<PAGE>

                      U. S. Securities and Exchange Commission
                              Washington, D.C.  20549

                                   FORM 10-KSB/A
                                  AMENDMENT NO. 2

(Mark One)
[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 number      0-17569
                            ----------------------

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

            Delaware                                         84-1063897
     (State or other jurisdiction                        (I.R.S. Employer
 of incorporation or organization)                       Identification No.)

1181 Grier Drive, Suite B, Las Vegas, Nevada                   89119
(address of principal executive offices)                     (Zip Code)

Issuer's telephone number: (702) 361-9873

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

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

                            Common Stock, $.0001 Par Value
                      ------------------------------------------
                                  (Title of class)

     Indicate by check whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
YES X  NO
    -     --

     Indicate by check if there is no disclosure of delinquent filers in
response to Item 405 of Regulation S-B 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. [ X]

     Issuer's revenues for its most recent fiscal year:  $1,523,994

     The aggregate market value of the voting stock held by non-affiliates
computed by reference to the last sale price of such stock on December 19, 1997
of $0.19 was $4,591,995

     As of December 19, 1997, the Issuer had 25,520,660 shares of Common Stock,
par value $.0001 per share, outstanding.

<PAGE>


                                      PART III

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

     The names, ages and respective positions of the Executive Officers and
Directors of the Company are as follows:
<TABLE>
<CAPTION>

 Name                     Age     Position
 ----                     ---     --------
<S>                       <C>     <C>
 Geoffrey  F. Hewitt      54      Chairman of the Board, President, Chief
                                  Executive Officer and Class A Director

 Dale W. Conrad           57      Class A Director

 Byron A. Denenberg       63      Class C Director

 Irwin J. Gruverman       64      Class A Director

 Walter Haemmerli         68      Class B Director

 Gerald T. Owens          70      Class C Director

 Melvin W. Pelley         53      Chief Financial Officer and Secretary

</TABLE>

     The names, ages and respective positions of the Executive Officers and
Directors of FCI Environmental are as follows:
<TABLE>
<CAPTION>

 Name                     Age     Position
 ----                     ---     --------
<S>                       <C>     <C>
 Dale W. Conrad           57      Chairman of the Board and Director

 Geoffrey F. Hewitt       54      Chief Executive Officer and Director

 Melvin W. Pelley         53      C h i ef  Financial  Officer,  Secretary  and
                                  Director

 Thomas A. Collins        51      President

</TABLE>

     GEOFFREY F. HEWITT has served as Chairman of the Board since November 14,
1997 and as President and Chief Executive Officer of the Company, as well as
Chief Executive Officer of FCI Environmental since August 1995.  Mr. Hewitt was
appointed as a Director of the Company on September 11, 1996.  He has also
served as a Director of FCI Environmental since April 1994 and as its President
from April 1994 to November 1996.   He served as Chief Operating Officer of FCI
Environmental from April 1994 to August 1995.  Prior thereto, from 1977 until
March 1994, Mr. Hewitt served as Vice President of worldwide sales and marketing
for H.N.U. Systems, Inc., a manufacturer of environmental and material analysis
instrumentation.

     DALE W. CONRAD has served as a Director of the Company since August 1995.
He has also served as Chairman of the Board of Directors of FCI Environmental
since March 1993, as President of


                                          22
<PAGE>

Environmental from March 1993 until April 1994, and as Chief Executive Officer
of FCI Environmental from March 1993 until August 1995.  Prior thereto, from
1988 to 1991, he was President and Chief Executive Officer of Biotope, Inc.,
Redmond, Washington, a defunct company engaged in the design and manufacturing
of blood diagnostic equipment.  From 1983 to 1988 he was President of Advanced
Technology Laboratories, Inc. ("ATL"), Bothell, Washington, which manufactures
and markets real-time ultrasound medical diagnostic equipment.  From 1981 to
1983 Mr. Conrad was Executive Vice President and General Manager for Advanced
Diagnostic Research Corporation ("ADR"), Tempe, Arizona, a designer,
manufacturer and marketer of diagnostic ultrasound scanners.  From 1965 to 1981,
he held various positions at Texas Instruments, Inc., including Site Manager for
the College Station, Texas plant from 1979 to 1981.

     BYRON A. DENENBERG has served as a Director of the Company since August
1995.  Mr. Denenberg has been a private investor since 1991.  Mr. Denenberg was
co-founder in 1969 of MDA Scientific, Inc. ("MDA"), a manufacturer and marketer
of toxic gas monitoring systems, where he was CEO from inception until 1991.
MDA was purchased by Zwellweger Uster AG in 1988.  Mr. Denenberg received a B.S.
degree in Mechanical Engineering from Bucknell University, Lewisburg,
Pennsylvania.  He currently serves as a Director of RCT Systems, Inc., MST
Measurement Systems, Inc., FPM Analytics, Inc., and Microsensor Technologies,
GmbH.

     IRWIN J. GRUVERMAN has served as a Director of the Company since May 1994.
Since 1990, Mr. Gruverman has served as the General Partner for G&G Diagnostics
Funds, a venture capital business, and in 1982 founded and currently serves as
Chairman of the Board of Directors and Chief Executive Officer of Microfluidics
Corporation, an equipment manufacturer and process research and development
company.

     WALTER HAEMMERLI has served as a Director of the Company since February
1990.  Mr. Haemmerli has been the Chief Executive Officer since 1978 of Manport
AG, Zurich, Switzerland, an investment management company owned by him.  Mr.
Haemmerli was employed by Union Bank of Switzerland, Geneva, Basle and Zurich
form 1960 to 1978, holding the position of Vice President from 1970.  Mr.
Haemmerli serves on the Board of Directors and is Vice-Chairman of Privatbank
Vermag AG, Chur, Switzerland, and is a Member of the Board of Directors for
American Cold Storage, Inc., Louisville, Kentucky.

     GERALD T. OWENS has served as a Director of the Company since December
1987.  Mr. Owens served with Mobil Oil from 1962 to 1983 when he retired.  At
retirement, he was President of Mobil Sales and Supply Corporation, a
wholly-owned subsidiary of Mobil Oil, and he was a Vice President of Mobil Oil.
From 1951 to 1961, Mr. Owens practiced law with the law firm of Andrews and
Kurth in Houston, Texas.  Mr. Owens received an L.L.B. degree from the
University of Texas in 1950 and a B.A. degree in history in 1948 from the
University of Texas.  He serves as Chairman of the Board of Trustees for the
Kenny Stout Memorial Golf Foundation, and as a member of the Board of Trustees
for the Monterey Institute of International Studies.

     MELVIN W. PELLEY has been the Chief Financial Officer and Secretary of the
Company since April 1994 and has been Chief Financial Officer and Secretary of
FCI Environmental since June 1993.  Prior thereto, from 1988 he was Vice
President of Finance and Administration of Acoustic Imaging Technologies
Corporation, Phoenix, Arizona, a manufacturer of diagnostic ultrasound medical
equipment.  From 1983 to 1988 he was Director of Costs, Financial Planning and
Analysis of ATL.  From 1977 to 1983, Mr. Pelley was Chief Financial and
Administrative Officer for ADR.

