<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                 FORM 10-KSB/A
(MARK ONE)

  X    ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
-----
       1934  (FEE REQUIRED)

       FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

                                       OR

       TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE 
-----
       ACT OF 1934   (NO FEE REQUIRED)

       FOR THE TRANSITION PERIOD FROM _____ TO _____

                          COMMISSION FILE NO.  0-18438
                                               -------

                       VITAFORT INTERNATIONAL CORPORATION
                       ----------------------------------
                 (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)

     DELAWARE                                         68-0110509
     --------                                         ----------
(STATE OR OTHER JURISDICTION OF          (I.R.S. EMPLOYER IDENTIFICATION NO.)
 INCORPORATION OR ORGANIZATION)

   1800 AVENUE OF THE STARS, SUITE 480, LOS ANGELES, CALIFORNIA      90067
 ----------------------------------------------------------------------------
         (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                  (ZIP CODE)

                                (310) 552-6393
                                --------------
               (ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:

                                      NAME OF EACH EXCHANGE
     TITLE OF EACH CLASS               ON WHICH REGISTERED
     -------------------               -------------------
          None                               None

SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:

                         COMMON STOCK, PAR VALUE $.0001
                         ------------------------------
                                (Title of Class)

CHECK WHETHER THE ISSUER:  (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION
13 OR 14(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 
                               --------         --------

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]

STATE ISSUER'S REVENUES FOR ITS MOST RECENT FISCAL YEAR:  $1,995,317.

THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES COMPUTED
BY REFERENCE TO THE AVERAGE BID AND ASKED PRICES OF SUCH STOCK ON MARCH 24, 1998
WAS $9,397,994.

THE NUMBER OF SHARES OUTSTANDING OF THE ISSUER'S COMMON STOCK AS OF MARCH 24,
1998 WAS 6,898,850.

TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE):   YES       NO   X
                                                                 -----    -----

                                       1
<PAGE>
 
                                     PART I

ITEM 1.   DESCRIPTION OF THE BUSINESS.

GENERAL

     Vitafort International Corporation (the "Company" or "Vitafort" or
"Registrant") was formed as a California corporation in 1986, and reincorporated
as a Delaware corporation in 1989.  Prior to May of 1993, Vitafort was in the
business of formulating and developing value-added foods and beverages for third
parties.  In addition, the Company was also marketing branded seafood.  In May
of 1993, these businesses were discontinued due to lack of revenues and profit
and later in the year the Company disposed of them.  In the fall of 1993, the
Company installed new management, who selected a new direction for the Company.
Vitafort would begin developing fat free and low fat bakery snacks that would be
marketed under Company owned trademarks.  Vitafort, however, did not own any
production facilities, so established contract manufacturers (co-packers) would
be utilized to manufacturer these branded products developed by the Company.

     In the spring of 1994, at the Natural Food Expo in Anaheim, California,
Vitafort introduced its first branded product called Fudgets(TM), a single-serve
fat free brownie with icing.  Four flavors of Fudgets were marketed throughout
1994 and 1995, while Vitafort research and development continued to develop
additional low fat and fat free snacks.  During this period Fudgets were sold at
retailers such as:  Price Costco (Bellevue, WA), Circle-K (Phoenix, AZ), Ralphs
(Compton, CA), Albertsons (Brea, CA), GNC (Pittsburgh, PA), Shop-Rite/Wakefern
(Woodbridge, NJ), along with many others.  In addition, Fudgets were being
marketed to hundreds of health food stores across the country by natural food
distributors.

     In the spring of 1995, the Company introduced double chocolate, cappuccino
and peanut flavor Fudgets in a multi-pack of five individually wrapped 1.4 oz.,
packages.  These three flavors were test marketed through the year. In the
latter part of 1995, Vitafort signed a co-packing agreement with The Keebler
Company ("Keebler") and began the marketing introduction of four flavors of fat
free cakes called Caketts(TM)  (lemon poppy, carrot, pound and banana).  The
Company believes that this unique snack was the first individually portioned fat
free snack cake with an extended shelf life to be merchandised in the cookie
section of supermarkets.

