that toxicity
studies  could be conducted  more quickly and with  significant  cost  reduction
using its CDK1 tests,  the regulatory  culture of these industries has prevented
rapid  penetration  by the Company of this  market.  Products  currently  on the
market that complete with the Company's  ELISA assays  include  3H-thymidine,  a
radioactive compound,  and  bromodeoxyuridine.  These compounds are the reagents
that are currently  used in  methodology  to assess the ability of a chemical to
generate a proliferative response in a cell. The testing protocols that are used
with these chemicals are time consuming,  taking up to several months to produce
a result, and the data are often difficult to interpret.

                                       8
<PAGE>

               As health care reform  increases  the pressure on  pharmaceutical
companies to reduce the prices of new drugs, it is conceivable  that pressure to
adopt  cost-cutting new technologies also will increase.  The mechanistic nature
of the Company's test could shorten the FDA approval time, which has indicated a
preference for such tests. In addition,  the Company anticipates  offering three
separate  products  to the  toxicology  market.  This  portfolio  of products is
expected to meet the needs for monitoring,  documenting  endpoints and analyzing
archival materials.

COMPETITION - VETERINARY CDK2 CANCER DIAGNOSTICS

               There are  currently no screening  tests for cancer being used in
veterinary medicine.  Therefore,  the Company expects single greatest barrier to
the successful  introduction of the CDK2 test to be acceptance by  veterinarians
and pet  owners.  Recent  growth of  oncology  as an area of  specialization  in
veterinary medicine is expected to facilitate the adoption of the test.

               The Company's  patented test is expected by the Company to impede
immediate  imitation.  The fact that the biomarker is a mechanistic  marker also
should make it  difficult  for another  test to enter the market  after  initial
acceptance.  The  Company  intends  to rely  upon  the  quality  reputation  and
capabilities of its intended partner to maintain sales and market share.

               For the companion  animal market,  general  economic factors will
play  a role  in the  willingness  of  customers  to  add a new  test  to  their
veterinary bills.  Major competitors may attempt to maintain  comparable product
lines,  so it is  expected  that  other  veterinary  suppliers  could  produce a
companion  animal  cancer-screening  test. The likelihood of success for another
company is difficult to predict,  although such success will require substantial
investments in research and development.

BUSINESS STRATEGY - LABORATORY ANIMAL DIAGNOSTICS

               The potential  customers for the IN VIVO-CDKTM and IN VITRO-CPATM
are toxicologists  working to characterize the  carcinogenicity  of chemicals in
the  pharmaceutical,  agrochemical,  food  and  cosmetic  industries.  The  CDK1
diagnostic  market in  toxicology  can be  estimated  based  upon the  number of
rodents  used in cancer  testing in the US.  Sixteen  percent of animals used in
research are involved in studies to evaluate the toxicity of chemicals.  Of that
number,  63% represent  studies that could use the CDK1 cancer  diagnostic test.
Currently,  20 to 40 million rodents are used each year for toxicology  testing.
Approximately  10% of these  animals  are  used in  studies  in  which  the CDK1
diagnostic test could be applied which  represents the Company's  target market.
The Company's  ELISA CDK1 diagnostic test kit currently on the market for rodent
tissues can assay 42 tissue samples per kit.  Estimating  usage at three or four
assays per animal based on the number of tissues or serum assays per animal, the
potential number of tests is estimated at eight to 16 million tests per year.


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                                       9
<PAGE>
SIGNAL TRANSDUCTION AND THE BIOSENSOR ASSAY FOR DIOXIN COMPOUNDS

SCIENTIFIC BACKGROUND

               The  Ah-IMMUNOASSAY(TM)  was  developed  by the Company to detect
chemical   carcinogens   of  the  dioxin  class  that  are  commonly   found  in
environmental  pollutants from  incineration of plastics and in paper production
and recycling. TCDD  (2,3,7,8-tetrachlorodibenzo-p-dioxin) or dioxin is the best
studied and most toxic of a number of these environmentally  important chemicals
known as dioxin-like compounds.

               Presently,  many  scientists  concur  that all toxic  effects  of
dioxin and a protein present in cells called the Aryl  hydrocarbon (Ah) receptor
mediates  structurally  related  compounds.  The initial step in dioxin toxicity
requires the binding to, and transformation of, the Ah receptor to a DNA-binding
form that then affects the  expression of several gene  products.  In support of
this concept,  the  susceptibility  of different species to the toxic effects of
dioxins can be correlated to the susceptibility of their Ah receptor molecule to
transformation by dioxins. Furthermore, the toxicity of dioxin-like compounds is
linked with their ability to transform the Ah receptor into a DNA-binding  form.
The Ah-IMMUNOASSAY(TM) was designed to be selective for the toxic members of the
dioxin family by utilizing the transformation of the Ah receptor as a biosensor.
The  Environmental   Protection  Agency  (the  "EPA")  has  circulated  proposed
regulations  providing for the  measurement of the dioxin family to be expressed
as "Toxic  Equivalent  Quotients".  The  Company's  assay  provides this form of
response and measurement.

PRODUCT
               As  designed  and  formatted,  the  Ah-IMMUNOASSAY(TM)  does  not
require the use of radioactivity,  sophisticated  equipment,  live cells or live
animals. Three convenient formats of the  Ah-IMMUNOASSAY(TM)  have been designed
by the Company to provide  several  methods of  quantification  of the amount of
several  important  classes  of  compounds  including  dioxins,  polychlorinated
biphenyls,  polybrominated  biphenyls and polycyclic aromatic hydrocarbons.  The
interaction of dioxin with the  Ah-biosensor  complex in the  Ah-IMMUNOASSAY(TM)
produces a transformation in the shape of the biosensor  complex.  The number of
molecules of the biosensor  complex that are  transformed can be quantified with
specific antibodies to the transformed, DNA-binding form of the complex.

               The  Ah-IMMUNOASSAY(TM)  responds  to the  toxicity  of the  test
sample  in terms of  fractional  equivalencies  of the  most  toxic  dioxin-like
compound:  TCDD. Because of the simplicity of the assay,  hundreds of air, soil,
food or water  samples may be tested in a single day. The format of the assay is
designed to be low-cost  and high  throughput  that can be  performed in several
hours by non-technical  personnel.  Sensitivity of the Ah-IMMUNOASSAY(TM) to the
contaminants  that it detects is comparable to  instrumental  methods  currently
used and is well below the recently proposed EPA  concentrations for water, food
and soil.

               Unlike competing products, the Ah-IMMUNOASSAY(TM)  biosensor test
does not detect the  contaminant  directly  with  antibodies,  but  detects  the
interaction of an intracellular  receptor and ligands contained in the sample of
interest.  The Company  believes that the advantages of this biosensor  approach
are (i)  simple  extraction  procedures  with  few  clean-up  steps,  (ii)  high
sensitivity, (iii) high specificity for the contaminant family of interest, (iv)
reduced  testing time,  (v) lower  testing costs and (vi)  adaptable to robotic,
high-throughput systems.

               On October 27,  1995,  the Company  filed a patent  covering  its
invention  of an  improved  biosensor  assay for the  detection  of  dioxin-like
compounds  that is capable of performing  several  thousand  assays per day at a
detection  level of 300 parts per  quadrillion.  See  "Patent  Applications  and
Proprietary  Technology."  The simplicity and speed of the new format,  which is
owned   entirely  by  the  Company,   are  ideal  for  countries  with  enormous
environmental    problems   and   little   financial   support   for   high-cost
instrumentation.

COMPETITION

               Many large  companies  with extensive  research and  development,
marketing,  financial  and  other  capabilities,  as well  as  government-funded
institutions  and  smaller  research  firms are  engaged in the  development  of
diagnostic assays for environmental  applications.  The significant  majority of
diagnostic tests developed for these companies, however, are designed for use in
laboratories that require sophisticated instrumentation and skilled technicians.
The Company has designed its Ah-IMMUNOASSAY(TM) system as an inexpensive, rapid,
field test for use by minimally skilled personnel and does not currently compete
with laboratory-based  systems. Early attempts to develop an 

                                       10
<PAGE>

antibody-based   test  for  all  dioxins  have  been   unsuccessful.   With  the
introduction of the Ah-IMMUNOASSAY(TM)  biosensor test, the Company provides the
first receptor-based environmental testing system.

               Based upon scientific  papers presented by the Company and others
at the 15th  International  Symposium on Dioxins and Related  Compounds  held in
Edmonton,   Alberta,   Canada,  the  Company  anticipates   performance  of  the
Ah-IMMUNOASSAY(TM) to be free of interference with common,  nontoxic,  naturally
occurring,   organic   compounds  that  are  capable  of  interacting  with  the
Ah-receptor. Furthermore, the Company's assay, unlike others presented, does not
require the use of dangerous  radioisotopes or cell culture and can be performed
in hours. The Company believes these qualities provide a significant competitive
advantage to the  Ah-IMMUNOASSAY(TM)  over all other known bioanalytical  assays
for dioxin-like compounds.

BUSINESS STRATEGY.

               Environmental   engineering   firms  must  rely   exclusively  on
sophisticated   instrumentation,   reagents,   highly   trained   personnel  and
significant  elapsed  time for the  information  they need to begin any plan for
remediation.   By  providing  a  real-time  assay  and  freeing  highly  trained
technicians  for  more  sophisticated   work,  the  Company  believes  that  the
Ah-IMMUNOASSAY(TM) would be an invaluable tool to these target markets. For this
application the Company has developed the  Ah-IMMUNOASSAY(TM) as a supplement to
and not a replacement  for existing  instrumental  methods by providing a system
for  use in  connection  with  existing  environmental  remediation  efforts  at
increased  efficiency  and decreased  cost. In the past year, the EPA circulated
proposed  regulations  providing for the  measurement of the dioxin family to be
expressed as "Toxic  Equivalent  Quotients".  The Company's  assay provides this
form of response and measurement.

               Additionally, developing economies in Asia and Eastern Europe are
facing significant  environmental  problems with dioxin-like  compounds and have
neither the sophisticated  instrumentation  nor the trained personnel to address
their analytical  needs. In these potential  markets there is the immediate need
for an inexpensive testing system that will reliably identify problematic water,
food and soil contamination.

               In January  1995,  the Company  announced an  agreement  with Dow
Environmental  providing  for a  non-exclusive  license  and  an  option  for an
exclusive license to evaluate and commercialize the Company's Ah-IMMUNOASSAY(TM)
technology.  Testing of the technology  conducted by Dow  Environmental  and the
Company  indicated  that the assay met or exceeded  milestones  developed in the
agreement.  Dow  Environmental,  however,  has  decided  not to  pursue  further
development. The Company is currently negotiating with Dow for the return of all
the rights to the  Ah-IMMUNOASSAY.  It is the Company's  intention to seek other
licensees for this technology.  There can be no assurance that such transfer and
license will be completed.




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                                       11
<PAGE>

PATENT APPLICATIONS AND PROPRIETARY TECHNOLOGY

               The Company  believes  that patent  protection  of  materials  or
processes  it  develops  and any  products  that may result  from the  Company's
research and development efforts are important to the  commercialization  of the
Company's  products.  The  Company  has five US  patent  applications  and three
foreign applications that are currently pending.

               In the 1995 fiscal year the Company filed a US patent  describing
the use of  compounds  identified  from  two of its  TCM  extracts.  The  patent
describes  uses  of  these  compounds  for the  treatment  of  cancer,  arterial
restenosis   following   angioplasty   and  the   prevention   or  treatment  of
cytopathology related to HIV-1, herpes or hepatitis infections.

               Two patent applications for the biosensor detection  methodology,
which  utilize   properties   of   ligand-receptor   interaction   such  as  the
Ah-IMMUNOASSAY(TM)  and  potential  derivative  products  using the Ah  receptor
technology,  have been filed in the United States Patent and Trademark Office on
behalf of Cornell Research  Foundation,  Inc. See "Exclusive  License  Agreement
with Cornell  Research  Foundation,  Inc.".  The first,  describing  an indirect
immunoassay  for the detection of dioxin-like  compounds has been approved.  The
second  application  was  approved in October  1995.  Filing for foreign  patent
protection  of this second patent in Europe,  Canada,  Japan and China also took
place in the first quarter of fiscal 1996.

               The Company  filed a third patent on October 27, 1995  describing
an  improved  Ah-IMMUNOASSAY(TM)  technology.  This new  assay is  targeted  for
markets in Asia and Eastern Europe. The simplicity and speed of the new formats,
which  will be owned  entirely  by the  Company,  are ideal for  countries  with
enormous  environmental  problems  and little  financial  support for  high-cost
instrumentation.

               The Company  filed for patent  protection in Europe and Canada in
fiscal 1994 on its findings of  increased  presence of CDK protein in cells that
are  exposed  to  carcinogenic  chemicals  and  after  becoming  cancerous.  The
International  Preliminary  Examining  Authority  during the  prosecution of the
patent  cooperation  treaty patent  application  accepted  this concept.  If the
patent is issued,  the patent  will give the  Company  exclusive  rights to data
supporting the use of CDKs as early diagnostic or prognostic markers for cancer.

               It is anticipated that continuing United States and corresponding
foreign  patent  applications  will be  filed  in the  future.  There  can be no
assurance that any patents will be issued based upon such  applications  or that
any  patents  that may be issued  will  provide  the  Company  with  significant
protection from competitors. Further, there can be no assurance that any patents
that may be  issued  based  upon  such  applications  will  not be  successfully
challenged and declared invalid.