     THOMAS A. COLLINS has served as President of FCI Environmental since
November 1996 and as Vice President of International Marketing and Product
Development from March 1996 to November 1996.  Prior thereto, from 1992 he was
Director of International Sales and Product Marketing of Arizona Instrument
Corporation, a manufacturer of environmental and control instrumentation; from
1990 to 1992 he was Director of Marketing of Wayne Division, Dresser Industries,
Inc., a manufacturer of dispensing


                                          23
<PAGE>

equipment for the gasoline industry; from 1986 to 1989 he was Manager of
Domestic Retail Marketing for Diebold, Inc., a manufacturer of transaction
terminals in the petroleum retailing market; and from 1968 to 1986 he held
marketing and engineering positions at ARCO Petroleum Products Co.

     Officers serve at the discretion of the Board of Directors.  All Directors
hold office until the expiration of their terms and the election and
qualification of their successors.  The Company's Board of Directors is divided
into three classes of approximately equal size with the members of each class
elected, after an initial phase-in-period, to three-year terms expiring in
consecutive years. Mr. Gruverman, Mr. Conrad and Mr. Hewitt were elected to
three-year terms as Directors at the Company's June 1997 Annual Meeting of
Shareholders.  Mr. Loomis and Mr. Haemmerli were elected to three-year terms as
Directors at the Company's May 1996 Annual Meeting of Stockholders.  Mr. Loomis
resigned December 23, 1997.    Mr. Owens was elected to a three-year term as
Director at the Company's May 1995 Annual Meeting of Stockholders and Mr.
Denenberg was appointed to the Board of Directors in August 1995.

     In January 1993, the Company established a Stock Option Committee.  The
Stock Option Committee is responsible for the granting of stock options under
the Company's Stock Option Plans.  The Company also established a Compensation
Review Committee, which is responsible for reviewing the compensation of the
Company's executives and employees.  In August 1995, Mr. Owens and Mr. Haemmerli
were appointed to a single Compensation Review and Stock Option Committee.
Also, in August 1995, Mr. Loomis and Mr. Owens were appointed to a newly
established Audit Committee.  Mr. Loomis resigned December 23, 1997.  Mr.
Gruverman was added to the Audit Committee on November 14, 1997.  The Board of
Directors did not have a standing nomination committee or committee performing
similar functions during the fiscal year ended September 30, 1997.

COMPLIANCE WITH 16(a) OF THE EXCHANGE ACT

     Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers, Directors and persons who own more than ten percent of a registered
class of the Company's equity securities, to file reports of ownership and
changes in ownership with the Securities and Exchange Commission.  Officers,
Directors and ten percent shareholders are required by regulation to furnish the
Company with copies of all Section 16(a) forms they file.  Based solely on the
Company's copies of such forms received or written representations from certain
reporting persons that no Form 5's were required for those persons, the Company
believes that, during the time period from October 1, 1996 to September 30,
1997, all filing requirements applicable to its officers, Directors and greater
than ten percent beneficial owners were complied with.


                                          24
<PAGE>

                                     SIGNATURES

     Pursuant to the requirement of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

Dated:    March 3, 1998

                              FIBERCHEM, INC.


                              By:       /s/ Geoffrey F. Hewitt
                                        -------------------------
                                        President and Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.

<TABLE>
<CAPTION>

<S>                           <C>                                          <C>
/s/ Geoffrey F. Hewitt        Chairman, President and Chief Executive      March 3, 1998
-------------------------     Officer (Principal Executive Officer)
Geoffrey F. Hewitt

/s/ Melvin W. Pelley          Chief Financial Officer                      March 3, 1998
-------------------------     (Principal Accounting Officer)
Melvin W. Pelley

/s/ Walter Haemmerli          Director                                     March 3, 1998
-------------------------
Walter Haemmerli

/s/ Gerald T. Owens           Director                                     March 3, 1998
-------------------------
Gerald T. Owens

/s/ Irwin J. Gruverman        Director                                     March 3, 1998
-------------------------
Irwin J. Gruverman

/s/ Dale W. Conrad            Director                                     March 3, 1998
-------------------------
Dale W. Conrad

/s/ Byron A. Denenberg        Director                                     March 3, 1998
-------------------------
Byron A. Denenberg


</TABLE>


                                          35
<PAGE>

                            INDEPENDENT AUDITORS' REPORT


To the Board of Directors
FiberChem, Inc.

We have audited the accompanying consolidated balance sheets of FiberChem, Inc.
and Subsidiaries as of September 30, 1997 and 1996 and the related consolidated
statements of operations, stockholders' equity, and cash flows for the years
then ended.  These financial statements are the responsibility of the Company's
management.  Our responsibility is to express an opinion on these financial
statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of FiberChem, Inc. and
Subsidiaries as of September 30, 1997 and 1996, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern.  As discussed in Note 1 to
the consolidated financial statements, the Company has suffered recurring losses
from operations which raise substantial doubt about its ability to continue as a
going concern.  Management's plans in regard to these matters are also described
in Note 1.  The consolidated financial statements do not include any adjustments
that might result from the outcome of these uncertainties.


/s/ GOLDSTEIN GOLUB KESSLER & COMPANY, P.C.
--------------------------------------------
GOLDSTEIN GOLUB KESSLER & COMPANY, P.C.
New York, New York

February 13, 1998


                                         F-1
<PAGE>
                           FIBERCHEM, INC. AND SUBSIDIARIES
                             CONSOLIDATED BALANCE SHEETS

                                        ASSETS

<TABLE>
<CAPTION>
 

                                                                     September 30,  September 30,
                                                                         1996           1997
                                                                     -------------  -------------

<S>                                                                   <C>           <C>         
Current assets:

          Cash and cash equivalents                                   $3,065,572       $427,488
          Accounts receivable, net of allowance for doubtful
            accounts of $204,711 and $240,796 in 1996 and 1997,
            respectively                                                 305,473        263,947
          Inventories (Note 3)                                         1,457,135      1,563,191
          Prepaid expenses and other                                      59,060         56,941
                                                                    ------------  -------------
                    Total current assets                               4,887,240      2,311,567
                                                                    ------------  -------------

Equipment                                                                616,192        716,465
Less accumulated depreciation                                           (483,827)      (549,175)
                                                                    ------------  -------------
                    Net equipment                                        132,365        167,290
                                                                    ------------  -------------

Other assets:

          Patent costs, net of accumulated amortization of
            $1,436,309 at September 30, 1996 and
            $1,678,845 at September 30, 1997 (note 5)                    474,462        287,905
          Technology costs, net of accumulated amortization
            and $354,942 at September 30, 1996 and                       114,764         83,333
            and $386,373 at September 30, 1997 (note 4)
          Financing costs, net of accumulated amortization of
            $65,678 at September 30, 1996 and
            $148,298 at September 30, 1997 (note 6)                      204,245        119,625

          Other                                                          247,383              -
                                                                    ------------  -------------
                    Total other assets                                 1,040,854        490,863
                                                                    ------------  -------------
Total assets                                                          $6,060,459     $2,969,720
                                                                    ------------  -------------
                                                                    ------------  -------------
</TABLE>
 






           The accompanying notes and independent auditor's reports should
          be read in conjunction with the consolidated financial statements.