     In the fourth quarter of 1995, as the Company was completing the final
stages of its financing, the Company put in place the distribution
infrastructure that would support the roll out of these seven new flavors of
Fudgets and Caketts.  In addition, the Company began the manufacture of Fudgets
at Michel's Bakery ("Michel's") at this time.  Food brokers agreed to represent
the Vitafort product line and serve as the sales agents to the marketplace for
the Company.

     The introduction of Fudgets and Caketts to grocery stores across the
country began in the first quarter of 1996, as retailers such as Acme
(Philadelphia, PA), Delchamps (Mobile, AL) and Shop-Rite/Wakefern (Woodbridge,
NJ) placed purchase orders for Fudgets and Caketts.  The roll out continued in
the second quarter as Vitafort's distributors added Caketts and Fudgets to the
shelves of hundreds of chain stores including:  Kroger (Cincinnati, OH),
Albertsons (Brea, CA), Meijer (Grand Rapids, MI), Albertsons (AZ, CA, UT and
TX), Price Chopper (Schenectady, NY) Demoulas (Tewksberry, MA), Winn-Dixie
(Jacksonville, Orlando and Tampa, FL), Kash and Karry (Tampa, FL), Publix
(Lakeland, FL) and others.  In addition, the company received direct purchases
orders from Food Lion (Salisbury, NC), Kroger (Roanoke, VA) and Richfoods
(Richmond, VA), while procuring purchase orders attached to national print
advertisements with both Thrifty Payless and Eckerd Drugs, two large drug store
chains.

     In the second half of 1996, Vitafort's distributors added Stop + Shop (MA),
Kroger (Atlanta, GA), Farmer Jack's (MI), Grand Union (NY), Ralphs (CA), Hughes
(CA), and others to the supermarkets selling the Company's products.  The
largest purchase order in the history of the Company was also received as K-Mart
placed a $550,000 order for product as part of a national advertisement for
2,300 stores.

                                       2
<PAGE>
 
     During the second quarter of 1996, the Company received complaints of mold
from Caketts being manufactured by The Keebler Company, Vitafort's primary co-
packer at the time.  The Company notified Keebler that it had received these
complaints and engaged Keebler in discussions to correct the problem.  Keebler
attempted to solve the mold problem by creating an inspection process that would
identify the acceptable product for reshipment.  The Company shipped this
inspected product to its customers.  Thereafter, however, the Company received
reports that this inspected product also turned moldy.  Vitafort continued to
engage Keebler in discussions regarding this problem, but in August, Keebler
abruptly terminated the manufacturing agreement.  This interrupted the supply of
Caketts to customers resulting in delayed shipments and lost sales.

     The Company anticipated strong orders toward the year-end of 1996 as
supermarkets across the country prepared for January and February healthy diet
promotions and advertisements.  During the third quarter, the Company shipped
orders of Caketts and Fudgets produced by its new co-packer.  In the fourth
quarter, however, complaints from retailers about mold on products produced by
Keebler (Caketts) by Michel's (Fudgets) continued.  By December the Company
learned that the damage to the consumer acceptance of these brands caused by the
previously shipped defective product was greater than previously realized.  This
quality problem created hundreds of consumer complaints that led to both loss of
distributor goodwill and a significant loss of shelf space in the supermarkets.
In addition, product had to be withdrawn from the marketplace.  As a result,
fourth quarter sales were significantly adversely affected and costs relating to
this problem were much greater than previously anticipated.

     During the first half of 1997, the Company continued to suffer declining
sales resulting from returned product, loss of distributor goodwill, and the
lack of adequate capital to resolve both broker financial issues and co-packer
payment demands.  This liquidity issue was the primary cause of the lack of new
product effort, the maintenance of harmonious broker relations which could have
led to increased sales, and the Company's inability to comply with customer
requests that orders be shipped complete and on time.