               The  patent  positions  of  biopharmaceutical  and  biotechnology
firms, as well as of academic and other research  institutions are uncertain and
involve complex factual and legal  questions.  Accordingly,  no firm predictions
can be made  regarding the  allowance,  breadth or  enforceability  of claims in
these  applications or others that may be filed by the Company.  The Company and
Cornell Research Foundation,  Inc. believe that they have the sole and exclusive
rights in the technologies  underlying the Company's products. The Company would
vigorously  defend any attempt by any  individuals  to assert any rights in such
technologies.   Although  Cornell  Research  Foundation,  Inc.  has  substantial
resources to legally  enforce its patent rights,  there can be no assurance that
it will do so. If Cornell  Research  Foundation,  Inc. elects not to enforce its
patent rights in the technologies underlying the Company's products, the Company
has the right under its license agreement with Cornell Research Foundation, Inc.
to seek to  enforce  those  rights.  However,  in such  event,  there  can be no
assurance  that the  Company  will  have the  financial  resources  to do so. In
addition, although all of the Company's employees are parties to confidentiality
agreements which are intended to protect the Company's  proprietary  technology,
there can be no assurance  that any of such employees will not compromise any of
the Company's proprietary rights.

               The Company also relies upon unpatented  proprietary  technology,
and no  assurance  can be  given  that  others  will not  independently  develop
substantially equivalent proprietary information or techniques or otherwise gain
access to the Company's  proprietary  technology or disclose such  technology or
that  the  Company  can  meaningfully  protect  its  rights  in such  unpatented
proprietary technology.

                                       12
<PAGE>

               United States  trademark  applications  were approved  during the
1995 fiscal year for IN VIVO-CDKTM and IN VITRO-CPATM ELISA assays.

EXCLUSIVE LICENSE AGREEMENT WITH CORNELL RESEARCH FOUNDATION, INC.

               The Company and Cornell Research Foundation, Inc., a wholly-owned
subsidiary corporation of Cornell University, are parties to a license agreement
(the  "License  Agreement")  pursuant to which the  inventors  have  assigned to
Cornell   Research   Foundation,   Inc.   their   ownership   interests  in  the
Ah-IMMUNOASSAYTM  technology  in  accordance  with Cornell  University's  patent
policy. Cornell University's patent policy states that all patentable inventions
conceived or first reduced to practice by Cornell University's faculty and staff
in the course of research conducted during an inventor's employment with Cornell
University  or with the use of Cornell  University's  resources  shall belong to
Cornell University,  thereby giving Cornell University, through Cornell Research
Foundation, Inc., the right to grant licenses under such patent applications and
patents issuing thereon.

               Pursuant to the License Agreement,  Cornell Research  Foundation,
Inc. has granted an exclusive license for any patent  applications  based on the
Ah-IMMUNOASSAYTM  and any patents issuing thereon to the Company and the Company
has issued to Cornell Research  Foundation,  Inc. 195,190 shares of Common Stock
of the Company. In the License Agreement,  Cornell Research Foundation, Inc. has
expressed an intention to maintain a passive non-voting position with respect to
its stock  holdings in the Company.  The Company also will pay Cornell  Research
Foundation,  Inc.  a  royalty  equal to 3% of the net  sales  price of  licensed
products based on Ah-IMMUNOASSAYTM  technology sold by the Company in the United
States and  throughout  the  world.  Dr.  John G.  Babish a  co-inventor  of the
Ah-IMMUNOASSAYTM  technology,  is entitled to a portion of such royalty payments
since Cornell  University's patent policy provides that the inventor of patented
technology  owned by Cornell  Research  Foundation,  Inc. shall be entitled to a
distribution of a portion of the net royalty income.  Dr. Babish has assigned to
the Company all of the royalty payments which he is entitled to receive pursuant
to  Cornell  University's  patent  policy.  Among  other  matters,  the  License
Agreement also provides that the Company shall  exercise  diligence to introduce
the licensed product into the commercial market.

               The  Company  has the  right  to  sublicense  under  the  License
Agreement with the approval of Cornell Research Foundation, Inc., which approval
may  not  be  unreasonably   withheld  or  delayed.  The  Company's  rights  and
obligations  under  the  License  Agreement  are  non-assignable,  except to its
successor  in  business  if such  assignment  is  approved  by Cornell  Research
Foundation,  Inc.,  which approval may not be unreasonably  withheld or delayed.
The License Agreement provides for the indemnification of the Company by Cornell
Research Foundation, Inc. from any damages, costs or expenses incurred by reason
of a breach of Cornell Research  Foundation,  Inc.,  warranties set forth in the
License  Agreement.  The License  Agreement  further  provides for the Company's
indemnification of Cornell Research  Foundation,  Inc. with respect to any claim
arising out of the Company's or its transferees'  use of inventions  licensed or
information  furnished  under the  agreement,  or out of any use,  sale or other
disposition  by the Company or its  transferees  of products made by use of such
inventions or information.

               Any exclusive license under a patent  application lasts until the
expiration date of the last to expire licensed patent,  unless otherwise earlier
terminated.   Cornell  Research  Foundation,  Inc.  may  terminate  the  License
Agreement for noncompliance with a material provision by six-month notice to the
Company.  Upon receipt of such  notice,  the Company has ninety days to cure its
noncompliance.

RELATIONSHIP WITH CORNELL UNIVERSITY AND CORNELL RESEARCH FOUNDATION, INC.

               The initial Ah-IMMUNOASSAYTM  technology was developed at Cornell
University.  The  Company  is a party  to the  License  Agreement  with  Cornell
Research Foundation, Inc. covering this system. See "Exclusive License Agreement
with Cornell Research Foundation, Inc."

               Cornell University received 78,660 shares of the Company's Common
Stock in  consideration  for  consulting  services  rendered  to the  Company by
various  members  of  the  faculty  of  Cornell  University.   Cornell  Research
Foundation,  Inc.  received  195,190  shares of the  Company's  Common  Stock in
consideration for entering into the License Agreement. In the License Agreement,
Cornell  Research  Foundation,  Inc.  has  expressed  an intention to maintain a
passive non-voting position with respect to its stock holdings in the Company.

                                       13
<PAGE>

GOVERNMENT REGULATION AND APPROVAL

               The FDA,  the EPA or other  Federal  regulatory  agencies  do not
currently  regulate the Company's Chinese herbs, as natural  products.  However,
extracts  of the  Chinese  herbs and pure  compounds  with  biological  activity
identified  from  these  herbs may be subject  to FDA,  EPA or other  regulatory
authorities and would then require extensive testing and validation procedures.

               The  Dietary  Supplement  Health  and  Education  Act of 1994 was
adopted in recognition of the role  supplements can play in health promotion and
the link between  supplements and prevention of chronic diseases such as cancer,
heart  disease and  osteoporosis.  This  legislation  established  a  regulatory
framework for supplements to ensure  continued  access to safe products that are
made to  quality  standards.  The law  defines  dietary  supplements,  creates a
mechanism  for  determining  safety,  regulates  health  claims and  labeling of
dietary supplements, provides for good manufacturing practices and establishes a
governmental entity to review, recommend and monitor regulations and research on
dietary  supplements.  The  provisions  in the law that are  significant  to the
Company  are: (i) If a product is marketed as a dietary  supplement,  defined as
any product  that  contains one or more  dietary  ingredients  such as vitamins,
minerals,  herbs or other  botanicals,  amino acids or other ingredients used to
supplement  the diet,  and is later approved as a new drug, it may remain on the
market as a dietary  supplement  unless the FDA  determines  it is unsafe.  If a
product is approved as a new drug before being marketed as a dietary supplement,
it may not later be marketed as a dietary supplement without FDA approval.  (ii)
A dietary  supplement  can be  removed  from the market if the FDA shows that it
presents "a significant or unreasonable risk of illness or injury," that it is a
"poisonous or deleterious  substance which may render it injurious to health" or
if the FDA  determines  that it presents an imminent  hazard to public health or
safety." (iii) Before marketing a new dietary  ingredient,  a manufacturer  must
supply the FDA with adequate  information to provide "reasonable  assurance that
the ingredient does not present a significant or unreasonable risk of illness or
injury." This  information  must be supplied at least 75 days before  marketing.
(iv) Commencing on December 31, 1996, a dietary  supplement  label must list the
name and quantity of each active  ingredient,  identify the product as a dietary
supplement  and, if an herbal  supplement,  identify  the part of the plant from
which it is taken.

               Neither the  Ah-IMMUNOASSAYTM  nor the IN  VIVO-CDKTM  and the IN
VITRO-CPA TM assays currently require pre-market approval by the FDA, the EPA or
any other  regulatory  agency.  However,  there can be no  assurance  that these
products will not become  subject to  pre-market  approval or some other form of
government regulation at a future date.

               The IN  VIVO-CDKTM  and the IN  VITRO-CPA  TM assays  can be used
immediately  by  customers  to  screen  drugs  and  compounds  as   nongenotoxic
carcinogens.  Sufficient data must be generated to substantiate  the correlation
to IN VIVO studies prior to the test being accepted as a complete substitute for
these IN VIVO  tests.  The Company  expects  that it will take up to eight years
before complete  acceptance is achieved.  The Company has based this estimate of
the  time  required  for   acceptance  for  prior  assays  that  test  genotoxic
carcinogens.  There is no guarantee that this  acceptance  will occur or that it
will occur in the time frame estimated by the Company.

               In addition,  diagnostic tests developed from the IN VITRO-CPA TM
ELISA kit will be subject to FDA or other  regulatory  approval if it is used in
clinical  diagnostics.  This  test may be  classified  by the FDA as a Class III
medical  device,  automatically  requiring an FDA-approved  pre-market  approval
application  ("PMA")  prior to  commercial  marketing  and  distribution  in the
clinical diagnostic market.

               A PMA for a diagnostic  test must contain the results of clinical
investigations  providing  reasonable  assurance  that  the  test  is  safe  and
effective for its intended use. Thus, the data in such a study must  demonstrate
the  sensitivity  and  specificity of the test to a sufficiently  high degree to
permit a  judgment  that the test  will be  clinically  useful in  diagnosing  a
specific  disease or condition,  and that the risk of a misdiagnosis is minimal.
The FDA usually  requires  investigations  at three  separate sites to establish
inter-laboratory  reproducibility of results. While this investigational process
is  typically  less  complex and costly than the  clinical  testing  process for
pharmaceuticals,  it nonetheless  requires a sizable investment of capital.  The
Company cannot  commercialize a medical diagnostic test classified by the FDA as
a Class III medical device until the FDA approves a PMA for the product.

                                       14
<PAGE>

               A Class III medical device may be exported for commercial sale in
other  countries  pending PMA approval upon the FDA's  consent.  Such consent is
given upon the filing of a  certification  that commercial sale of the device is
approved  by the  country  to which  it will be  exported  and  upon  the  FDA's
determination  that  exportation of the product is not contrary to public health
or safety.

               Under the Patent Term  Restoration  Act of 1984,  an entity which
owns a patent claiming a Class III medical device  requiring PMA approval,  or a
method of using or manufacturing  such a product,  may apply for an extension of
the normal  statutory  patent term of 17 years to compensate  for the time taken
for clinical  research and FDA review of the  product's  PMA. The Company may be
eligible to apply for such  additional  patent  protection if a patent issues on
any of its medical  diagnostic  tests  requiring PMA  approval.  There can be no
guarantee,  however,  that any such  patents  will be issued or that such patent
term extensions will be obtained.

EFFECT OF GOVERNMENTAL REGULATIONS ON THE COMPANY

               Initially,   the  Company  does  not  anticipate  that  its  drug
discovery program will be effected by government regulations,  since the Company
intends to license drug compounds to established  pharmaceutical companies prior
to extensive testing and development.  In the future, it is conceivable that the
Company  could move further  downstream  in the  development  process,  possibly
through  Phase  I  clinical   trials,   in  which  case   compliance   with  FDA
pharmaceutical regulations would become an important factor.

               The EPA's 1994 report,  "Risk  Assessment of Dioxin," states that
toxicity  should be  determined  in toxic  equivalency  factors  and that  toxic
effects are  mediated  via the  Ah-receptor  protein.  It is expected  that this
report will expand the market for the Ah-IMMUNOASSAYTM, of which there can be no
assurance.  Due to the  nature of the  Company's  products,  they  could  become
subject to governmental  regulation in the future, and changes in regulations on
other industries or products could indirectly affect the pricing and markets for
the Company's products.

               Proposed   legislation  for  health  care  reform  has  increased
pressure on pharmaceutical companies to reduce their pricing. The Company's Cell
Proliferation  Assays can provide its customers with the ability to reduce their
direct costs and time required to either  perform  tests or to develop  products
for market.  They also provide the customer with information  regarding toxicity
that is not currently available from any other source.

FUNDING OF RESEARCH AND DEVELOPMENT

               The Company  expended  1,409,686  and  1,362,971  on research and
development in fiscal years 1997 and 1996, respectively.  None of these research
and development costs were borne directly by customers.

COSTS OF ENVIRONMENTAL COMPLIANCE

               The Company  believes it is in compliance with all  environmental
laws and the cost to the Company for this compliance has been minimal.

EMPLOYEES

               As of  September  30,  1997,  the Company had 7  employees.  Four
employees are primarily engaged in product engineering or manufacturing. Five of
the  employees  have a Ph.D. or MD degree.  None of the  Company's  employees is
covered  by  a  collective  bargaining  agreement.  The  Company  considers  its
relationship  with its employees to be  excellent.  All employees of the Company
are signatories to confidentiality  agreements that restrict  proprietary rights
in, and commercial development of, all technology developed by the employees.