                                         F-2
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                             CONSOLIDATED BALANCE SHEETS

                         LIABILITIES AND STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
 

                                                            September 30,     September 30,
                                                                 1996             1997
                                                         ---------------    ---------------
<S>                                                      <C>                <C>
Current liabilities:

     Current installments of note payable (note 6)              $7,315              $6,878
     Accounts payable                                          270,503              95,469
     Accrued expenses                                          206,565             307,891
     Interest payable                                           18,016              17,778
                                                          ------------        ------------
            Total current liabilities                          502,399             428,016

Senior convertible notes payable (note 6)                    1,675,000           1,650,000
Note payable, net of current installments (note 6)               2,551               7,942
                                                          ------------        ------------
            Total liabilities                                2,179,950           2,085,958
                                                          ------------        ------------

Stockholders' equity (notes 4, 6 and 7):

     Preferred stock, $.001 par value.  Authorized
       10,000,000 shares;  205,089 and 218,998 convertible
       shares issued and outstanding at September 30,
       1996 and September 30, 1997, respectively;
       at liquidation value of $15 per share                 3,076,335           3,284,970
     Common stock,  $.0001 par value.  Authorized
       40,000,000 shares at September 30, 1996, and
       50,000,000 shares at September 30, 1997;
       25,705,216 and 25,515,660 shares issued and
       outstanding at September 30, 1996, and
       September 30, 1997, respectively                          2,571               2,552
     Additional paid-in capital                             28,714,804          27,192,749
     Deficit                                               (26,369,551)        (29,596,509)
                                                          ------------        ------------
                                                             5,424,159             883,762
     Notes receivable for exercise of options               (1,543,650)                 --
                                                          ------------        ------------
            Total stockholders' equity                       3,880,509             883,762

Commitments and contingencies (notes 6, 7 and 8)
                                                          ------------        ------------
Total liabilities and stockholders' equity                  $6,060,459          $2,969,720
                                                          ------------        ------------
                                                          ------------        ------------


</TABLE>
 

          The accompanying notes and independent auditor's reports should
          be read in conjunction with the consolidated financial statements.

                                         F-3
<PAGE>


                           FIBERCHEM, INC. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>




                                                                      Years ended September 30,
                                                                     --------------------------
                                                                         1996           1997
                                                                     -----------    -----------
<S>                                                                  <C>            <C>
Revenues                                                                $908,700     $1,523,994
Cost of revenues                                                         367,779        945,434
                                                                     -----------    -----------
                    Gross profit                                         540,921        578,560
                                                                     -----------    -----------

Operating expenses:

          Research, development and engineering                        1,233,054      1,257,324
          General and administrative                                   1,109,456      1,101,781
          Sales and marketing                                          1,007,975      1,004,172
          Provision for loss on accounts receivable                      201,225         36,085
          Writedown of obsolete inventory                                281,313            --
                                                                     -----------    -----------
                    Total operating expenses                           3,833,023      3,399,362
                                                                     -----------    -----------
                    Loss from operations                              (3,292,102)    (2,820,802)
                                                                     -----------    -----------

Other income (expense):

          Interest expense                                              (183,795)      (223,161)
          Interest income                                                201,268         81,787
          Other, net                                                          --       (264,782)
                                                                     -----------    -----------
                    Total other income (expense)                          17,473       (406,156)
                                                                     -----------    -----------
                    Net loss                                         ($3,274,629)   ($3,226,958)
                                                                     -----------    -----------

Shares of common stock used in computing loss per share               22,274,226     25,623,614
                                                                     -----------    -----------
                                                                     -----------    -----------

                    Net loss per share                                    ($0.15)        ($0.13)
                                                                     -----------    -----------
                                                                     -----------    -----------
</TABLE>










           The accompanying notes and independent auditor's reports should
          be read in conjunction with the consolidated financial statements.


                                         F-4

<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                   CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                       YEARS ENDED SEPTEMBER 30, 1996 AND 1997



<TABLE>
<CAPTION>

                                                             Preferred Stock                    Common Stock           Additional
                                                   --------------------------------------------------------------        Paid-In
                                                      Shares           Amount           Shares           Amount          Capital
                                                   -----------      -----------      -----------      -----------      -----------
<S>                                                <C>              <C>              <C>              <C>              <C>
Balance at  September 30, 1995                         214,462       $3,216,930       20,532,033           $2,053       24,844,392

  Preferred stock dividend:
     In stock (note 7)                                  15,214          228,210               --               --         (228,210)
     In cash (note 7)                                       --               --               --               --          (23,645)
  Common stock issued:
     For cash                                               --               --        3,333,333              333        2,653,884
     For services                                           --               --           13,954                1           15,416
     Conversion of senior
       convertible notes payable (note 6)                   --               --        1,437,500              144          991,576
     Conversion of preferred stock (note 7)            (14,587)        (218,805)         145,870               15          218,790
     Exercise of warrants                                  --               --             1,031                1            1,030
     Exercise of options                                   --               --           241,495               24          241,571
  Treasury stock retired                               (10,000)        (150,000)              --               --               --
  Payments received on notes receivable for
     exercise of options                                    --               --               --               --               --
  Deferred compensation earned                              --               --               --               --               --
  Net loss                                                  --               --               --               --               --
                                                   -----------      -----------      -----------      -----------      -----------
Balance at  September 30, 1996                         205,089      $3,076,335        25,705,216          $2,571        28,714,804


  Preferred stock dividend:
     In stock (note 7)                                  13,909          208,635               --               --         (208,635)
     In cash (note 7)                                       --               --               --               --          (46,171)
  Common stock issued:
     Exercise of options                                    --               --          150,496               15           55,071
     Exercise of warrants                                   --               --          103,179               10           30,944
     Conversion of senior
       convertible notes payable (note 6)                   --               --           61,304                6           22,994
     Write down of notes receivable for
       exercise of options                                  --               --              --               --          (619,504)
  Shares forfeited upon cancellation of notes
     receivable for exercise of options                     --               --         (504,535)             (50)        (756,754)
  Payments received on notes receivable for
     exercise of options                                    --               --               --               --               --
  Net loss                                                  --               --               --               --               --
                                                   -----------      -----------      -----------      -----------      -----------
Balance at  September 30, 1997                         218,998        3,284,970       25,515,660            2,552       27,192,749
                                                   -----------      -----------      -----------      -----------      -----------
                                                   -----------      -----------      -----------      -----------      -----------

</TABLE>


<TABLE>
<CAPTION>

                                                     Treasury                          Notes
                                                     Stock -                         Receivable
                                                     Preferred                      for Exercise      Deferred
                                                      Stock           Deficit        of Options      Compensation         Total
                                                   -----------      -----------      -----------     ------------      -----------
<S>                                                <C>              <C>              <C>             <C>               <C>
Balance at  September 30, 1995                        (150,000)     (23,094,922)      (1,597,837)          (5,596)       3,215,020