     The Keebler arbitration award announcement in June 1997 and the receipt of
proceeds in July 1997 allowed the Registrant to begin reestablishing mutually
acceptable payment terms with its suppliers, negotiating settlements of
chargebacks from its customers as a vehicle to reestablish channels of
distribution, and planning the product introduction schedules for the remainder
of 1997 and 1998.  See Note 16 to the Consolidated Financial Statements.

     During the second half of 1997, the Company focused its sales and marketing
efforts on reestablishing relationships with its distributors and brokers to
address past commission issues, chargebacks from retailer issues, and the
Company's ability to currently ship product on a timely basis.

     While the Company has continued to ship Fudgets and Caketts, it has done so
in reduced volume due primarily to customer dissatisfaction with the brand name
based on past performance, not based on current product or availability.   In
May 1998, the Company discontinued the Caketts line and two of the three
stockkeeping units ("SKU's") of Fudgets to avoid further customer illwill.  The
Company believes there are some regional markets remaining for the product.

     The Company attributes its poor 1996 and 1997 results primarily to the
quality control problems of its prior co-packers, particularly from the damage
caused by The Keebler Company.  The Company believes that its current co-packers
have solved this problem and that the products currently being shipped will have
minimal quality control problems, although no assurances can be made as to the
level of quality control acceptability.   In light of the fact that the Company
must overcome the damage to its Caketts and Fudgets brands caused by the 1996
quality control problems, there can be no assurance as to the level of success
the Company will achieve with its marketing plan in 1997 and beyond.  In
addition, the Company will require additional capital to carry out the marketing
and sales programs scheduled for 1998 due to the current lack of operating
profits.  Should the Company begin to generate operating profits, the future
capital requirements will be reduced, but there can be no assurance that the
Company will be able to do so.

                                       3
<PAGE>
 
     The poor sales performance in 1998 may continue to erode working capital
and once again damage relations with suppliers that the Company has worked so
hard to reestablish.  While the Company believes such sales performance will not
continue, no assurance can be given that it will not continue.

     The Company's fat free and low fat snack items are based upon the Company's
proprietary formulas and procedures and are developed in conjunction with its
co-packers.  The Company seeks to protect its proprietary information through
confidentiality agreements with employees, suppliers and manufacturers.  These
products are made from generally available ingredients, which are then converted
into the Company's products.

     The Company introduced a new brand called Avenue of the Stars in late 1997
for snack foods and confectionery products.  The purpose was to use motion
picture studios logos and trademarks for packaging differentiation  of the
Company's products.

     Although management believes that the Company's products are unique and are
superior in taste to competitively available products, the food industry is
characterized by the continual development of new products employing various new
technologies and processes.  Additionally, the Company must overcome the
negative goodwill associated with the defective products produced by its former
co-packers.  Accordingly, no assurance can be given that new products will not
be developed and marketed, which are superior to the Company's products in
taste, texture and feel and or that the Company's products will achieve or
maintain reasonable levels of market acceptance.

ACQUISITION OF AUBURN FARMS, INC. BRANDS

     On May 2, 1996, pursuant to the terms of a letter agreement, dated May 1,
1996, and the attachments thereto (the "Foreclosure Purchase Agreement" or
"FPA"), the Company acquired the trademarks "Auburn Farms" and "Natures
Warehouse" and certain related trademarks, trade dress, and related intangibles
in a foreclosure sale from secured lenders to Auburn Farms, Inc., dba. Natures
Warehouse ("AFI").  The purchase price under the FPA consisted of a cash payment
of $75,000 and deferred payments based upon gross sales, as defined in the FPA,
of products sold by the Company which bear the acquired trademarks.  The
deferred payment for AFI's existing products, as defined in the FPA, equals
three and one half (3  1/2%) per cent of gross sales for a period of thirty
months commencing May 1, 1996; three (3%) per cent of gross sales for the next
ensuing period of thirty months; two and one half (2  1/2%) per cent of gross
sales for the next ensuing period of thirty months; and two (2%) per cent of
gross sales for the next ensuing period of thirty months.  For newly created
products, as defined in the FPA, which utilize the acquired trademarks, the
Company is required to pay a deferred purchase price equal to one and one half
(1  1/2%) per cent of gross sales for a period of 120 months commencing May 1,
1996. $72,000 of inventory was purchased under such option in 1996.  The FPA
agreement also provides that the Company has the option to purchase certain
inventories of packaging materials from AFI.  During 1996, sales of products
bearing the acquired trademarks were $1,337,475; and, the total deferred
payments under the FPA were $45,612.  During 1997, 18,501 of deferred payments
were made under the FPA and total sales of products bearing the acquired
trademarks were $1,036,851.  For the first quarter of 1998, sales of products
were $210,371 and deferred payments were $3,709.