ITEM 2.        DESCRIPTION OF PROPERTIES.

               The  Company's  executive  offices and  research  facilities  are
located at Langmuir  Laboratories in Ithaca, New York, and occupy  approximately
6,000  square feet at that  location.  The Company  occupies  this space under a
one-year lease from Cornell  University,  which expires in 1998 and provides for
automatic  annual  renewals.  At this time and for the foreseeable  future,  the
Company believes that this space is more than sufficient for its  administrative

                                       15
<PAGE>

offices  as  well as  currently  contemplated  manufacturing  and  research  and
development  activities;  the  Company  anticipates  reducing  its  space in the
future. The Company believes that the cost of such space is competitive.

ITEM 3.        LEGAL PROCEEDINGS.

               In June 1993, a suit was  commenced in the New York State Supreme
Court (Onondaga  County) by certain persons,  individually and doing business as
In Vitro  Bioanalytic  Systems,  against the  Company,  Dr. John G.  Babish,  an
officer and director of the Company,  and Edward Heslop, a founding  shareholder
of the Company.

               The plaintiffs allege, among other things, that in 1990, prior to
the Company's  incorporation,  a partnership had been formed with Messrs. Babish
and  Heslop  to  commercialize  products  that the  Company  is now  developing.
Damages,  an accounting  and an injunction are being sought against the Company.
By  decision  dated  September  14,  1994,  the Court  dismissed  certain of the
plaintiffs'  claims against the Company while permitting a claim alleging unfair
competition to proceed. The Company believes that the suit against it is without
merit, intends to continue to vigorously oppose the allegations and is appealing
the Court's  ruling to the extent that it did not dismiss the entire  complaint.
Plaintiffs have filed a cross-appeal  as to the portion of the action  dismissed
by the Court.

               On April  27,  1997 the  Company  filed a  complaint  in the U.S.
District Court for the Northern  District of New York against John G. Babish,  a
former  officer and  director of the  Company.  The  complaint  alleges that Mr.
Babish  engaged in a pattern of wrongful  conduct by which he sought to unjustly
enrich himself and to seize control of the Company as the expense of the Company
and its  shareholders.  That conduct  included in part the  manipulation  of the
Company's  stock price,  trading in the Company's  stock on inside  information,
breach of fiduciary  and  contractual  duties,  theft of Company  property,  and
usurpation of corporate opportunities.

               The  Company  initially  obtained a temporary  restraining  order
prohibiting the defendant alone or in cooperation with others from  transferring
any of the stock or assets of or other interests in the Company,  from issuing a
press release, or contacting stock brokers or major shareholders with the intent
to affect the price of plaintiff's stock or from disseminating any trade secrets
or other  confidential  information of the  plaintiffs.  The  restraining  order
against the defendant  expired,  and the court declined the Company's request to
extend the order in a preliminary injunction.

               The  defendant  denied  any  wrongdoing  in  his  answer  to  the
complaint,  and  counterclaimed for damages "between $375,000 and $1,829,587" on
account of the  Company's  alleged  failure to register  shares of common  stock
underlying  certain  warrants.  Defendant  moved to dismiss  the suit,  and that
motion was denied.  The parties have commenced mutual  disclosure of evidence as
required  by law and are  currently  in  negotiations  for  mutual  release  and
settlement.

               On May 20, 1997, Dr. T. Colin Campbell,  a former director of the
Company,  filed a petition in the Delaware Court of Chancery pursuant to Section
211 of the Delaware  General  Corporation  Law ("DGCL").  The petition sought an
order  compelling  the  Company to hold an annual  meeting of  stockholders  and
sought other forms of relief  relating  thereto,  including  requesting that the
Court set a time and place for the meeting and ordering that certain board seats
be put up for election.  On June 11, 1997, the Company  announced that the Board
of Directors had scheduled the annual  meeting for August 13, 1997 and had set a
record date of July 10, 1997 for stockholders entitled to attend and vote at the
meeting. On the same day, the Company moved to dismiss the petition.

               On June 20, 1997,  petitioner  filed a cross-motion in opposition
to the  Company's  motion to dismiss,  and an  application,  pursuant to Section
223(c) of the DGCL,  to require  the  Company to hold an  election at the annual
meeting to replace  directors  recently  appointed  to the Board.  Subsequently,
petitioner  moved to postpone the scheduled August 13th meeting in order to have
more time to conduct a proxy contest. The Court scheduled a hearing for July 28,
1997 to hear  argument on that motion.  Following  the hearing,  the Court ruled
form the bench and denied  petitioner's  request to postpone  the  meeting,  but
granted the petitioner leave to amend his petition.  To date, petitioner has not
filed an amended petition.

                                       16
<PAGE>


ITEM 4.        SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

               None.


                                       17
<PAGE>


                                     PART II


ITEM 5.        MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

               The  Company's  Common  Stock,  par value  $0.01  per share  (the
"Common Stock"),  commenced trading on February 11, 1992 on the over-the-counter
market  and is  quoted  on  the  National  Association  of  Securities  Dealers'
Automated  Quotation  System  ("NASDAQ")  under the symbol PRLN.  The  Company's
Redeemable Common Stock Purchase Warrants (the "Warrants")  commenced trading on
September 24, 1993 on the over-the-counter  market and is quoted on NASDAQ under
the symbol PRLNW.

               The  following  table  sets forth the high and low bid prices for
the Common  Stock and  Warrants  during the  periods  indicated  as  reported by
NASDAQ. The prices reported reflect inter-dealer  quotations,  may not represent
actual   transactions  and  do  not  include  retail   mark-ups,   markdowns  or
commissions.
<TABLE>
<CAPTION>

                                           Common Stock                       Warrant
                                           ------------                       -------
                                    High Bid           Low Bid         High Bid     Low Bid
                                    --------           -------         --------     -------
<S>                                  <C>                <C>             <C>           <C>
Fiscal 1996
     First Quarter                   7 5/8              2 1/2           4 1/8         7/8
     Second Quarter                  2 9/16             2 9/32          1 1/8         7/16
     Third Quarter                   4 1/4              2 5/32          1 5/8         3/4
     Fourth Quarter                  3 3/4              2 5/8           1 9/16        5/8

Fiscal 1997
     First Quarter                   1 11/16              11/2            7/16        3/8
     Second Quarter                  1 3/8                11/4            7/16       11/32
     Third Quarter                     1/8                 1/8            1/8         1/8
     Fourth Quarter                    15/32               7/16           1/16        1/16
</TABLE>


               As of December 22,  1997,  the Company had  12,004,867  shares of
Common  Stock  outstanding  held by 292 record  holders.  As of such  date,  the
Company had 4,632,773 Warrants outstanding and 66 record holders of Warrants.

               The Company did not pay cash dividends on the Common Stock during
the two fiscal years ended  September 30, 1997. It is the present  policy of the
Company to retain earnings, if any, to finance the development and growth of its
business.  Accordingly, the Company does not anticipate that cash dividends will
be paid until earnings of the Company warrant such  dividends,  and there can be
no assurance that the Company can achieve such earnings or any earnings.


                                       18
<PAGE>

ITEM 6.        MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND
               RESULTS OF OPERATIONS

               The following  discussions should be read in conjunction with the
consolidated  financial  statements  and  related  notes  thereto of the Company
included elsewhere herein.

GENERAL

               Research  and  product  engineering   expenses  include  internal
expenditures  as well as expenses  associated  with third party  consultants and
collaborators.  Newsletter  expenses  and costs  include  the cost of  printing,
supplies,  and other  administrative costs incurred with operating the Company's
New  Century  Nutrition  newsletter  and the costs  related to winding  down the
operation  which ceased  publication  with its December 1996 issue.  General and
administrative  expenses include salaries,  overhead, and legal,  accounting and
consulting  costs incurred in connection  with  maintaining the Company's day to
day operations.  Product launch costs are expenses associated with the Company's
canceled  product  launch of its  andrographide  based  products.  The Company's
historical revenues have primarily been attributable to licensing fees generated
from the use of its technology.

RESULTS OF OPERATIONS

Fiscal years ended September 30, 1997 and 1996

REVENUES

               Revenues  decreased  to $6,146 in the fiscal 1997 from $59,000 in
the  fiscal  1996.  This  decrease  in revenue is  primarily  attributable  to a
decrease in sales of product and  subscription  revenue related to the cessation
of the newsletter.

RESEARCH AND PRODUCT ENGINEERING EXPENSES

               Research  and product  engineering  expenses  increased  by 3% to
$1,410,000  in the fiscal  1997 as compared to  $1,363,000  in the fiscal  1996.
Research  expenses in the fiscal  1997  include  the  continued  research on the
Andrographis   paniculata  based  products  and  expenses  associated  with  the
agreement with the National Cancer Institute.


GENERAL AND ADMINISTRATIVE EXPENSES

               General  and   administrative   expenses  were   $2,437,000   and
$2,007,000  in  fiscal  1997 and  fiscal  1996,  respectively,  representing  an
increase of 18% in fiscal 1997 from fiscal 1996.  These  expenses  relate to the
administration  and  management of the  Company's,  including  personnel  costs,
legal, accounting,  consulting, investor relations and the administration of the
research, development and product engineering activities.

               The   primary   reasons   for  the   increase   in  general   and
administrative  expenses  in  fiscal  1997 are due to  increases  in  legal  and
professional fees resulting from litigation against the Company. These increases
have been offset by significant  reductions in payroll costs. Included in fiscal
1997,  is the write off of the East West  option  acquisition  costs of $92,866,
$56,000  of bad debt  expense  associated  with  write off of a loan to a former
employee and officer,  $162,770 of the write-down of the capitalized  patent and
trademark costs and $30,475 of non-cash expenses associated with stock issued in
consideration of services performed.

NEWSLETTER EXPENSES AND COSTS

               During  November  1995,  the  Company,  through its  wholly-owned
subsidiary, purchased substantially all of the assets related to the New Century
Nutrition  (formerly  Nutrition   Advocate),   a  newsletter  promoting  disease
prevention through nutrition,  from Advocacy  Communications,  Inc. The purchase
price for the acquired  assets was $350,000 in cash. T. Colin  Campbell,  then a
Director of the Company and his son T. Nelson Campbell, then a Vice President of
the Company, were majority shareholders and officers of Advocacy Communications,
Inc.

                                       19
<PAGE>

               The purchase  price  represented  principally  intangible  assets
which were to be amortized on a  straight-line  basis over 10 years. In December
1996,  the Company  decided to cease  publication  of the  newsletter  effective
January  1,  1997.   During  fiscal  1996,  the  Company  incurred  expenses  of
approximately  $531,000 developing the newsletter and soliciting  subscriptions.
The Company  wrote off the  purchase  price of the  newsletter  of $350,000  and
accrued $75,000 for the anticipated  costs to wind up the newsletter  operations
all of which are reflected in the September 30, 1996 financial statements.

PRODUCT LAUNCH COSTS

               During  1997,   the  Company   intended  to  launch  the  dietary
supplements  Andro Vir and  AndroCar to persons  with HIV and  cancer.  In April
1997,  the  Company  was  advised by the Food and Drug  Administrative  that the
marketing  of these  products to persons  with HIV and cancer  would  constitute
claims that the products are intended to treat persons with serious diseases and
thus  intended  for drug  use and not  dietary  supplement  use.  After  careful
consideration  the Company  decided to cancel the launch.  The Company  incurred
$300,000 of expenses in the year ended September 30, 1997.

NET LOSS

               The  Company  has  incurred  net  losses  of   $16,493,000  as  a
development  stage  company  since  inception  to September  30, 1997,  of which
$3,942,000 was incurred in the current year. Net loss per share was $.33 for the
year compared to .68 per share loss in fiscal 1996.  The loss per share includes
 .19 per share  related to  preferred  dividends  and the  beneficial  conversion
feature on the Company's common stock. The Company  anticipates that losses will
continue into next year, but at a significantly reduced amount.

LIQUIDITY & CAPITAL RESOURCES

               As of September 30, 1997, the Company  maintained working capital
of $806,000,  which included cash and cash equivalents of $886,000. On September
30, 1996,  working  capital was  $3,820,000 and cash and cash  equivalents  were
$4,171,000.  This decrease of  approximately  $3,014,000 in working  capital and
$3,285,000 of cash is  attributable  to the  Company's  operating  loss.  During
fiscal  1996,  the  Company  raised $9.9  million in equity  through a series of
transactions as described below.

               In June and July 1996, the Company  completed a private placement
to certain investors for net proceeds of $2.2 million in which it issued 825,001
shares of common stock and 1.2 million  warrants  with various  exercise  prices
ranging from $3.25 to $4.50 and other  terms.  In  September  1996,  the Company
completed a private  placement  financing to many of the same  investors for net
proceeds of $2.0 million in which it issued  683,333  shares of common stock and
683,333  warrants with various  exercise  prices ranging from $3.25 to $4.00 and
other terms.

               During the period,  August through October 1995, the Company sold
300,000  shares of common stock and 102,351 of  convertible  preferred  stock in
private transactions  generating net proceeds of $5.7 million. During the period
October 31, 1995 through February 1, 1996, all of the holders of the convertible
preferred stock converted such shares into 5.4 million shares of common stock.

               During November 1995, the Company purchased 265,478 shares of its
common stock on the open market for an aggregate cost of $1,342,515. The Company
has no further plans to make any additional purchases of its shares.