  Preferred stock dividend:
     In stock (note 7)                                      --               --               --               --               --
     In cash (note 7)                                       --               --               --               --          (23,645)
  Common stock issued:
     For cash                                               --               --               --               --        2,654,217
     For services                                           --               --               --               --           15,417
     Conversion of senior
       convertible notes payable (note 6)                   --               --               --               --          991,720
     Conversion of preferred stock (note 7)                 --               --               --               --               --
     Exercise of warrants                                   --               --               --               --            1,031
     Exercise of options                                    --               --               --               --          241,595
  Treasury stock retired                               150,000               --               --               --               --
  Payments received on notes receivable for
     exercise of options                                    --               --           54,187               --           54,187
  Deferred compensation earned                              --               --               --            5,596            5,596
  Net loss                                                  --       (3,274,629)              --               --       (3,274,629)
                                                   -----------      -----------      -----------      -----------      -----------
Balance at  September 30, 1996                               0      (26,369,551)      (1,543,650)               0        3,880,509

  Preferred stock dividend:
     In stock (note 7)                                      --               --               --               --               --
     In cash (note 7)                                       --               --               --               --          (46,171)
  Common stock issued:
     Exercise of options                                    --               --               --               --           55,086
     Exercise of warrants                                   --               --               --               --           30,954
     Conversion of senior
       convertible notes payable (note 6)                   --               --               --               --           23,000
     Write down of notes receivable for
       exercise of options                                  --               --          619,504               --               --
  Shares forfeited upon cancellation of notes
     receivable for exercise of options                     --               --          756,804               --               --
  Payments received on notes receivable for
     exercise of options                                    --               --          167,342               --          167,342
  Net loss                                                  --       (3,226,958)              --               --       (3,226,958)
                                                   -----------      -----------      -----------      -----------      -----------
Balance at September 30, 1997                                0      (29,596,509)               0                0          883,762
                                                   -----------      -----------      -----------      -----------      -----------
                                                   -----------      -----------      -----------      -----------      -----------

</TABLE>



           The accompanying notes and independent auditor's reports should
          be read in conjunction with the consolidated financial statements

                                         F-5

<PAGE>


                           FIBERCHEM, INC. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>


                                                                     Years ended September 30,
                                                                    ---------------------------
                                                                        1996          1997
                                                                    ------------   ------------
<S>                                                                 <C>            <C>
Cash flows from operating activities:

  Net loss                                                           ($3,274,629)   ($3,226,958)
  Adjustments to reconcile net loss to net
    cash flows used in operating activities:
    Depreciation                                                          50,542         69,853
    Amortization of patent and technology costs                          266,147        273,967
    Amortization of financing costs                                       65,678         82,620
    Accrued interest on notes receivable for exercise of options        (107,367)       (26,985)
    Write off of accrued interest on notes receivable
        for exercise of options                                              --         248,212
    Common stock issued for services                                      15,417            --
    Reduction in notes receivable for the exercise
       of options in exchange for services                                42,263            636
    Deferred compensation recognized                                       5,596            --
    Provision for loss on accounts receivable                            201,225         36,085
    Write down of obsolete inventory                                     281,313         36,290
    Changes in assets and liabilities:
        Decrease in note receivable from sale of subsidiary              106,390            --
        Decrease in accounts receivable                                   59,068          5,441
        (Increase) in inventories                                       (747,146)      (142,346)
        Decrease in prepaid expenses and
          other current assets                                            50,784          2,119
        Increase (decrease) in accounts payable                           93,729       (175,034)
        Increase (decrease) in accrued expenses                          (80,942)       101,326
        Increase (decrease) in interest payable                           18,016           (238)
                                                                    ------------   ------------
    Net cash used in operating activities                             (2,953,916)    (2,715,012)
                                                                    ------------   ------------


Cash flows from investing activities:

  Purchase of equipment                                                  (45,476)       (83,505)
  Payments for patents                                                  (128,873)       (55,979)
                                                                    ------------   ------------
    Net cash used in investing activities                               (174,349)      (139,484)
                                                                    ------------   ------------
</TABLE>




           The accompanying notes and independent auditor's reports should
         be read in conjunction with the consolidated financial statements.
                                                                     (continued)


                                         F-6
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>


                                                                               Years ended September 30,
                                                                              ---------------------------
                                                                                  1996          1997
                                                                              ------------   ------------
<S>                                                                           <C>            <C>

Cash flows from financing activities:

  Proceeds from common stock and warrant Units                                  $3,000,000   $        --
  Proceeds from senior convertible notes payable                                 2,825,000            --
  Payment of financing costs                                                      (773,987)           --
  Payments on note payable to bank and others                                       (6,832)       (16,319)
  Cash restricted as security for note payable                                          --         18,456
  Proceeds from the exercise of options and warrants                               242,626         86,040
  Proceeds from interest and notes receivable for exercise of options               19,489        174,406
  Payment of dividend on preferred stock                                           (23,645)       (46,171)
                                                                              ------------   ------------
        Net cash provided by financing activities                                5,282,651        216,412
                                                                              ------------   ------------
Net  increase (decrease) in cash and cash equivalents                            2,154,386     (2,638,084)
Cash and cash equivalents at beginning of period                                   911,186      3,065,572
                                                                              ------------   ------------
Cash and cash equivalents at end of period                                      $3,065,572       $427,488
                                                                              ------------   ------------
                                                                              ------------   ------------


                                   Supplemental Cash Flow Information

Noncash investing and financing activities:

  Senior convertible notes payable converted to common stock                    $1,150,000        $25,000
  Reduction in additional paid-in capital due to
    write down of notes receivable for exercise of options                            --          619,504
  Reduction in common stock and additional paid-in capital
    upon cancellation of shares held as collateral for
    notes receivable for the exercise of options                                      --          756,804
  Unamortized deferred financing costs associated with senior
    convertible notes payable converted to common stock                            158,281          2,000
  Preferred stock converted to common stock                                        218,805           --
  Preferred stock issued as dividends                                              228,210        208,635
  Equipment purchased through capital lease                                           --           21,273
  Reduction in notes receivable for exercise of options
    in exchange for services                                                        42,263            636
  Retirement of treasury stock - preferred                                         150,000           --
                                                                              ------------   ------------
                                                                              ------------   ------------

Interest paid                                                                     $100,101       $140,785
                                                                              ------------   ------------
                                                                              ------------   ------------
</TABLE>




           The accompanying notes and independent auditor's reports should
         be read in conjunction with the consolidated financial statements.


                                         F-7

<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

(1)  NATURE OF BUSINESS AND LIQUIDITY

     FiberChem, Inc. and its subsidiaries (collectively the "Company" or "FCI")
develops, produces, markets and licenses fiber optic chemical sensors (FOCS) for
environmental monitoring in the air, water and soil.  The Company's primary
markets and potential customers are the petroleum production, refinery and
distribution chains.  Other important markets and customers include remediation
companies, environmental consultants, shipping ports, airports and military
bases.  The Company markets its products world-wide using strategic alliances,
distribution agreements and direct sales activities.

     The Company's consolidated financial statements for the years ended
September 30, 1996 and 1997 have been prepared on a going concern basis which
contemplates the realization of assets and the settlement of liabilities and
commitments in the normal course of business.  The Company incurred a net loss
of $3,274,629 and $3,226,958 for the years ended September 30, 1996 and 1997,
respectively and as of September 30, 1997 had an accumulated deficit of
$29,596,509.