     The Company is using co-packers to produce products bearing the acquired
trademarks.

PRODUCT MANUFACTURING

     The Company manufacturers its products by entering into agreements with
established food manufacturers ("co-packers"), who have the facilities, staff,
quality assurance and process control programs for the production of their own
products as well as the Company's products ("co-packer agreements").  Co-packer
relations are intended to enable the Company to secure the expertise of
qualified food manufacturers with respect to the development, manufacture and
packaging of the product; and, to achieve economies of scale in production and
staffing requirements, while providing production flexibility to meet changes in
product mix demand by customers that the Company could not achieve on its own.
Additionally, the

                                       4
<PAGE>
 
Company benefits from, and relies upon, the production experience and expertise
of these companies while avoiding the capital outlays, staffing requirements,
quality control, legal process requirements and other manufacturing costs and
delays that the Company would encounter were it to attempt to manufacture its
products utilizing its own facility. However, there can be no assurance that co-
packers will meet their obligations.

     Management believes that the most recent switch in co-packer arrangements
has improved product quality and availability, while improving the Company's
gross profit margin.  Management believes that the current co-packers have
sufficient capacity to meet the Company's requirements.

     The Company is in the process of negotiating co-packing agreements with
other established firms to act as co-packers for various other products.
Management believes that, if the research and development of the products is
completed and the Company's capital resources allow, it will be able to select
co-packers and enter agreements on terms acceptable to the Company.

DISTRIBUTION

     Vitafort utilizes distributors and brokers to market its brands of fat free
and low fat snacks.  These distributors ship to grocery chains in the United
States.  Wholesale club stores, drug store chains and mass merchandisers are
distributed, by the Company, directly into their warehouses.  Management
believes that, with sufficient funding, distribution can expand throughout the
marketplace with additional products and distributors.

MARKETING

     Vitafort developed a phased strategic marketing plan in the latter part of
1995, which continued into 1996, involving the development and expansion of the
Fudgets Fat Free Brownies and Juliette's Low Fat Chocolate Creams brands while
staging the rebuilding of the more mature Auburn Farms and Natures Warehouse
brands. The mold problem associated with the co-packers of Caketts and Fudgets
during 1996 has had a serious impact on the distribution channels of the
products.  In addition, the liquidity problems caused by the same production
issue, has severely hampered the Company's ability to increase the distribution
of its products through the increase in product introduction costs.  The Company
does not have formal agreements with its distributors which are the primary
customers of the Company, but delivers products under normal industry terms of
sales.

     In connection with Auburn Farms and Natures Warehouse the Company has
changed packaging and formulations in an effort to appeal to a broader customer
base.  The first new product was Toast `N Jammers, a toaster pastry line.
Combined with icing and a product presentation that is closer to mainstream
products, Vitafort is attempting to establish Toast `N Jammers as the standard
for the toaster pastry segment.  The Company is preparing similar new products
for the other Auburn Farms brands.  The severity of financial losses suffered as
a result of the product quality problem could hamper the Company's ability to
market Auburn Farms and Natures Warehouse products, as well as to execute other
projects.