               On April 9, 1996,  the Company  signed an option to acquire  East
West Herbs Ltd.  of  Kingham,  England  ("EWH").  EWH  markets  and  distributes
traditional Chinese medicines in the United Kingdom and throughout Europe. Under
terms of the option, the Company had the right to acquire all of the outstanding
shares of EWH on or before  April 6, 1997 for $780,000 in cash and shares of the
Company  with  a  value  of  approximately   $2,400,000  for  a  total  proposed
acquisition price of $3.2 million.  Consideration for the option was made in the
form of an option fee of $20,000 and a working  capital  loan of  $340,000.  The
loan bears  interest at the LIBOR rate and is payable in eight  equal  quarterly
installments  with the first  installment  to be paid six months after the first
anniversary  

                                       20
<PAGE>

of the loan  agreement.  The loan is guaranteed by the majority  shareholder  of
EWH. The Company elected not to exercised its option and subsequently  wrote off
its option acquisition costs of $92,866.

               The Company  intends to incur  continuing  product  research  and
development  expenses.  The expenses during fiscal 1997 include  payments to the
National  Cancer  Institute  as  part  of  a  CRADA  (Cooperative  Research  and
Development  Agreement).  The terms of the CRADA are  included  in an  agreement
signed by the  parties  in  December  1996.  Under the terms of the  CRADA,  the
parties had agreed to share certain,  extensive  proprietary  data,  methods and
models for use in evaluating the efficacy of certain of the Company's  compounds
against  HIV and certain  cancers.  The CRADA was  terminated  by the Company in
September 1997 and the Company is obligated  under the agreement to fund certain
costs estimated at $17,000 for a six months period.

               The Company has  significantly  reduced its  personnel  and other
costs since June 1997 and  continues  to reduce  costs and  preserve  cash.  The
Company intends to seek additional funding sources of capital however, there can
be no assurance that additional  financing will be available on acceptable terms
or at all.

               In January,  1997 the  Company  signed an  agreement  with Biomar
International,  Inc. ("Biomar") in which  Biomar  agrees to  purchase  3,571,429
shares of common stock for $500,000.  In addition,  Biomar will receive warrants
to purchase an additional  2,971,429  shares of common stock at a price of $.175
per share or a total of $520,000. These warrants expire 90 days after the shares
and warrants are registered with the Securities and Exchange Commission ("SEC").
Biomar will also become the major  shareholder and received control of the Board
of Directors. Biomar is controlled by T. Colin Campbell a former director of the
Company and his son, T. Nelson Campbell a former Vice President of the Company.

               This  additional  financing  will enable the Company's  available
cash and  existing  sources  of funding to satisfy  its  capital  and  operating
requirements  through September 1998. The Company's future capital  requirements
will depend on many  factors,  including  continued  scientific  progress in its
research  and  development  programs,  the  magnitude  of such  programs and the
settlement of various law suits.

RECENTLY ISSUED ACCOUNTING STANDARDS

               In  February  1997,  the  Financial  Accounting  Standards  Board
("FASB") issued Statement of Financial  Accounting  Standards  ("SFAS") No. 128,
"Earnings  Per Share." This  Statement  establishes  standards for computing and
presenting earnings per share ("EPS") and applies to entities with publicly held
common stock or potential common stock. This Statement  simplifies the standards
for  computing  earnings  per share  previously  found in APB  Opinion  No.  15,
"Earnings Per Share," and makes them comparable to international  EPS standards.
It replaces the presentation of primary EPS with a presentation of basic EPS. It
also  requires  dual  presentation  of basic and  diluted EPS on the face of the
income statement for all entities with a complex capital  structure and requires
a  reconciliation  of the numerator and denominator of the basic EPS computation
of the numerator and denominator of the diluted EPS computation.  This Statement
is effective for financial  statements  issued for periods ending after December
15, 1997, including interim periods; earlier application is not presented.  This
Statement requires of all prior period EPS data presented.  The adoption of this
Statement  will not have any  impact on the  Company's  EPS  disclosure,  as the
Company's stock options and warrants are anti-dilutive and will be excluded from
the denominator of earnings per share; thus, earnings (loss) per common share is
equal to the basic earnings (loss) per share as computed under SFAS No. 128.


                                       21
<PAGE>

ITEM 7.        FINANCIAL STATEMENTS

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

Consolidated   Balance  Sheets  as  of  September  30,  1997  and
September 30, 1996. .......................................................24

Consolidated   Statements  of  Operations  for  the  years  ended
September 30, 1997 and 1996, and the period from inception (April
15, 1991) to September 30, 1997. ..........................................25

Consolidated  Statements of  Stockholders'  Equity for the period
from inception (April 15, 1991) to September 30, 1997. ....................26

Consolidated  Statements  of  Cash  Flows  for  the  years  ended
September 30, 1997 and 1996 and the period from inception  (April
15, 1991) to September 30, 1997.

Notes to Consolidated Financial Statements. ...............................29

Financial  Statement  Schedules:   No  schedules  were  submitted
because  they are not  applicable,  not  required  or because the
required  information is included in the Financial  Statements or
notes thereto.


                                       22

<PAGE>


                          Independent Auditors' Report

The Board of Directors and Stockholders
Paracelsian, Inc.


We have audited the accompanying consolidated balance sheet of Paracelsian, Inc.
and  subsidiary (a  development  stage  enterprise) as of September 30, 1997 and
1996,  and the related  consolidated  statements  of  operations,  stockholder's
equity,  and cash  flows  for each of the  years in the  two-year  period  ended
September  30,  1997 and for the  period  from  April 15,  1991  (inception)  to
September  30,  1997.   These   consolidated   financial   statements   are  the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these  consolidated  financial  statements  based on our  audit.  The
cumulative  statements of operations,  stockholders'  equity, and cash flows for
the period April 15, 1991  (inception) to September 30, 1997 include amounts for
the period from April 15, 1991 (inception) to September 30, 1991 and for each of
the years in the four-year  period ending September 30, 1995, which were audited
by other  auditors  whose  report has been  furnished  to us,  and our  opinion,
insofar as it relates to the  amounts  included  for the period  April 15,  1991
(inception)  through  September  30,  1995 is based  solely on the report of the
other auditors.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards  require that we plan and perform the audit to obtain reasonable
assurance   about  whether  the  financial   statements  are  free  of  material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our  opinion,  based on our audit and the report of the other  auditors,  the
consolidated  financial  statements  referred to above  present  fairly,  in all
material respects, the financial position of Paracelsian, Inc. and subsidiary (a
development stage enterprise) as of September 30, 1997, and the results of their
operations  and their  cash flows for each of the years in the  two-year  period
ended  September  30,  1997 and for the period  April 15,  1991  (inception)  to
September 30, 1997, in conformity with generally accepted accounting principles.


                                                       /s/ KPMG PEAT MARWICK LLP
                                                           ---------------------
                                                           KPMG PEAT MARWICK LLP

Jericho, NY
January 14, 1998

                                       23

<PAGE>

                        PARACELSIAN, INC. AND SUBSIDIARY
                          (A Development Stage Company)
                           Consolidated Balance Sheets
                           September 30, 1997 and 1996

<TABLE>
<CAPTION>
                                                                         1997            1996
                                                                     ------------    ------------
<S>                                                                  <C>             <C>         
Assets
Current Assets:
         Cash and cash equivalents                                   $    886,249    $  4,171,402
         Inventory                                                        156,323              --
         Prepaid expenses and other current assets                         61,437         278,367
         Loan to East West Herbs, Ltd., - current portion                 170,000              --
                                                                     ------------    ------------
                  Total current assets                                  1,274,009       4,449,769
                                                                     ------------    ------------

Equipment, net                                                            305,079         384,790

Other Assets:
         TCM extracts on-hand                                             466,839         622,419
         Licensing agreement, net                                         367,258         555,602
         Patents and trademarks, net                                      125,586         258,206
         Option to acquire East West Herbs, Ltd. 
           and related acquisition costs                                       --          92,866
         Loan to East West Herbs, Ltd., - noncurrent portion              170,000         340,000
                                                                     ------------    ------------
                                                                        1,129,683       1,869,093
                                                                     ------------    ------------
                                                                     $  2,708,771    $  6,703,652
                                                                     ------------    ------------

Liabilities and Stockholders' Equity
Current Liabilities:
         Accounts payable                                            $    268,702    $    312,817
         Accrued expenses                                                 180,664         192,790
         Deferred revenue                                                      --          46,858
         Due to related party                                              18,557          77,597
                                                                     ------------    ------------
                  Total current liabilities                               467,923         630,062
                                                                     ------------    ------------

Commitments and Contingency

Stockholders' Equity:
         Common stock, $.01 par value; 20,000,000 shares
                   authorized; 12,004,867 shares outstanding
                    September 1997 and 11,935,082 September 1996          120,045         119,348
         Additional paid-in capital                                    22,084,315      21,976,005
         Deficit accumulated during the development stage             (18,620,997)    (14,679,248)
         Treasury stock, at cost; 265,478 shares in 1997               (1,342,515)     (1,342,515)
                                                                     ------------    ------------
                  Total stockholders' equity                            2,240,848       6,073,590
                                                                     ------------    ------------
                                                                     $  2,708,771    $  6,703,652
                                                                     ============    ============
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       24
<PAGE>
<TABLE>
<CAPTION>

                        PARACELSIAN, INC. AND SUBSIDIARY
                          (A Development Stage Company)
                      Consolidated Statements of Operations
                For the years ended September 30, 1997 and 1996 ,
               And the period from inception to September 30, 1997
                                                                                     Cumulative
                                                                                    Period from
                                                                                    Inception to
                                                                                   September 30,
    Revenues:                                           1997            1996            1997
                                                    ------------    ------------    ------------
<S>                                                 <C>             <C>             <C>         
      Marketing rights                              $         --    $      5,000    $    254,995
      Products                                             4,900          22,411         162,713
      Product royalties                                    1,246              --           1,246
      Subscription revenue                                    --          31,625          31,625
                                                    ------------    ------------    ------------
                                                           6,146          59,036         450,579

Operating expenses:
      Research and product engineering                 1,409,686       1,362,971       6,667,620
      Research concerning Indian herbs                        --              --         375,000
      Newsletter expenses                                     --         955,586         955,586
      General and administrative                       2,436,939       2,006,801       7,827,903
      Product launch costs                               300,544              --         300,544
      Cost of products sold                                   --          10,538          95,023
      Officer stock compensation                              --              --       1,228,275
                                                    ------------    ------------    ------------
                                                       4,147,169       4,335,896      17,449,951
                                                    ------------    ------------    ------------
            Loss from operations during
                   the development stage              (4,141,023)     (4,276,860)    (16,999,372)

Interest income, net                                     167,754          75,096         474,855
Gain on sale of assets                                    31,520              --          31,520

                                                    ------------    ------------    ------------
            Net loss during the development stage   $ (3,941,749)   $ (4,201,764)   $(16,492,997)
                                                    ============    ============    ============

            Net loss per weighted average
                  shares of common stock            $      (0.33)   $      (0.68)
                                                    ============    ============ 

Weighted average number of
      common stock outstanding                        11,956,171       8,597,479 
                                                    ============    ============ 
</TABLE>


          See accompanying notes to consolidated financial statements.

                                       25
<PAGE>

<TABLE>
<CAPTION>

                        PARACELSIAN, INC. AND SUBSIDIARY
                          (A Development Stage Company)
                 Consolidated Statements of Stockholders' Equity
               For the period from inception to September 30, 1997

                                                                                                     Deficit
                                                                                                    Accumulated
                                                                                         Additional During the
                                                 Preferred Stock    Common Stock          Paid-in   Development Treasury
                                                 Shares  Amount   Shares      Amount      Capital      Stage     Stock     Total
                                                 -----   ----- ----------    --------  ----------- -----------   -----  -----------
<S>                                               <C>      <C>  <C>        <C>          <C>         <C>          <C>    <C>        
Issuance of Common Stock April - July 1991          --   $  --    806,250    $  8,063  $        -- $        --   $  --  $     8,063
Issuance of Common Stock for licensing,
   technology and consulting services - July 1991   --      --    333,850       3,338           --          --      --        3,338
Private placement of Common Stock - August -
             September 1991, net of costs           --      --    267,288       2,673      369,017          --      --      371,690
Net loss (April 15, 1991 to September 30, 1991)     --      --         --          --           --    (133,469)     --     (133,469)
                                                 -----   ----- ----------    --------  ----------- -----------   -----  -----------
BALANCE, September 30, 1991                         --      --  1,407,388      14,074      369,017    (133,469)     --      249,622

Redemption of Common Stock - November 1991          --      --   (245,000)     (2,450)          --          --      --       (2,450)
Initial Public Offering of Common Stock -
              February 1992, net of costs           --      --  1,150,000      11,500    5,103,451          --      --    5,114,951
Issuance of Warrants - February 1992                --      --         --          --        1,000          --      --        1,000
Net loss (for the year ended September 30, 1992)    --      --         --          --           --  (1,221,943)     --   (1,221,943)
                                                 -----   ----- ----------    --------  ----------- -----------   -----  -----------
BALANCE, September 30, 1992                         --      --  2,312,388      23,124    5,473,468  (1,355,412)     --    4,141,180

Warrant dividend - September 1993                   --                 --          --      436,898    (500,000)     --      (63,102)
Net loss (for the year ended September 30, 1993)    --      --         --          --           --  (2,022,614)     --   (2,022,614)
                                                 -----   ----- ----------    --------  ----------- -----------   -----  -----------
BALANCE, September 30, 1993                         --      --  2,312,388      23,124    5,910,366  (3,878,026)     --    2,055,464

Net loss (for the year ended September 30, 1994)    --      --         --          --           --  (1,940,262)     --   (1,940,262)
                                                 -----   ----- ----------    --------  ----------- -----------   -----  -----------
BALANCE, September 30, 1994                         --      --  2,312,388      23,124    5,910,366  (5,818,288)     --      115,202

Issuance of Common Stock for acquisition of
   Pacific Liaisons - October 1994                  --      --  1,116,666      11,167    1,632,833          --      --    1,644,000
Exercise of Warrants                                --      --    221,200       2,212      716,644          --      --      718,856
Common Stock purchased by Officer -
                January 1995                        --      --    705,000       7,050    1,311,075          --      --    1,318,125

                                    See accompanying notes to consolidated financial statements.