     Management recognizes that the Company must generate additional revenues or
reductions in operating costs and may need additional financing to enable it to
continue its operations.  The Company is reviewing alternatives for raising
additional capital including an offering (subject to, among other things,
approval by the SEC) of rights to purchase shares and warrants, to be offered to
holders of the Company's Common and Preferred Stock, Class D and all other
Warrants.  The Company has engaged consultants to assist in raising additional
capital.  (See Note 12.)  However, no assurance can be given that forcasted
sales will be realized to achieve profitable operations, nor that additional
financing, if needed, can be obtained on terms satisfactory to the Company, if
at all, nor in an amount sufficient to enable the Company to continue
operations.

(2)  SIGNIFICANT ACCOUNTING POLICIES
          
     (a)  PRINCIPLES OF CONSOLIDATION
     
          The accompanying consolidated financial statements include the
          accounts of the Company and its subsidiaries.  All inter-company
          accounts and transactions have been eliminated.  The Company develops,
          produces, markets and licenses fiber optic chemical sensors
          ("FOCS-Registered Trademark-") for environmental monitoring in the
          air, water and soil.
               
     (b)  CASH AND CASH EQUIVALENTS

          Cash equivalents consist of financial instruments with original
          maturities of no more than 90 days.
          
     (c)  INVENTORIES
     
          Inventories are stated at the lower of cost (first-in, first-out) or
          market.
                                      
     (d)  EQUIPMENT

          Equipment is stated at cost.  Depreciation is calculated using the
          straight-line method over the estimated useful lives of the assets,
          generally five years.
          
     (e)  TECHNOLOGY COSTS
     
          Technology costs represent values assigned to proven technologies
          acquired for cash and in exchange for issuance of common stock (Note
          4).  Patents on certain technologies are 

                                         F-8
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

          pending.  Proven technologies are amortized using the straight-line
          method over an eight year period.
          
     (f)  PATENT COSTS
     
          Costs incurred in acquiring, filing and prosecuting patents are
          capitalized and amortized using the straight-line method over the
          shorter of economic or legal life.  All existing patents are being
          amortized over eight years.
     
     (g)  REVENUE RECOGNITION
     
          The Company generally recognizes revenue when title passes, which is
          normally upon shipment of product to the customer.  There is generally
          no right of return except for normal warranties.
          
     (h)  WARRANTY

          The Company warrants its products for a period of one year from the
          date of delivery, provided the products are used under normal
          operating conditions.  The Company accrues a reserve for product
          warranty at the time of sale.      

     (i)  RESEARCH AND DEVELOPMENT
     
          Research and development costs are expensed as incurred.
          
     (j)  PER SHARE DATA
     
          Loss per common share has been computed based upon weighted average
          shares outstanding during the periods presented.  Contingently
          issuable shares have been excluded because of their anti-dilutive
          effect.
          
          In March 1997, the Financial Accounting Standards Board issued
          Statement No. 128, Earnings Per Share ("SFAS 128"), which modifies
          existing guidance for computing earnings per share and requires the
          disclosure of basic and diluted earnings per share.  Under the new
          standard, basic earnings per share is computed as earnings available
          to common stockholders divided by weighted average shares outstanding
          excluding the dilutive effects of stock options and other potentially
          dilutive securities.  Diluted earnings per share includes the dilutive
          effect of these securities.  The effective date of SFAS 128 is
          December 15, 1997 and early adoption is not permitted.  The Company
          intends to adopt SFAS 128 during the quarter ending December 31, 1997.
          Had the provisions of SFAS 128 been applied to the Company's results
          of operations for each of the two years in the period ended September
          30, 1997, the Company's basic loss per share would have been $0.15 and
          $0.13 per share.
          
     (k)  INCOME TAXES
     
          The Company utilizes Statement of Financial Standards No. 109,
          ACCOUNTING FOR INCOME TAXES ("Statement 109"). Under this asset and
          liability method, deferred tax assets and liabilities are recognized
          for the future tax consequences attributable to differences between
          the financial statement carrying amounts of existing assets and
          liabilities and their respective tax bases and operating loss and tax
          credit carry forwards.  Deferred tax assets and liabilities are
          measured using the enacted tax rates expected to apply to taxable
          income in the years in which those temporary differences are expected
          to be recovered or 

                                         F-9
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

          settled.  Under Statement 109, the effect on deferred tax assets and
          liabilities of a change in tax rates is recognized in income in the
          period that includes the enactment date.

     (l)  STOCK-BASED EMPLOYEE COMPENSATION AWARDS         
          
          In Fiscal 1996 the Company adopted Statement of Financial Accounting
          Standards ("SFAS") No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. 
          In accordance with the provisions of SFAS No. 123, the Company has
          elected to apply APB Opinion 25 and related interpretations in
          accounting for its stock options issued to employees and, accordingly,
          does not recognize additional compensation cost as required by the new
          principle.  The Company,  however, has provided the pro forma
          disclosures as if the Company had adopted the cost recognition
          requirements (see Note 7).
     
      (m) ESTIMATES
     
          Preparing financial statements in conformity with generally accepted
          accounting principles requires management to make estimates and
          assumptions that may affect the reported amounts of assets,
          liabilities, revenues and expenses and the disclosure of contingent
          assets and liabilities.  Examples include provision for bad debts;
          inventory obsolescence; and the useful lives of patents, technologies
          and equipment.  Actual results may differ from these estimates.

     (n)  Certain reclassifications have been made in the 1996 presentation to
          conform to the 1997 presentation.
     
     (o)  Recent accounting pronouncements.  
     
          In June 1997, the Financial Accounting Standards Board issued
          Statement No. 130, Reporting Comprehensive Income ("SFAS 130"), and
          Statement No. 131, Disclosures about Segments of an Enterprise and
          Related Information ("SFAS 131").  The Company is required to adopt
          these Statements in fiscal 1999.  SFAS 130 establishes new standards
          for reporting and displaying comprehensive income and its components. 
          SFAS 131 requires disclosure of certain information regarding
          operating segments, products and services, geographic areas of
          operation and major customers.  Adoption of these Statements is
          expected to have no impact on the Company's consolidated financial
          position, results of operations or cash flows.

(3)  INVENTORIES

     Inventories are stated at the lower of cost (first in, first out) or market
and consist of:

<TABLE>
<CAPTION>

                                                             September 30,
                                                          --------------------
                                                            1996        1997
                                                          ---------   ---------
<S>                                                    <C>          <C>
     Raw materials                                     $  439,392  $  551,832
     Work in process                                       21,305      24,643
     Finished goods                                     1,534,542   1,312,804
                                                       ----------  ----------
             Subtotal                                   1,995,239   1,889,279
     Valuation and obsolescence reserves, primarily
             against finished goods                      (538,104)   (326,088)
                                                       ----------  ----------
     Net inventories                                   $1,457,135  $1,563,191
                                                       ----------  ----------
                                                       ----------  ----------

</TABLE>

                                         F-10
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

(4)  TECHNOLOGY COSTS

     Technology costs include proven technologies acquired by the Companies to
be utilized for various environmental and medical purposes.  These technologies
include FOCS-Registered Trademark- which are capable of detecting and monitoring
various chemical conditions to be used in environmental, medical and process
control applications.  The technologies were acquired by the issuance of Common
Stock of the Company valued at $349,830 and cash of $187,876. 

(5)  PATENT COSTS
     
     Patent costs include costs incurred in acquiring, filing and prosecuting
patents and patent applications.  The Company's policy in general is to apply
for patents in major European and Asian countries as well as in the United
States.  

(6)  NOTES PAYABLE
     
     In December 1994 the Company borrowed $21,000 from Bank of America Nevada
("Bank") at an interest rate of 7.25% per annum.  Principal and interest
payments of $647 are payable monthly until maturity in January 1998.  As part of
the terms of the loan agreement, the Bank required that a certificate of deposit
("CD") be maintained as collateral for the note.  The CD is reduced periodically
as the note is paid down and accrues interest at a rate of 5% per annum.  During
August 1997 the remaining balance of the note was extinguished using a portion
of the proceeds of the CD, which was liquidated at the same time.

     On February 15, 1996, the Company completed an offering under Regulation S,
promulgated under the Securities Act of 1933, as amended (the "Offering"), of 8%
Senior Convertible Notes due February 15, 1999 (the "Notes"), for $2,825,000. 
Interest on the Notes is to be paid semi-annually, commencing August 15, 1996,
at a rate of 8% per annum.  The Notes are convertible into shares of Common
Stock of the Company at a conversion price (the "Conversion Price") of,
initially, $0.80 per share at any time after March 26, 1996 and before the close
of business on February 14, 1999.  The Conversion Price was adjusted to $0.4078,
a price representing a 10% discount from the average closing bid price of the
Common Stock for the 30 business days prior to February 15, 1997.  As of
September 30, 1997, an aggregate face amount of $1,175,000 of the Notes had been
converted to Common Stock resulting in the issuance of 1,498,804 shares of
Common Stock.
     
     The Company paid fees and expenses associated with the offering amounting
to $428,204, which is being amortized as interest expense over the three-year
term of the Notes or until conversion, if earlier, when the proportionate
unamortized amount is charged to additional paid in capital.  As of September
30, 1997 approximately $160,281 of unamortized deferred financing cost has been
recorded as a reduction in additional paid-in capital associated with the
$1,175,000 of the Notes converted to Common Stock.  Also in connection with the
Offering, the Company issued to the Placement Agent for the Offering, for
nominal consideration, warrants to purchase up to 353,125 shares of Common
Stock, at an exercise price of $0.80 per share (the "Exercise Price"), which has
been adjusted to $0.4078 per share.  Also in accordance with the terms of the
warrants, the number of shares exercisable has been adjusted, based on the
adjusted Exercise Price, to 692,742 shares of Common Stock.   These warrants are
exercisable at any time on or after August 15, 1996 through February 14, 2001
and contain certain piggyback registration rights.

     In November 1996, the Company acquired $21,273 in equipment through a
36-month capital lease with monthly payments of approximately $715 and an
implicit interest rate of approximately 14.5% per annum.

                                         F-11
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

     The maturities of the notes payable are as follows:
<TABLE>
<CAPTION>

                                              September 30,     September 30,
                                                  1996              1997
                                            --------------     --------------
                    <S>                     <C>                <C>
                    Fiscal 1997             $     7,315        $      6,878
                    Fiscal 1998                   2,551               7,942
                    Fiscal 1999               1,675,000           1,650,000
                                            -----------        ------------
                                            $ 1,684,866        $  1,664,820
                                            -----------        ------------
                                            -----------        ------------

</TABLE>

     
(7)  STOCKHOLDERS' EQUITY

     During Fiscal 1993 and Fiscal 1994, the Company conducted a private
placement of convertible preferred stock ("Convertible Preferred Stock").  Each
share of the Convertible Preferred Stock is convertible into ten shares of FCI
Common Stock, initially at $1.50 per share.  The conversion ratio is subject to
customary anti-dilution provisions.  Dividends are cumulative and are payable
annually, at the sole discretion of the holders, in cash (11%) or additional
shares of Convertible Preferred Stock (8% of the number of shares owned at date
of declaration). In November 1995, the Company paid cash dividends of $23,645
and issued 15,214 shares of Convertible Preferred Stock dividends.  In November
1996, the Company paid cash dividends of $46,171 and issued 13,909 shares of
Convertible Preferred Stock dividends.  The Convertible Preferred Stock entitles
the holder to a liquidation preference of $15 per share upon liquidation,
dissolution or winding up of the Company.  The Convertible Preferred Stock is
redeemable by the Company when and if the closing bid price of FCI's Common
Stock is at least 200% of the conversion price for twenty consecutive trading
days.  Upon redemption, the Company would issue ten shares of its Common Stock
for each share of Convertible Preferred Stock.  During Fiscal 1996, 14,587
shares of Convertible Preferred Stock were converted to 145,870 shares of Common
Stock.  As of September 30, 1997, the Company had 218,998 shares of Convertible
Preferred Stock outstanding.  On September 12, 1997, the Board of Directors
determined that, in view of the recent trading price of the Company's Common
Stock and in view of the Company's current cash position, it would not be
appropriate to declare the annual dividend payable on the Convertible Preferred
Stock on November 1, 1997.  As a result, the divident amounting to $361,347 (if
elected entirely in cash, or 17,250 additional shares of Convertible Preferred
Stock if elected wholly in additional shares) will accumulate in accordance with
the terms of the Convertible Preferred Stock.

     On May 31, 1996 the Company completed an offering under Regulation S, of
3,333,333 Units, at a price of $0.90 per Unit for total gross proceeds of
$3,000,000 before costs and expenses of the offering. The Company paid fees and
expenses associated with the Unit offering amounting to $345,683.   Each Unit
consisted of one share of Common Stock and one warrant to purchase one share of
Common Stock (the "Unit Warrants") the shares and warrants being immediately
separable.  The Unit Warrants are each exercisable at $1.00 at any time from May
31, 1996 through May 30, 2001.  Also in connection with the Unit offering, the
Company issued to the Placement Agent for the offering, for nominal
consideration, warrants to purchase up to 333,333 shares of Common Stock ("the
Placement Agent Warrants"), at an exercise price of $0.90 per share which  has
been adjusted to $0.2343 per share, and the number of shares issuable upon
exercise has been adjusted to 1,280,411.  These Placement Agent Warrants are
exercisable at any time from November 30, 1996 through May 30, 2001.

     In January 1993, the Company's Board of Directors adopted a 1993 Employee
Stock Option Plan ("1993 Plan"), approved by stockholders at the May 1993 Annual
Shareholders meeting, covering an aggregate of 2,300,000 shares of  FCI Common
Stock.  As of September 15, 1996, an aggregate of 

                                         F-12
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

1,681,519 options had been exercised and 274,641 options forfeited (of which
171,822 had been regranted) under the 1993 Plan.  The remaining 515,662 options
expired on September 15, 1996.

     Primarily in order to provide a means to raise additional cash through
existing outstanding options, warrants and promissory notes receivable, on April
4, 1997, the per share exercise price of all employee stock options, all Unit
and other Warrants (except Class D Warrants) were decreased as follows: to $0.32
from April 4 through April 11, 1997, and thereafter adjusted weekly to the
average closing bid price for the five prior trading days less a discount of 10%
(but never to a price less than $0.30) through May 16, 1997, when the prices
reverted to the original prices.  As a result, the Company received $39,943 for
the exercise of 131,453 options at prices ranging from $0.30 to $0.32 per share.
 Effective April 17, 1997 the per share exercise price of  Class D Warrants was
decreased to $0.30 through May 16, 1997 when the exercise price reverted to its
prior $1.10 per share.  As a result, the Company received approximately $30,954
for the exercise of 103,179 Class D Warrants exercised at $0.30 per share. 
     