                                                                 26
</TABLE>

<PAGE>
<TABLE>
<CAPTION>

                        PARACELSIAN, INC. AND SUBSIDIARY
                          (A Development Stage Company)
                 Consolidated Statements of Stockholders' Equity
               For the period from inception to September 30, 1997


                                                                                                          Deficit
                                                                                                         Accumulated
                                                                                            Additional   During the
                                                   Preferred Stock      Common Stock       Paid-in     Development Treasury
                                                  Shares    Amount    Shares    Amount     Capital        Stage    Stock     Total
                                                 --------  -------  ---------- -------- ------------  ------------ ------  ---------
<S>                                              <C>       <C>      <C>         <C>         <C>      <C>          <C>      <C>
Continued from the previous page

Issuance of Common Stock for services rendered -                                                                                   
                January 1995                         --      --     33,330      333      21,167          --          --      21,500
                  April 1995                         --      --    200,000    2,000     373,000          --          --     375,000
Issuance of Common Stock for conversion                                                                                            
   of short-term liabilities - June 1995             --      --     13,000      130      48,849          --          --      48,979
Issuance of Common Stock - August 1995               --      --    300,000    3,000     749,625          --          --     752,625
Issuance of Preferred Stock - September 1995                                                             
      Series A, net of costs                     10,700     107         --       --     361,018          --          --     361,125
      Series B, net of costs                     10,000     100         --       --     399,900          --          --     400,000
      Series C, net of costs                      5,000      50         --       --     218,422          --          --     218,472
Net loss (for the year ended September 30, 1995)     --      --         --       --          --  (3,031,196)         --  (3,031,196)
                                                -------  ------ ---------- -------- ----------- -----------  ----------  ----------
BALANCE, September 30, 1995                      25,700     257  4,901,584   49,016  11,742,899  (8,849,484)         --   2,942,688

Issuance of Series B Preferred Stock,
   net of costs                                  76,651     767         --       --   3,999,233          --          --   4,000,000
Exercise of Warrants                                 --      --     73,318      733     154,676          --          --     155,409
Issuance of Common Stock for services rendered -
                October 1995                         --      --     33,336      331      42,669          --          --      43,000
Purchase of Treasury Stock - November 1995           --      --         --       --          --          --  (1,342,515) (1,342,515)
Conversion of Preferred Stock                  (102,351) (1,024) 5,371,010   53,710     (52,686)         --          --          --
Preferred dividends and beneficial
          conversion feature                         --      --         --       --   1,628,000  (1,628,000)         --          --
Issuance of Common Stock for conversion
   of short-term liabilities - January 1996          --      --      2,500       25       9,975          --          --      10,000
Issuance of Common Stock for services rendered -
               February 1996                         --      --     25,000      250      27,875          --          --      28,125
Issuance of Warrants and Options for services -
               rendered  - February 1996             --      --         --       --     132,500          --          --     132,500
Issuance of Common Stock - June 1996                 --      --    733,334    7,333   1,965,663          --          --   1,972,996


                                    See accompanying notes to consolidated financial statements.

                                                                 27
</TABLE>

<PAGE>
<TABLE>
<CAPTION>

                        PARACELSIAN, INC. AND SUBSIDIARY
                          (A Development Stage Company)
                 Consolidated Statements of Stockholders' Equity
               For the period from inception to September 30, 1997

                                                                                                          Deficit
                                                                                                         Accumulated
                                                                                            Additional   During the
                                                   Preferred Stock      Common Stock       Paid-in     Development Treasury
                                                  Shares    Amount    Shares    Amount     Capital        Stage    Stock     Total
                                                 --------  -------  ---------- -------- ------------  ------------ ------  ---------
<S>                                              <C>       <C>      <C>         <C>         <C>      <C>          <C>      <C>
Continued from the previous page

Sale of Warrants - June 1996                         --      --         --       --      35,000          --          --      35,000
Issuance of Common Stock - July 1996                 --      --     91,667      917     250,075          --          --     250,992
Issuance of Common Stock for services rendered -
                   July 1996                         --      --      5,000       50       4,950          --          --       5,000
Exercise of Options - September 1996                 --      --     15,000      150      37,350          --          --      37,500
Issuance of Common Stock - September 1996            --      --    683,333    6,833   1,997,826          --          --   2,004,659
Net loss (for the year ended September 30, 1996)     --      --         --       --          --  (4,201,764)         --  (4,201,764)
                                               --------  ------ ---------- -------- ----------- -----------  ----------  ----------
BALANCE, September 30, 1996                          --      -- 11,935,082  119,348  21,976,005 (14,679,248) (1,342,515)  6,073,590

Issuance of Common Stock for services rendered -
                January 1997                         --      --      7,285       72      22,835          --          --      22,907
Termination of warrants - February 1997              --      --         --       --     (35,000)         --          --     (35,000)
Repayment of officer stock subscription receivable   --      --         --       --      89,850          --          --      89,850
Issuance of Common Stock for services rendered -
                   July 1997                         --      --     62,500      625      30,625          --          --      31,250
Net loss (for the year ended September 30, 1997)     --      --         --       --          --  (3,941,749)         --  (3,941,749)
                                                -------  ------ ---------- -------- ----------- -----------  ----------  ----------
BALANCE, September 30, 1997                          -- $    -- 12,004,867 $120,045 $22,084,315$(18,620,997)$(1,342,515) $2,240,848
                                               ======== ======= ========== ======== ============ ==========  ==========  ==========


                                    See accompanying notes to consolidated financial statements.

                                                                 28
</TABLE>
<PAGE>

<TABLE>
<CAPTION>
                                                  PARACELSIAN, INC. AND SUBSIDIARY
                                                    (A Development Stage Company)
                                                Consolidated Statements of Cash Flows
                                          For the years ended September 30, 1997 and 1996,
                                         And the period from inception to September 30, 1997

                                                                                                         Cumulative
                                                                                                        Period from
                                                                                                        Inception to
                                                                                                        September 30,
                                                                              1997           1996           1997
                                                                          -----------    -----------    ------------
<S>                                                                       <C>            <C>            <C>          
Cash flows from operating activities:
      Net loss                                                            $(3,941,749)   $(4,201,764)   $(16,492,997)
      Adjustments to reconcile net loss to net cash used in
      operating activities:
            Non-cash compensation expense                                          --             --       1,228,275
            Other non-cash expenses                                           369,545        725,658       1,510,203
            Depreciation and amortization                                     469,368        274,818       1,246,972
            Changes in assets and liabilities:
                  (Increase) decrease in inventory                           (156,323)            --        (156,323)
                  (Increase) decrease in prepaid expenses and other           216,930             --         (32,017)
                  (Decrease) increase in accounts payable                     (21,207)      (183,142)        623,225
                  (Decrease) increase in due to related party                 (59,040)       (59,664)         18,557
                  (Decrease) increase in deferred revenue                     (46,858)        46,858              --
                  (Decrease) increase in accrued expenses                     (12,126)       127,462         180,664
                                                                          -----------    -----------    ------------
            Net cash used in operating activities                          (3,181,460)    (3,401,986)    (11,873,441)
                                                                          -----------    -----------    ------------

Cash flows from investing activities:
      Purchase of investments                                                      --             --      (6,719,089)
      Redemption of investments                                                    --             --       6,719,089
      Purchase of equipment                                                   (16,887)       (54,352)       (732,186)
      Proceeds from sale of equipment                                              --             --          20,000
      Acquisition of licensed technology                                       (3,656)       (50,000)        (53,656)
      Acquisition of patents and trademarks                                   (48,150)       (69,457)       (352,953)
      Acquisition of New Century Nutrition newsletter                              --       (350,000)       (350,000)
      Acquisition of option for East West Herbs, Ltd. 
            and related acquisition costs                                          --        (92,866)        (92,866)
      Loan to East West Herbs, Ltd.                                                --       (340,000)       (340,000)
                                                                          -----------    -----------    ------------
            Net cash used in investing activities                             (68,693)      (956,675)     (1,901,661)
                                                                          -----------    -----------    ------------

Cash flows from financing activities:
      Sale of common stock, initial public offering, net of costs                  --             --       5,124,014
      Sale of common and preferred stock, net of costs                             --      8,228,647      10,330,109
      Proceeds from the exercise of warrants                                       --        155,409         666,295
      Proceeds from the exercise of options                                        --         37,500          37,500
      Proceeds from the sale (redemption) of warrants                         (35,000)        35,000              --
      Purchase of treasury stock                                                   --     (1,342,515)     (1,342,515)
      Cost of warrant dividend                                                     --             --         (63,102)
      Payment on equipment contract                                                --             --         (90,950)
                                                                          -----------    -----------    ------------
            Net cash (used in) provided by financing activities               (35,000)     7,114,041      14,661,351
                                                                          -----------    -----------    ------------

Net increase (decrease) in cash and cash equivalents                       (3,285,153)     2,755,380         886,249

Cash and cash equivalents, beginning of period                              4,171,402      1,416,022              --
                                                                          -----------    -----------    ------------

Cash and cash equivalents, end of period                                  $   886,249    $ 4,171,402    $    886,249
                                                                          ===========    ===========    ============
</TABLE>

                                       29
<PAGE>

<TABLE>
<CAPTION>
                                                  PARACELSIAN, INC. AND SUBSIDIARY
                                                    (A Development Stage Company)
                                                Consolidated Statements of Cash Flows
                                          For the years ended September 30, 1997 and 1996,
                                         And the period from inception to September 30, 1997

                                                                                                         Cumulative
                                                                                                        Period from
                                                                                                        Inception to
                                                                                                        September 30,
                                                                              1997           1996           1997
                                                                          -----------    -----------    ------------
<S>                                                                       <C>            <C>            <C>          
Supplemental disclosures:
      Cash paid during the period for interest                            $     4,484    $     6,875    $     19,284
                                                                          ===========    ===========    ============

Supplemental disclosure of non-cash investing and financing activities:
      Fair value of assets acquired, net of cash acquired                 $        --    $        --    $  1,702,000
      Less - liabilities assumed                                                   --             --          52,000
      Less - issuance of common stock                                              --             --       1,644,000
                                                                          -----------    -----------    ------------
            Net cash paid                                                 $        --    $        --    $      6,000
                                                                          ===========    ===========    ============
      Warrant dividend                                                    $        --    $        --    $    500,000
      Issuance of common stock/warrants for services
            and to reduce short-term liabilities                          $    53,382    $   218,625    $    550,456
      Purchase of equipment                                               $        --    $        --    $     90,950
      Repayment of officer stock subscription receivable                  $    89,850             --          89,850
      Issuance of common stock for licensing and technology rights        $        --    $        --    $      3,338
                                                                          ===========    ===========    ============

                                    See accompanying notes to consolidated financial statements.

                                                                 30
</TABLE>
<PAGE>
                        PARACELSIAN, INC. AND SUBSIDIARY
                          (A Development Stage Company)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                   ------------------------------------------
                          SEPTEMBER 30, 1997 AND 1996
                          ---------------------------

1.             ORGANIZATION, BUSINESS, AND RISK FACTORS:

ORGANIZATION AND BUSINESS

Paracelsian,  Inc.,  (the  "Company") is a drug discovery  service  company that
utilizes its  proprietary  screening  technology to identify  novel  therapeutic
compounds from herbal sources and to define the  biological  mechanisms  through
which traditional herbal medicines affect cellular function. This technology has
been  developed by the Company to identify  potential  products that inhibit the
biological  signals  generated by targeted  cells that result in  controlled  or
uncontrolled growth and division.  The Company's screening  technology evaluates
the effects of herbal products on  intracellular  signals referred to as "Signal
Transduction Technology."

Cell  division is one of the basic steps in biology  necessary for normal growth
of tissues to support life.  The Company's  technology  enables  researchers  to
observe signal  transduction  and measure the effects of chemicals  contained in
synthetic or natural compounds,  and chemicals occurring in nature such as herbs
and  combinations of herbal extracts,  on cell division.  In the course of these
observations,  the Company can  distinguish  the  effects of such  chemicals  on
targeted  cells,  thereby  screening  compounds to identify those with promising
favorable  therapeutic  effects.  (This  proprietary  technology,  including the
components, methods, procedures and know-how employed in this screening process,
is referred to herein as the "Screening Technology".)

In  October  1994,  Pacific  Liaisons   (Pacific),   a  partnership  engaged  in
identifying and acquiring  biologically active drugs, natural products and foods
from Eastern Asia, merged with a wholly-owned  subsidiary of the Company and the
Company  now  maintains a large  library of natural  medicinal  extracts.  These
extracts  are being  processed  with the  Company's  screening  technology.  The
Company also has access to the  informational  database related to the medicinal
extracts,  which  contains,  among other things,  a history of the usage of each
extract (see Note 3).