     In March 1994, the Company's Board of Directors approved a plan by which
employees and directors of the Company and its subsidiaries would be given an
opportunity to exercise certain eligible stock options under an early incentive
plan through the execution of promissory notes.  As of March 15, 1994, the
Company received promissory notes aggregating $1,815,099 for the exercise of
1,210,066 stock options.  The promissory notes bear interest at 7%, and were
initially due on or before September 15, 1995. On April 7, 1995, the Board of
Directors extended the due date of the notes to March 15, 1998.  The underlying
FCI Common Stock was held in escrow, as collateral, until payment was made on
the promissory notes.  As of September 30, 1996, an aggregate of $271,449 had
been paid on these notes in addition to $43,467, respectively, in interest.  The
remaining accrued interest of  $228,927 at September 30, 1996 is included in
other long-term assets in accordance with the April 1995 extension of the due
date of the notes.  The outstanding principal at September 30, 1996 of
$1,543,650 is included as a reduction of stockholders' equity.  In conjunction
with the temporary reduction of the exercise prices of the options and warrants
effective April 4, 1997 and Class D Warrants effective April 17, 1997, as
described above, the remaining unpaid principal on the promissory notes could be
fully paid in an amount determined by multiplying the unpaid balance by a
fraction, the numerator of which was the revised exercise price, and the
denominator of which was $1.50 (the original exercise price).  If the unpaid
principal was not so paid by May 16, 1997 the underlying collateral shares would
be forfeited and all unpaid principal and accrued interest would be
extinguished.  

     As a result, the Company received $160,875 in payment for 520,252 escrowed
shares at prices ranging from $0.30 to $0.32 per share, which amount liquidated
$780,379 of original note principal.  The remaining $756,804 of unpaid note
principal was extinguished and the underlying collateral of 504,535 shares were
forfeited to the Company and immediately canceled, thereby reducing the total
number of shares outstanding.  Unpaid accrued interest receivable aggregating
$248,212 was expensed.   

     In March 1994, the Company's Board of Directors adopted a 1994 Employee
Stock Option Plan ("1994 Plan"), approved by stockholders at the May 23, 1994
Annual Shareholders meeting, covering an aggregate of 1,000,000 shares of  FCI
Common Stock.  As of September 30, 1997, the Company has issued 984,885 stock
options, net of forfeitures and regrants, (with initial exercise prices ranging
from $1.00 per share to $2.125 per share and current exercise prices of $1.00
per share) under the 1994 Plan to employees of the Company's wholly-owned
subsidiary, FCI Environmental, Inc. ("Environmental").  An aggregate of 821,114
options remain exercisable under the 1994 Plan. 

     On April 7, 1995, the Company's Board of Directors resolved that all
options to purchase shares of the Company's Common Stock granted prior to April
7, 1995, and which had an exercise price in excess of $1.00 per share, would as
of April 7, 1995 have an exercise price of $1.00 per share, which price was
above the fair market value of the Common Stock as of the last quoted market
trade on April 7, 1995.  Options to purchase an aggregate of 2,309,479 shares at
prices ranging from $1.125 to $2.125 per share were accordingly changed to $1.00
per share.

                                         F-13
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

     In April 1995, the Company's Board of Directors adopted a 1995 Employee
Stock Option Plan ("1995 Plan"), approved by the stockholders at the May 8, 1995
Annual Shareholders meeting, covering an aggregate of 1,000,000 shares of FCI
Common Stock.  As of September 30, 1997, the Company has issued 761,547 stock
options, net of forfeitures, (with initial and current exercise prices ranging
from $0.93 per share to $1.38 per share) under the 1995 Plan to employees of
Environmental and Directors of the Company.  An aggregate of 643,942 options
remain exercisable under the 1995 Plan.

     In January 1997 the Company's Board of Directors adopted a 1997 Employee
Stock Option Plan ("1997 Plan"), approved by the stockholders at the June 23,
1997 Annual Stockholders Meeting, covering an aggregate of 1,500,000 shares of
Common Stock and restricting the granting of options to purchase approximately
675,000 shares of Common Stock authorized under previous stock option plans.  As
of September 30, 1997 the Company has issued options to purchase 636,500 shares
of Common Stock at prices ranging from $0.22 to $0.25 under the 1997 Plan to
employees of Environmental and Directors of the Company.   An aggregate of
631,500 options remain exercisable under the 1997 Plan. 

     During Fiscal 1996, the Company has expensed an aggregate of $99,000 in
directors' compensation for the Company's non-management directors, applying
$63,728 to the payment of promissory notes, interest and payroll taxes, and
$35,272 to the exercise of 35,272 stock options.  Effective October 1, 1996, 
director compensation was eliminated and replaced by the granting of stock
options for service as a director and for service on standing committees.  
During Fiscal 1997, the Company granted to its six non-management directors
options to purchase an aggregate of 186,500 shares of Common Stock at $0.22 per
share, which was the fair market value of the Common Stock as of the date of the
grants.  

     During Fiscal 1996, the Company issued to two individuals a total of 13,954
shares of  Common Stock of the Company, valued at $15,417 for services performed
for the Company.

     On August 1, 1995, the Company's Board of Directors resolved that the
exercise price of all outstanding Class D Warrants be changed from $1.50 per
share to $1.00 per share, which price was above the fair market value of the
Common Stock as of the last quoted market trade on August 1, 1995.  An aggregate
of 1,031 Class D Warrants were exercised during Fiscal 1996; no Class D Warrants
were exercised during Fiscal 1995.  On August 21, 1996, the Board of Directors
extended the expiration date of the Class D Warrants from their original
expiration date of September 15, 1996, to September 15, 2000, and changed the
exercise price from $1.00 to $1.10 from September 16, 1996 through September 15,
1997; then $1.15 through September 15, 1998; then $1.20 through September 15,
1999; then $1.25 through September 15, 2000.

     The Company has granted options under qualified stock option plans as well
as other option plans to employees, directors, officers, consultants and other
persons associated with the Company who are not employees of, but are involved
in the continuing development of the Company.   A summary of the status of the
Company's stock option plans as of September 30, 1996 and 1997 and changes
during those years are as follows:

<TABLE>
<CAPTION>
 

                                          1996                           1997
                               ---------------------------   ---------------------------
                                                Weighted                       Weighted
                                                 Average                       Average
Fixed Options                   Options          Exercise      Options         Exercise
                                                  Price                         Price
-------------------------      -----------      ----------   -----------      ---------
<S>                           <C>               <C>          <C>              <C>
Outstanding at beginning       2,457,023        $  1.00      1,670,552        $  0.99
of year
Granted during year              784,504            .99        676,500            .28
Exercised                       (246,282)          1.00       (150,496)           .37
Forfeited                     (1,324,693)          1.00       (100,000)          1.00
                              -----------       ---------    ----------       --------
Outstanding at end of year     1,670,552        $  0.99      2,096,556        $  0.76
                              -----------                    ----------
                              -----------                    ----------
 

</TABLE>
                                         F-14
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

     The following table summarizes information about stock options outstanding
and exercisable at September 30, 1996 and 1997.

<TABLE>
<CAPTION>
 

                                                              Weighted Average           Weighted
                   Range of Exercise     Number Outstanding       Remaining               Average
  September 30          Prices            and Exercisable      Contractual Life       Exercise Price
---------------   ------------------     ------------------   ------------------      ---------------
<S>               <C>                    <C>                  <C>                     <C>
     1996           $0.93 - 1.00             1,670,552           3.75 years               $0.99
     1997           $0.22 - 1.00             2,096,556           4.80 years               $0.76

</TABLE>
 


     If the Company had elected to recognize compensation cost based on the fair
value of the options granted at grant date as prescribed by SFAS No.123, net 
loss and loss per share would have been adjusted to the pro forma amounts
indicated in the table below:
<TABLE>
<CAPTION>

                                As Reported                    Pro Forma
                        ----------------------------  -------------------------
                            1996           1997           1996          1997
                        -------------  -------------  ------------  -----------
      <S>               <C>            <C>            <C>           <C>
      Net Loss          $(3,274,629)   $(3,226,958)   $(3,490,698) $(3,501,930)

      Loss per share      $(0.15)        $(0.13)       $(0.16)       $(0.14)

</TABLE>

     No tax effect was applied in computing loss per share under SFAS No. 123. 
The Company's assumptions used to calculate the fair values of options issued
was (i) risk-free interest rate of 6.0%, (ii) expected life of five years, (iii)
expected volatility of 172%, and (iv) expected dividends of zero.

(8)  COMMITMENTS AND CONTINGENCIES

     The Company entered into an agreement to lease office space for a five-year
period beginning in January 1990, which expired in January 1995.  The Company
and the lessor have agreed to a month-to-month lease which is terminable by
either party upon 30 days notice.  Monthly payments under the lease were
originally $8,807 and escalated approximately $1,300 every twelve months. 
Current base monthly payments under the month-to-month lease are $12,786.  Rent
expense during Fiscal 1996 and 1997 was $172,492 and $172,551, respectively. The
Company is pursuing alternatives, including a renewal of the month-to-month
lease at approximately the current base monthly rental charge.

     Effective January 1, 1994, the Company implemented an Internal Revenue Code
Section 401(k) Profit Sharing Plan (the "Plan").  The Plan provides for
voluntary contributions by employees into the Plan subject to the limitations
imposed by Internal Revenue Code Section 401(k).  The Company will match
employee contributions at a rate of 50% of the employee's contribution up to a
maximum of 2% of the employee's compensation.  The Company matching funds are
determined at the discretion of management and are subject to a five-year
vesting schedule from the date of original employment.  The Company's 401(k)
matching expense for the years ended September 30, 1996 and 1997  totaled
$18,508 and $21,263, respectively. 

     The Company is involved in litigation incidental to its business.  In the
opinion of the Company's management, the expected outcome of such litigation
will not have a material effect on the financial position of the Company.

                                         F-15
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

(9)  INCOME TAXES

     Income tax benefit attributable to losses from continuing operations for
the year ended September 30, 1996 and 1997 differed from the amount computed by
applying the federal income tax rate of 34% to pretax loss from operations as a
result of the following:
     


<TABLE>
<CAPTION>
 

                                                                                      1996                 1997
                                                                                    ------               ------
<S>                                                                            <C>                 <C>
Computed "expected" tax benefit                                                $(1,113,374)        $(1,097,166)
Reduction in income tax benefit resulting from:
     Non-deductible expenses                                                        38,374              28,166
     Increase in valuation allowance                                             1,075,000           1,069,000
                                                                               -----------         -----------
Net tax benefit                                                                $       ---         $       ---
                                                                               -----------         -----------
                                                                               -----------         -----------

  Components of net deferred tax assets as of September 30, 1996 and 1997 are as follows:
<CAPTION>

                                                             1996                    Change                1997
                                                            -----                   -------               -----
<S>                                                    <C>                      <C>                 <C>
Deferred tax assets                                    $7,889,000               $1,063,000          $8,952,000
Less valuation allowance
                                                       (7,873,000)              (1,069,000)         (8,942,000)
                                                      -----------               ----------          ----------
Total net deferred tax assets                              16,000                   (6,000)             10,000
Deferred tax liabilities
                                                          (16,000)                   6,000             (10,000)
Net deferred tax assets                                $      ---               $      ---          $      ---
                                                      -----------               ----------          ----------
                                                      -----------               ----------          ----------

</TABLE>
 

     Deferred tax assets are comprised primarily of the tax effects of the net
operating loss carryforwards, reserve for inventory obsolescence and allowance
for doubtful accounts recorded for financial reporting purposes.  Deferred tax
liabilities primarily represent the tax effect of the difference between
depreciation recorded for financial statement and income tax reporting purposes.

     The Company has recorded a valuation allowance in accordance with the
provisions of Statement 109 to reflect the estimated amount of deferred tax
assets which may not be realized.  In assessing the realizability of deferred
tax assets, Management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized.  The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible.

     At September 30, 1997, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $25,449,000 which are available to
offset future taxable income, if any, through 2012.  However, carryforwards to
offset future taxable income is dependent upon having taxable income in the
legal entity originally incurring the loss and will be further limited in each
year to an amount equal to the Federal long-term tax exempt interest rate times
the entity's market value at the time a significant change in ownership
occurred.  The Company cannot determine the effect of these limitations.   

 (10)     FAIR VALUE OF FINANCIAL INSTRUMENTS

     The following disclosure of the estimated fair value of financial
instruments was made in accordance with Statement of Financial Accounting
Standards No. 107 ("SFAS No. 107"), DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL
INSTRUMENTS. Accordingly, the aggregate fair value amounts presented are not
intended to represent the underlying value of the net assets of the Company.


                                         F-16
<PAGE>

                           FIBERCHEM, INC. AND SUBSIDIARIES
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
==============================================================================

     The carrying amounts at September 30, 1997 for cash, receivables, accounts
payable and accrued liabilities approximate their fair values due to the short
maturity of these instruments.  In addition the estimated fair value of notes
payable approximates the related carrying value at September 30, 1997.

(11) MAJOR CUSTOMERS

     During Fiscal 1997, the Company had sales to one customer of approximately
$985,000.  During Fiscal 1996, the Company had sales to three customers of
$190,000, $100,000 and $93,000.

(12) SUBSEQUENT EVENTS

     On October 2, 1997, the Company entered into an agreement with entrenet
Group, LLC ("entrenet") for advice and assistance in developing and executing
business plans, financing strategies and business partnerships, acquisitions and
mergers.  For its services, entrenet will receive a cash fee of $5,000 per month
for twelve months; $60,000 in the form of a 10% convertible note, payable on the
earlier of (a) a financial transaction (as defined in the agreement) or (b) two
years; 5% of the value of any financial transaction (as defined in the
agreement); and 5% of any financing provided by or introduced directly by
entrenet.

                                         F-17