In November 1995, the Company purchased  substantially all the assets related to
NEW  CENTURY  NUTRITION,  a  newsletter  promoting  disease  prevention  through
nutrition.  In December  1996, the Company  decided to cease  publication of the
newsletter.

DEVELOPMENT STAGE COMPANY AND RISK FACTORS

The  Company  is  considered  to be a  development  stage  company as defined in
Statement of Financial  Accounting Standards No. 7, "Accounting and Reporting by
Development Stage Enterprises." Since inception,  the Company has been primarily
engaged in research, product engineering and raising capital.

The Company, as a development stage enterprise,  has yet to generate significant
revenues and has no assurance of substantial future revenues.  Even if marketing
efforts are successful,  it may take several years before  significant  revenues
are  realized.  The  Company is subject to a number of risks that may affect its
ability to become an  operating  enterprise  or impact its  ability to remain in
existence,  including  risks related to successful  development and marketing of
its products, patent protection of proprietary technology, government regulation
competition from substitute  products  (including  technologies that may not yet
have  been  developed),  dependence  on key  employees  and the  need to  obtain
additional funds that may not be available to it.

As shown in the accompanying  financial  statements,  the Company incurred a net
loss of  approximately  $3,942,000 for the year ended September 30, 1997 and has
working capital of approximately  $806,000 at year-end. The Company continues to
expend funds on product research and development and general and  administrative
expenses and has not generated significant revenues subsequent to year-end.  The
Company has  significantly  reduced its  expenses  and as  discussed  in Note 10
raised  $500,000  through  the sale of common  stock.  Management  believes  the
additional  financing and the collection of the amounts due from East West (Note
4(a)) will enable the Company to satisfy its capital and operating  requirements
through September 30, 1998.

                                       31
<PAGE>

2.             SIGNIFICANT ACCOUNTING POLICIES:

CONSOLIDATION

The  consolidated  financial  statements of the Company  include the accounts of
Paracelsian,  Inc. and its wholly owned subsidiary ParaComm, Inc. formerly known
as Para Acquisition  Corp. All intercompany  balances and transactions have been
eliminated.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents  consist of highly liquid investments with an original
maturity of three months or less. Cash  equivalents as of September 30, 1997 and
1996 approximated $857,000 and $2,145,000, respectively.

RESEARCH AND PRODUCT ENGINEERING

Company-sponsored  research  and  product  engineering  expenditures  have  been
charged to expense as  incurred.  These  costs  consist  primarily  of  employee
salaries and direct  laboratory costs. The cost of extracts used in research and
development activities is expensed as consumed.

INVENTORY
Inventory represents tablets of ANDROGRAPHIS PANICULATA held for resale at cost.

NET LOSS PER SHARE

Net loss per share  was  computed  by  dividing  net loss for the  period by the
weighted average number of shares of common stock outstanding during the period.
Common stock  equivalents  are not included in the computation of average shares
outstanding  because the effect of such inclusion  would be to decrease the loss
per share.

The computation of net loss per share is as follows:
<TABLE>
<CAPTION>

                                                                  1997            1996
                                                              ------------    -----------

<S>                                                           <C>             <C>         
Net loss                                                      $ (3,941,749)   $(4,201,764)

Preferred stock dividends and beneficial conversion feature
                                                                        --     (1,628,000)
                                                              ------------    -----------

Net loss attributable to common stockholders                  $ (3,941,749)   $(5,829,764
                                                              ============    ===========

Weighted average shares outstanding                             11,956,171      8,597,479

Net loss per share of common stock                            $      (0.33)   $     (0.68)
</TABLE>

In accordance with a SEC Staff Announcement issued in March 1997, the beneficial
conversion benefit related to the convertible  preferred stock (see Note 4 ) has
been  recognized  as a dividend to the  preferred  shareholders  and used in the
computation of net loss per share for fiscal 1996 as reflected above.

PATENTS AND TRADEMARKS

The Company has  acquired or applied for certain  patent and  trademark  rights.
Costs associated with the acquisition and application for these rights have been
capitalized  and are  being  amortized  on the  straight-line  method  over  the
estimated legal life of the assets which range from 15 to 17 years.  Accumulated
amortization  of  the  patents  and  trademarks  totaled  $76,747  and  $58,747,
respectively, at September 30, 1997 and 1996. At September 30, 1997, the Company
conducted an  assessment of its  capitalized  patent and trademark and wrote off
the  unamortized  value of $162,770  related to patents and trademarks no longer
being pursued by the Company.

                                       32
<PAGE>

EQUIPMENT AND DEPRECIATION

Equipment is stated at cost and is depreciated  over the estimated  useful lives
of  the  assets  using  the  straight-line  method.  Equipment  consists  of the
following as of September 30:

<TABLE>
<CAPTION>
                                            Useful Lives         1997               1996
                                            ------------         -----              ----
<S>                                           <C>           <C>                <C>         
     Laboratory equipment                     10 Years      $    511,691       $    500,623

     Office furniture and equipment           10 Years            86,345             88,095

     Computer equipment and software           5 Years           133,852            133,033
                                                            ------------       ------------

                                                                 731,888            721,751

     Less - accumulated depreciation                             426,809            336,691
                                                            ------------       ------------

                                                            $    305,079       $    384,790
                                                            ============       ============
</TABLE>

Depreciation  expense of $96,598 and $81,554 were charged to operations  for the
years ended September 30, 1997 and 1996, respectively.

USE OF ESTIMATES

The  preparation of the  consolidated  financial  statements in conformity  with
generally accepted  accounting  principles requires management to make estimates
and assumptions  that affect the reported  amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements.  Estimates also affect the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

3.          PRODUCT LAUNCH:

During 1997, the Company intended to launch the dietary supplements AndroVir and
AndroCar  to persons  with HIV and  cancer,  respectively.  In April  1997,  the
Company was advised by the Food and Drug  Administrative  that the  marketing of
these products to persons with these diseases would  constitute  claims that the
products are intended to treat  persons with serious  diseases and thus intended
for drug use and not dietary  supplement  use. After careful  consideration  the
Company decided to cancel the launch.  The Company incurred $300,000 of expenses
which were expensed in the year ended September 30, 1997. The Company is seeking
pharmaceutical  and or  nutritional  companies  as  marketing  partners for this
product.  In the opinion of management  the inventory  held by the Company as of
September 30, 1997 will be recovered by the sale of the ANDROGRAPHIS  PANICULATA
tablets during the fiscal 1998.

4.          ACQUISITIONS:

(a) East West Herbs, Ltd.
-------------------------

On April 9, 1996,  the Company  signed an option to acquire East West Herbs Ltd.
of Kingham,  England.  East West Herbs Ltd. markets and distributes  traditional
Chinese  medicines in the United Kingdom and throughout  Europe.  Under terms of
the option,  the Company had the right to acquire all of the outstanding  shares
of East West Herbs on or before April 6, 1997 for $780,000 in cash and shares of
the  Company  with a value  of  approximately  $2,400,000  for a total  proposed
acquisition price of $3.2 million.  Consideration for the option was made in the
form of an option fee of $20,000 and a working  capital  loan of  $340,000.  The
loan was to be used by East  West  Herbs  for  inventory  purchases,  continuing
research and  development  including the clinical  trials of two herbal products
for cancer patients and corporate working capital. In connection with the option
and loan  agreements,  the Company also  incurred  other direct costs of $92,866
which were written off in 1997  because the Company  elected not to exercise its
option.

The loan to East West  Herbs,  Ltd.  bears  interest  at the  LIBOR  rate (6% at
September 30, 1996) and is payable in eight equal  quarterly  installments  with
the first  installment to be paid six months after the first  anniversary of the
loan  agreement.  The loan is guaranteed by a majority  shareholder of East West
Herbs. The following is a schedule of payment to be received:

                                                       Amount
               For the years ended September 30,     ----------
                                            1998     $  170,000
                                            1999        170,000
                                                     ----------
                                                     $  340,000
                                                     ==========

                                       33
<PAGE>

The  eventual  collectibility  of the loan will be subject  to East West  Herbs'
ability to achieve  profitable  operations  and positive cash flow in the future
and the financial resources of the loan's guarantor.

(b) New Century Nutrition Newsletter
------------------------------------

During  November  1995,  the  Company,   through  its  wholly-owned  subsidiary,
purchased  substantially  all of the assets related to the NEW CENTURY NUTRITION
(FORMERLY NUTRITION ADVOCATE), a newsletter promoting disease prevention through
nutrition,  from  Advocacy  Communications,  Inc.  The  purchase  price  for the
acquired  assets was $350,000 in cash. T. Colin  Campbell,  a former Director of
the Company  and his son T. Nelson  Campbell,  a former  Vice  President  of the
Company,  were majority  shareholders  and officers of Advocacy  Communications,
Inc.

The purchase price  represented  principally  intangible assets which were to be
amortized on a straight-line  basis over 10 years. In December 1996, the Company
decided to cease  publication of the newsletter  effective  January 1, 1997. The
Company wrote off the purchase price of the  newsletter and accrued  $75,000 for
the anticipated costs to close down the newsletter  operations which amounts are
included  in  newsletter  expenses  and costs in the  accompanying  consolidated
statement of operations  for the year ended  September  30, 1996.  During fiscal
1996, the Company  incurred  expenses of approximately  $531,000  developing the
newsletter  and  soliciting  subscriptions.  The Company  recorded  subscription
revenues  of $0 and $31,625  for the years  ended  September  30, 1997 and 1996,
respectively.

(c) Pacific Liaisons
--------------------

During October 1994, a wholly-owned  subsidiary of the Company  acquired Pacific
Liaisons for  approximately  $1.6 million in common stock.  The  acquisition has
been accounted for using the purchase method and the  accompanying  statement of
operations  includes the results of operations of Pacific  Liaisons from October
25,  1994.  The  allocation  of the purchase  price was based on an  independent
appraisal of certain assets acquired which include  traditional Chinese medicine
("TCM") extracts and a licensing agreement. The approximately 2,800 TCM extracts
can  be  sold  outright  or  utilized  in  various   research  and   development
applications  using the  Company's  screening  technology.  It is the  Company's
intention  to  sell/license  the  extracts  to  established  pharmaceutical  and
biotechnology companies. Effective October 1, 1995, the Company elected to begin
amortizing  the  cost  of the TCM  extracts  on a  straight  line  basis  over a
five-year period,  which represents the estimated period over which the extracts
will be used in the Company's research and development efforts.  Amortization of
the extracts totaling $155,580 and $155,602 are included in research and product
engineering expense in the accompanying consolidated statement of operations for
the year ended September 30, 1997 and 1996.

Through  the  licensing  agreement  with the  Institute  of  Nutrition  and Food
Hygiene,  an institute  within the Chinese Academy of Preventive  Medicine,  the
Company has the exclusive right to acquire up to 5,000 to 10,000  extracts.  The
licensing  agreement was being amortized over a period of five years  commencing
in October 1994.  Amortization of the license  agreement  totaling  $192,000 and
$173,290  are  included  in  research  and  product  engineering  expense in the
accompanying consolidated statements of operations for the years ended September
30, 1997 and 1996, respectively.

At the time of the  acquisition,  T. Colin  Campbell  became a  director  of the
Company and his son, T. Nelson  Campbell  was hired as a Vice  President  of the
Company. Both individuals were majority stockholders of Pacific Liaisons.


5.       STOCKHOLDERS' EQUITY:

(a) Common Stock Offerings
--------------------------

In September  1996,  the Company  completed a private  placement  financing  for
approximately $2.05 million in which it issued:

1)  683,333 shares of common stock;

                                       34
<PAGE>

2) Warrants to purchase  372,727  shares of common stock at an exercise price of
$4.00 per share,  of which the right to purchase  300,000 shares of common stock
is not immediately  exercisable  and is void after the fifth  anniversary of the
date on which they first become  exercisable  and of which the right to purchase
72,727  shares  of  common  stock is  immediately  exercisable  and  void  after
September 30, 2001; and

3) Warrants to purchase  310,606  shares of common stock at an exercise price of
$4.50  per  share,  of  which  the  right  to  purchase  250,000  shares  is not
immediately  exercisable and is void after the fifth  anniversary of the date on
which they first become  exercisable  and of which the right to purchase  60,606
shares is immediately exercisable and void after September 30, 2001.

In June and July 1996,  the  Company  completed a private  placement  to certain
investors for approximately $2.25 million in which it issued:

1)   825,001 shares of common stock;

2) Warrants to purchase  825,001  shares of common stock at an exercise price of
$3.25 per share,  of which the right to purchase  550,000 shares of common stock
is not immediately  exercisable  and is void after the fifth  anniversary of the
date on which they first become  exercisable  and of which the right to purchase
275,000 shares is immediately exercisable and void after June 26, 2001; and

3) Warrants to purchase  375,001  shares of common stock at an exercise price of
$4.50  per  share,  of  which  the  right  to  purchase  250,000  shares  is not
immediately  exercisable and is void after the fifth  anniversary of the date on
which they first become  exercisable and of which the right to purchase  125,001
shares is immediately exercisable and void after June 26, 2001.

In August 1995, the Company  completed a private  placement of 300,000 shares of
common stock to certain  investors at $2.76 per share resulting in net proceeds,
after expenses, to the Company of $752,625.

The  Company  used the  proceeds of the private  placements  for product  launch
expenses, working capital and research and development.

(b)  Convertible Preferred Stock Offerings
------------------------------------------

In the period  August  through  November  1995,  the  Company  sold  convertible
preferred stock through various  private  placements.  The Company issued 10,700
shares of its Series A preferred stock at $37.50 per share, 86,651 shares of its
Series B  preferred  stock at an  average  price of  $63.47  per share and 5,000
shares of its Series C  preferred  stock at $50.00 per share.  The net  proceeds
from these  issuance's  were used primarily to provide  working capital and fund
research and development.

The preferred  stock had a stated  dividend rate of 8% payable in cash or common
stock at the option of the Company.  The preferred  stock was  convertible  into
common stock based on the following conversion prices:


             Shares
 Series    Authorized                   Conversion Price
 ------    ----------                   ----------------

    A          50,000   Lower of $3.75 or 85% of five-day average Closing Price

    B         100,000   80% of three-day average Closing Price

    C          50,000   72.5% of three-day average Closing Price

The Closing  Price is defined in the  agreements  as the bid price of the common
stock beginning on the trading day prior to conversion.

During the period October 31, 1995 through  February 1, 1996, all of the holders
of the preferred  shares  converted such shares into common stock  summarized as
follows:

                                       35
<PAGE>

               Preferred           Gross                           Common Shares
   Series     Stock Issued        Proceeds          Net Proceeds     Converted
   ------     ------------        --------          ------------     ---------

      A          10,700       $     402,250       $       361,125       372,253

      B          86,651           5,500,000             4,400,000     4,918,409

      C           5,000             250,000               218,472        80,348
                -------       -------------       ---------------     ---------
                102,351       $   6,152,250       $     4,979,597     5,371,010
                =======       =============       ===============     =========

Included in the common shares converted are 58,031 shares issued in exchange for
the cumulative dividends payable on the preferred stock.

(c) Other Transactions
----------------------

In June 1996, the Company sold an investor  350,000 warrants at $.10 per warrant
to purchase  350,000  shares of common  stock at $5.25 per share.  The  warrants
could be exercised at any time over a three-year  period.  The cash paid for the
warrants of $35,000 was reflected as an addition to additional  paid-in  capital
in the accompanying  consolidated statement of stockholders' equity for the year
ended  September 30, 1996.  During fiscal year 1997,  the Company  redeemed this
warrant at a cost of $35,000.

During November 1995, the Company  purchased  265,478 shares of its common stock
on the open market for an aggregate cost of $1,342,515.

In April 1995,  the Company  issued  200,000  shares of common stock,  at a fair
value of $375,000, to an individual in connection with the Company's research of
Indian herbs.

During  fiscal 1997 and 1996,  the Company  issued  62,500 and 63,336  shares of
common  stock in  exchange  for  services  rendered  and issued  7,285 and 2,500
shares,  respectively,   for  the  conversion  of  short-term  liabilities.  The
transactions  have been valued based on the  estimated  fair value of the common
stock on the date issued.

On  September  8, 1993,  the  Company  granted a warrant  dividend.  The Company
distributed to each stockholder,  excluding one of the Company's  founders,  one
redeemable  common stock purchase warrant for each share of the Company's common
stock  owned,  entitling  the holder to purchase an  additional  share of common
stock for $3.25 per share.  On October 12,  1994,  the Company  granted  375,000
warrants to one of the Company's  founders,  under similar  terms.  The warrants
were originally  valued at $500,000.  These warrants expire on September 7, 1998
and would have had to be called at a redemption  price of $.05 per  warrant,  if
the Company's common stock traded at $4.75 or higher for 15 consecutive days. As
of  September  30,  1997,  a total of  2,312,388  warrants  have been issued and
269,518 warrants have been exercised and none have been redeemed.

In February 1992, the Company  completed its initial  public  offering  covering
1,150,000  shares of common  stock at $5.50 per share.  Issuance  costs  totaled
approximately  $1,210,000  which were  treated as a reduction  of  proceeds.  In
connection  with the offering,  the Company sold warrants to the underwriter for
$1,000 exercisable for a four-year period beginning in February 1993 for 100,000
shares of common  stock at a price of $6.60 per share.  The number of shares and
the  exercise  price per share of the  warrants  are to be adjusted  for certain
events, as defined in the agreement.


6.    COMMON STOCK OPTIONS:

In 1991,  the Company  adopted a Stock  Option Plan (the Plan).  Under the Plan,
directors,  key employees and consultants of the Company are eligible to receive
grants of options  which are  intended  to qualify as  incentive  stock  options
within the  meaning of Section  422 of the  Internal  Revenue  Code of 1986,  as
amended  (the  Code) or which are  non-qualified  stock  options.  In  addition,
non-employee directors of the Company may receive grants of 

                                       36
<PAGE>

options  according to a formula which upon the adoption of the Plan provided for
an  initial  grant of an option to  purchase  5,000  shares of common  stock and
annual  grants of  options to  purchase  2,500  shares of common  stock for each
person who is  subsequently  elected or re-elected  and for each year of service
thereafter  as a director.  An aggregate  of 394,000  shares of common stock has
been  reserved  for  issuance  under the  Plan.  The Plan is  administered  by a
committee (the  Committee)  designated by the Board of Directors of the Company.
The exercise  price per share for the options  granted under the plan may not be
less than the fair value of the Company's common stock on the date of grant. The
exercise price and the term are fixed by the Committee,  subject to the terms of
the Plan.

Changes in the status of options  under the Plan for the years  ended  September
30, 1997, 1996 and 1995 are summarized as follows:
<TABLE>
<CAPTION>

                                          1997                         1996
                                        -------                      --------
<S>                                     <C>                           <C>    
Outstanding at beginning of period      135,650                       150,150

Granted                                  83,500                        57,500

Exercised                                     0                       (15,000)

Forfeited                               (49,150)                      (57,000)
                                       --------                      --------
Outstanding at end of period            170,000                       135,650
                                       ========                      ========

Number of options at end of period -

     Exercisable                        153,750                       130,650

     Available for grant                224,000                       258,350

Average exercise price of options
    outstanding                        $   1.98                      $   2.68
</TABLE>

During  fiscal 1996,  15,000  options  were granted  pursuant to the Plan and an
additional 200,000 (for a total of 215,000) were granted  consultants  providing
communications  services  to the  Company.  The fair  value of these  options of
$107,500 were being  amortized over the two year period ended September 30, 1997
during which the services  were  performed.  In  addition,  50,000  options were
issued to the  Company's  legal counsel in exchange for services  rendered.  The
fair value of this option of $25,000 in fiscal 1996 and the  amortization of the
options  issued to the  consultants  of  $35,000 in fiscal  1996 and  $72,500 in
fiscal  1997,  are  included  in  general  and  administrative  expenses  in the
accompanying  consolidated statements of operations for the year ended September
30, 1996.

On January 23,  1995,  the Company  approved a stock  purchase by the  Company's
President and then Chief  Executive  Officer to purchase an aggregate of 705,000
shares  of the  Company's  common  stock at a price of $.05 and $.56 per  common
share  for  245,000  and  460,000  shares  of  common  stock,  respectively.  In
connection with this transaction,  the Company  recognized a one-time,  non-cash
compensation expense of approximately $1,228,000 in the year ended September 30,
1995. In conjunction  with the purchase of these shares,  the Company extended a
note to officer for $230,000, due December 31, 1995. Subsequently, this note was
extended  until  December 31, 1997.  In January  1998,  the shares of stock were
returned  to the Company  and the note was  forgiven.  The shares of stock had a
fair market value that  approximated  the outstanding note balance of 180,000 at
September  30,  1997  which  has  been  reflected  as an  offset  to  additional
paid-in-capital.

Stock option grants are set at the closing  price of the Company's  common stock
on the date of grant and the related  number of shares granted are fixed at that
point in time.  Therefore,  under the  principles  of APB  Opinion  No.  25, the
Company does not recognize  compensation  expense  associated  with the grant of
stock options. SFAS No. 123, "Accounting for Stock-Based Compensation," requires
the use of option valuation models to provide supplemental information regarding
options  granted  after 1995.  Pro forma  information  regarding  net income and
earnings per share shown below was  determined  as if the Company has  accounted
for its employee  stock  options and shares sold under its stock  purchase  plan
under the fair market value method of that statement.

The fair  value  of the  options  was  estimated  at the  date of grant  using a
Black-Scholes   option   pricing  model  with  the  following   weighted-average
assumptions for 1997 and 1996,  respectively:  risk-free  interest rates of 5.8%
and 6.3%;  dividend  yields of 0% and 0%;  volatility  factors  of the  expected
market price of the  Company's  common stock of 96% and 96% and expected life of

                                       37
<PAGE>

the   options  of  5  years  and  5  years.   These   assumptions   resulted  in
weighted-average  fair  values of $1.32  and  $1.90 per share for stock  options
granted in 1997 and 1996, respectively.

For purposes of pro forma  disclosures,  the estimated fair value of the options
is amortized  over the  options'  vesting  periods.  The pro forma effect on net
income for 1997 and 1996 is not  representative  of the pro forma  effect on net
income in future  years  because it does not take into  consideration  pro forma
compensation expense related to grants made prior to 1996. Pro forma information
in future  years  will  reflect  the  amortization  of a larger  number of stock
options granted in several succeeding years. The Company's pro forma information
is as follows:

                                                     September 30,
                                             ---------------------------
                                                   1997          1996
                                             ------------   ------------ 
     Pro forma net loss..................    $ (5,079,605)  $ (5,844,014)

     Pro forma loss per share:
        Primary..........................    $      (0.42)  $      (0.68)


7.  LICENSING AGREEMENTS:

The Company entered into an exclusive  licensing agreement with Cornell Research
Foundation,  Inc. in July 1991 in exchange for common stock of the Company,  for
proprietary  rights  allowing the Company to use certain  technology and patents
for the purpose of developing,  manufacturing  and selling any products  derived
therefrom. The agreement provides that the Company will pay royalties to Cornell
Research  Foundation,  Inc. for certain licensed products sold by the Company in
the United States and throughout the world.

In January  1995,  the Company  entered into an agreement  with The Dow Chemical
Company (Dow) for a non-exclusive license and an option for an exclusive license
to evaluate  and  commercialize  the  Company's  Ah-IMMUNOASSAY  technology.  In
connection  with the agreement,  the Company  received a license fee of $250,000
for the worldwide,  non-exclusive  license. Dow has notified the Company that it
does not intend to execute the exclusive worldwide license for the assay.

In December 1995, the Company entered into a license agreement with Northwestern
University  with  respect  to use of  certain  biological  materials  for dioxin
assays. The Company paid Northwestern $50,000 for an exclusive worldwide license
to the materials for the specified use of dioxin assays.


8.  INCOME TAXES:

Effective  October 1, 1993,  the  Company  prospectively  adopted  Statement  of
Financial  Accounting  Standards No. 109,  "Accounting for Income Taxes",  which
requires an asset and liability  approach to financial  accounting and reporting
for income taxes. The cumulative  effect of this change in accounting  principle
did not have a material effect on the Company's financial position or results of
operations.

The income tax effects of temporary  differences  that give rise to the deferred
tax  asset/(liability)  as of  September  30 are  approximately  as follows  (in
thousands):

                                             1997       1996
                                            ------     ------ 

Net operating loss                         $ 5,110    $ 3,600

Start-up costs                                  70        150

Patents and trademarks                         (30)       (30)

Inventory                                       50         --

Newsletter costs                                --        130

Accelerated depreciation                       (70)       (70)
                                            ------     ------ 

                                             5,130      3,780

Less - valuation allowance                  (5,130)    (3,780)
                                            ------     ------ 

    Net deferred tax asset / (liability)   $    --    $    --
                                           =======    =======

                                       38
<PAGE>

Valuation allowances of $5,130,000 and $3,780,000 were recorded at September 30,
1997 and 1996, respectively, to offset the related net deferred tax asset due to
the uncertainty of realizing the related tax benefit (see Note 1). The Company's
net operating loss carryforwards may be subject to certain annual limitations.

9.  RELATED PARTIES:

During fiscal 1996 and 1995,  the Company made loans to its then Vice  President
and Chief Science Officer.  Such loans are due on demand and bear interest at 8%
per annum.  This loan of $56,000 was determined to be uncollectible  and written
in for the year ended September 30, 1997.

During fiscal 1994 and 1993, the Company had research and sponsorship agreements
with Cornell.  Approximately  $165,000 and $376,000  were  expensed  under these
agreements  in 1994 and  1993,  respectively.  In the  opinion  of the  Board of
Directors,  the terms of these  agreements  were at least as  favorable as could
have been obtained if the agreements were  undertaken  with an unrelated  party.
Amounts payable to Cornell total approximately  $18,555 and $77,000 at September
30, 1997 and 1996, respectively.

10.   COMMITMENTS AND CONTINGENCY:

Lease and Rental Commitments
----------------------------

The Company has  entered  into  noncancellable  operating  leases for  executive
offices  and  laboratory  facilities  from an entity  owned by Cornell  covering
approximately  6,000 square feet and expiring in April 1998. Such leases provide
for automatic  renewals for a one year term.  Amounts charged to expense in 1997
and 1996 totaled approximately $101,800 and $90,000, respectively.

Cooperative Research and Development Agreement
----------------------------------------------

The Company has entered into a Cooperative  Research and  Development  Agreement
(CRADA)  with the  Laboratory  of Tumor  Cell  Biology  of the  National  Cancer
Institute  (NCI).  The  principal  goals  of this  proposed  CRADA  involve  the
screening of a library of traditional Chinese medicines (TCMs) for their affects
on reducing HIV induced cytotoxicity and/or their ability to inhibit cell growth
in various tumor cell lines.

This  agreement  signed on  December  18,  1996 calls for the Company to pay NCI
$500,000  over a two year  period.  The  payment  terms  are  $100,000  upon the
execution of the agreement and the one year  anniversary and quarterly  payments
of  $50,000  during the year.  The  Company  is  allowed  offsets  for "in kind"
contributions, such as salaries and consultants paid by directly by Paracelsian.
In September, the Company canceled the contract. The Company is obligated to pay
certain expenses for six months totaling approximately $17,000.

                                       39
<PAGE>

Contingency:
------------

During  1993,  an action was  commenced  against  the  Company,  a Company  Vice
President and a shareholder  and former  employee of the Company.  The complaint
seeks  money  damages  and  alleges  that  in  1990,   prior  to  the  Company's
incorporation,   certain   individuals   became  partners  with  the  individual
defendants in a venture formed to  commercialize  products which the Company had
originally  intended to develop.  Management believes that the action is without
merit  and  is  vigorously  opposing  the  allegations  and  that  the  ultimate
resolution of this  litigation  will not have a material  adverse  effect on the
Company's financial position or results of operations.

On April 25, 1997 the Company filed a complaint in the U.S.  District  Court for
the Northern  District of New York against John G. Babish,  a former officer and
director of the Company.  The  complaint  alleges that Mr.  Babish  engaged in a
pattern of wrongful conduct by which he sought to unjustly enrich himself and to
seize control of the Company at the expense of the Company and its shareholders.
That conduct  included in part the  manipulation  of the Company's  stock price,
trading in the Company's  stock on inside  information,  breach of fiduciary and
contractual  duties,  theft of Company  property,  and  usurpation  of corporate
opportunities.

The Company  initially  obtained a temporary  restraining  order prohibiting the
defendant alone or in cooperation with others from transferring any of the stock
or assets of or other interests in the Company, from issuing a press release, or
contacting  stock  brokers or major  shareholders  with the intent to affect the
price of  plaintiff's  stock or from  disseminating  any trade  secrets or other
confidential  information of the plaintiffs.  The restraining  order against the
defendant  expired,  and the court declined the Company's request to extend that
order in a preliminary injunction.

The  defendant  denied  any  wrongdoing  in his  answer  to the  complaint,  and
counterclaimed  for damages "between  $375,000 and $1,829,587" on account of the
Company's alleged failure to register shares of common stock underlying  certain
warrants.  Defendant moved to dismiss the suit, and that motion was denied.  The
parties have commenced mutual  disclosure of evidence as required by law and are
currently in negotiations for mutual release and settlement.

On May 20, 1997, Dr. T. Colin Campbell, a former director of the Company,  filed
a petition  in the  Delaware  Court of  Chancery  pursuant to Section 211 of the
Delaware  General  Corporation  Law  ("DGCL").  The  petition  sought  an  order
compelling  the  Company to hold an annual  meeting of  stockholders  and sought
other forms of relief relating thereto,  including requesting that the Court set
a time and place for the meeting and ordering that certain board seats be put up
for  election.  On June 11,  1997,  the  Company  announced  that  the  Board of
Directors  had  scheduled  the annual  meeting for August 13, 1997 and had set a
record date of July 10, 1997 for stockholders entitled to attend and vote at the
meeting. On the same day, the Company moved to dismiss the petition.

On June 20, 1997, petitioner filed a cross-motion in opposition to the Company's
motion to dismiss,  and an application,  pursuant to Section 223(c) of the DGCL,
to require  the  Company to hold an  election  at the annual  meeting to replace
directors  recently  appointed to the Board.  Subsequently,  petitioner moved to
postpone the scheduled August 13th meeting in order to have more time to conduct
a proxy  contest.  The  Court  scheduled  a  hearing  for July 28,  1997 to hear
argument on that motion.  Following the hearing,  the Court ruled from the bench
and denied  petitioner's  request to  postpone  the  meeting,  but  granted  the
petitioner  leave to amend his petition.  To date,  petitioner  has not filed an
amended petition.

                                       40
<PAGE>

11.   SUBSEQUENT EVENT

On January 14, 1997 the Company signed an agreement  with Biomar  International,
Inc. ("Biomar") in which Biomar  agrees to purchase  3,571,429  shares of common
stock for  $500,000.  In addition,  Biomar will receive  warrants to purchase an
additional  2,971,429  shares of common stock at a price of $.175 per share or a
total of $520,000.  These warrants  expire 90 days after the shares and warrants
are registered with the Securities and Exchange Commission ("SEC").  Biomar will
also  become  the  major  shareholder  and  received  control  of the  Board  of
Directors.  Biomar is controlled by T. Colin  Campbell a former  director of the
Company and his son, T. Nelson Campbell a former Vice President of the Company.

12.   RECENTLY ISSUED ACCOUNTING STANDARDS

In March, 1995, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 121. "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", which becomes
effective  for the  Company as of October 1, 1996.  This  statement  establishes
accounting   standards  of  the   impairment  of  long-lived   assets,   certain
identifiable  intangibles  and  goodwill  related to those assets to be held and
used and for  long-lived  assets  and  certain  identifiable  intangibles  to be
disposed.  The initial application of FASB No. 121 did not have an impact on the
Company's financial statements.  An expense of $122,453 has been included in the
accompanying Statements of Operation under Impairment of Assets.

In February  1997, the Financial  Accounting  Standards  Board  ("FASB")  issued
Statement of Financial  Accounting  Standards  ("SFAS") No. 128,  "Earnings  Per
Share." This  Statement  establishes  standards  for  computing  and  presenting
earnings per share  ("EPS") and applies to entities  with  publicly  held common
stock or potential  common stock.  This  Statement  simplifies the standards for
computing  earnings per share  previously found in APB Opinion No. 15, "Earnings
Per  Share,"  and makes them  comparable  to  international  EPS  standards.  It
replaces the  presentation  of primary EPS with a presentation  of basic EPS. It
also  requires  dual  presentation  of basic and  diluted EPS on the face of the
income statement for all entities with a complex capital  structure and requires
a  reconciliation  of the numerator and denominator of the basic EPS computation
of the numerator and denominator of the diluted EPS computation.  This Statement
is effective for financial  statements  issued for periods ending after December
15, 1997, including interim periods; earlier application is not presented.  This
Statement requires of all prior period EPS data presented.  The adoption of this
Statement  will not have any  impact on the  Company's  EPS  disclosure,  as the
Company's stock options and warrants are anti-dilutive and will be excluded from
the denominator of earnings per share; thus, earnings (loss) per common share is
equal to the basic earnings (loss) per share as computed under SFAS No. 128.

                                       41

<PAGE>


ITEM 13.   EXHIBITS, LISTS AND REPORTS ON FORM 10-K.

a.         Exhibits: The following Exhibits are filed as a part of this Report:
           --------

Exhibit No.    Description
-----------    -----------

      3.1      Certificate of Incorporation of the Registrant.  (Incorporated by
               reference  to  Exhibit  3.1  to  the  Registrant's   Registration
               Statement on Form S-1, File No. 33-44809 (the "1992  Registration
               Statement").

      3.2      By-Laws of the Registrant.  (Incorporated by reference to Exhibit
               3.2 to the 1992 Registration Statement.)

      4.1      Form of Stock Certificate.  (Incorporated by reference to Exhibit
               1.1 to the Registrant's  Registration Statement on Form 8-A, File
               No. 0-19844.)

      4.3*     Form of Warrants  issued to  institutional  investors in June and
               September 1996.

      10.1     Exclusive License  Agreement,  dated as of July 1, 1991,  between
               the   Registrant   and   Cornell   Research   Foundation,    Inc.
               (Incorporated   by   reference   to  Exhibit  10.1  to  the  1992
               Registration Statement).

      10.2     Assignment  Agreement,  dated as of December 1, 1991, between the
               Registrant  and John G.  Babish  (Incorporated  by  reference  to
               Exhibit 10.3 to the 1992 Registration Statement).

      10.3     Amended 1991 Stock Option Plan and form of Stock Option Contracts
               (Incorporated  by reference  to Exhibit 10.4 to the  Registration
               Statement).

      10.4*    Lease  Agreement,  dated as of February  31,  1966 (sic)  Between
               ParaComm,  Inc.  and  Cornell  University  c/o Sibley Real Estate
               Services, Inc.

      10.5     Agreement and Plan of Merger, dated as of October 25, 1994, among
               the Registrant,  Para Acquisition Corporation,  Pacific Ventures,
               Inc.,  China  Consultants,  Inc.,  Pacific  Liaisons,  T. Nelson,
               Campbell,  T. Colin Campbell,  Dr. Chen Junshi, Dr. Wu Boping and
               Mr. Ming Li.  (Incorporated  by  reference  to Exhibit 2.1 to the
               Registrant's  Report on Form 8-K dated October 25, 1994, File No.
               0-19844.)

      10.6     Agreement,  Dated September 23, 1994,  between the Registrant and
               IDEXX  Laboratories  Corp.  (Incorporated by reference to Exhibit
               2.1 to the  Registrant's  Report  on Form 8-K dated  October  25,
               1994, File No. 0-19844.)

      10.7     License Agreement, dated January 19, 1995, between the Registrant
               and Dow Environmental. (Incorporated by reference to Exhibit 10.8
               to the  Registrant's  Report on form  10-KSB for the Fiscal  year
               ended September 30. 1995).

      10.8*    Cooperative Research and Development Agreement dated December 18,
               1995,  by and  between the  Registrant  and the  National  Cancer
               Institute.

      10.9*    Agreement, dated April 9, 1996 between the Registrant,  East West
               Herbs Limited, Robert E. Miller and A. E. Lyon.

                                       42
<PAGE>

      10.10    Option Agreement,  dated April 9, 1996,  relating to the purchase
               of East West  Herbs  Limited,  RE:  Robert E.  Miller  and Others
               (defined therein) and the Registrant and East West Herbs Limited.

      10.11*   Exclusive  Licensing  Agreement,  dated  April 1,  1996,  between
               Calbiochem-Novabiochem International and the Registrant.

      21*      Subsidiaries of the Registrant.

      23.1*    Consents of Arthur Andersen LLP

      23.2*    Consent of KPMG Peat Marwick LLP

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

*Filed December 30, 1996.

b.             Reports on Form 8-K
               -------------------

               None

                                       43

<PAGE>


ITEM:8   CHANGES IN AND DISAGREEMENTS  WITH ACCOUNTS ON ACCOUNTING AND FINANCIAL
         DISCLOSURE

On November 8, 1996 the Company engaged KPMG Peat Marwick LLP as its independent
auditors  for the year  ending  September  30,  1996 as approved by its Board of
Directors and simultaneously dismissed Arthur Andersen LLP.

The reports of Arthur Andersen LLP on the Company's financial statements for the
two previous  fiscal years did not contain an adverse opinion or a disclaimer of
opinion and were not qualified or modified as to  uncertainty,  audit scope,  or
accounting principles.

In connection with the audits of the Company's financial  statements for each of
the two years ended  September 30, 1995 and 1994, and in the subsequent  interim
period there were no  disagreements  with Arthur  Andersen LLP on any matters of
accounting principles or practices,  financial statement disclosure, or auditing
scope and  procedures  which,  if not  resolved  to the  satisfaction  of Arthur
Andersen LLP would have caused  Arthur  Andersen  LLPL to make  reference to the
matter in their report.


                                    PART III

ITEM 9.  DIRECTORS,   EXECUTIVE  OFFICERS,  PROMOTERS  AND  CONTROL  PERSONS  IN
         COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

                                       AND

ITEM 10. EXECUTIVE COMPENSATION

                                       AND

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

                                       AND

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS


Omitted,  per general instruction E. The information  required by Part III shall
be incorporated by reference from the  registrant's  definitive  proxy statement
pursuant to Regulation 14A for the fiscal year ended September 30, 1997 which is
to be filed with the Commission.

                                       44


                                   SIGNATURES

               In  accordance  with Section 13 or 15(d) of the Exchange Act, the
Registrant  caused  this  report to be signed on its behalf by the  undersigned,
thereunto duly authorized.

Date:          January 14, 1998


PARACELSIAN, INC.



By:            /s/ THOMAS G. TACHOVSKY
               -------------------------------------
               Thomas G. Tachovsky
               President and Chief Executive Officer



          In accordance with the Exchange Act, this report has been signed below
by the following  persons on behalf of the  Registrant and in the capacities and
on the dates indicated.

<TABLE>
<CAPTION>
      Signature                           Title                       Date
      ---------                           -----                       ----


<S>                                   <C>                        <C> 
/s/ THEODORE P. NIKOLIS                Chairman of the Board     January 14, 1998
---------------------------------      Director
    Theodore P. Nikolis

/s/ STEVEN DENTALI
---------------------------------      Director                  January 14, 1998
    Steven Dentali

/s/ LEE HENDERSON
---------------------------------      Vice President,           January 14, 1998
    Lee Henderson                      Director

/s/ STEPHEN IP
---------------------------------      Director                  January 14, 1998
    Stephen Ip

/s/ JAMES NICHOLS
---------------------------------      Director                  January 14, 1998
    James Nichols

/s/ T. NELSON CAMPBELL
---------------------------------      Director                  January 14, 1998
    T. Nelson Campbell

</TABLE>


                                       45
<PAGE>