INTELLECTUAL PROPERTY RIGHT PROTECTION AND TRADEMARKS

     The Company believes that its trademarks do afford it some degree of
protection from competition and do allow it to differentiate its products from
those of its competitors through brand loyalty and identity.  There are however,
no assurances that such trademarks may offer significant protection from
competitors or that the Company would be successful should litigation to protect
such trademarks become necessary.  The Company is seeking to determine whether
its various formulas and procedures are patentable in the United States, and
relies upon non-disclosure, secrecy agreements and its common law rights in
order to protect its proprietary formulae, procedures, and other information.
No assurance can be given that such steps will adequately protect the Company
against competing products or that the Company will be able to adequately
enforce its rights against third parties who may be utilizing the Company's
proprietary formulae, procedures

                                       5
<PAGE>
 
and other information. If the Company is advised by counsel that any of its
formulae, processes, procedures or other techniques are patentable, then it may
seek appropriate patent protection.

     The Company has developed several proprietary formulations for its
products.  While these formulations may or may not be protected under the U.S.
Patent laws, they may have value inasmuch as they provide Vitafort with its
unique competitive edge.  The Company has established brands within certain
market niches of major product categories.  The consumer acceptance of the
nutritional and flavor profiles of the products, have been heavily influenced by
the proprietary formulations and processes.

     The Company's trademarks and their marketing status are detailed below:

<TABLE>
<CAPTION>
TRADEMARK                                                 MARKETING ACTIVITY
-----------------------   ----------------------------------------------------------------------------------
<C>                       <S>
VITAFORT                  This is an actively marketed mark and used on all Company material; however,
                          quality problems encountered in 1996 have impaired the value of this mark.
 
AUBURN FARMS              Recently acquired trade name with existing presence in the specialty grocery
                          classes of trade.
NATURES WAREHOUSE         Trade name acquired in May, 1996 with existing presence in the health food class
                          of trade.
TOAST `N JAMMERS          A repositioned brand name with  specialty grocery presence.  With the
                          repositioned product, this brand has experienced expansion versus a year ago.
JAMMERS                   One of the all natural fat free cookie brands in both the health food and
                          specialty food classes of trade.
7-GRAINERS                A snack cracker brand within the health food class of trade. This brand also
                          holds a shelf position within the specialty grocery class of trade.
AVENUE OF THE STARS       A new mark used for products which shall be part of motion
                          picture licensing agreements.
JULIETTE'S PRIVATE        A mark established for a line of low fat chocolate products first shipped in
COLLECTION                December 1997.
CAKETTS                   This product once occupied significant shelf space in supermarkets throughout the
                          country and continues to maintain a minor presence.  Quality problems associated
                          with this product, however, appear to have substantially diminished the value of
                          this mark.  The Company ceased marketing Caketts in May 1998.
FUDGETS                   This was one of the key food products with distribution in a number of
                          supermarkets throughout the U.S.  Quality problems encountered in 1996 have
                          severely limited the realization of this mark.  The Company discontinued all but
                          one SKU in May 1998.
</TABLE>

GOVERNMENTAL REGULATION

     In general, production, packaging, processing and labeling of food and
beverage products are subject to various federal and state regulations.  The
Company relies upon the experience and expertise of its co-packers to assure
compliance with applicable federal and state regulations.  The Company believes
that it is in compliance with all applicable governmental regulations.

RESEARCH AND DEVELOPMENT

     The Company has modified its research and development strategies from prior
years.  In the past, the Company retained highly trained technical support
professionals to independently develop formulations and work with contract
manufacturers to bring the products to market readiness.  The strategy moving
forward in 1997 and beyond is to work with existing manufacturers from the
outset and utilize their internal research and technical staff to develop new
products.  By working in this manner, the Company intends to reduce its research
and development costs and to create a joint interest in "ownership" of a
successful, high quality product.  This strategy inherently builds a strong
total quality end result.

                                       6
<PAGE>
 
     The Company spent $337,806 and $737,044 on research and development in 1997
and 1996, respectively, and $61,359 in the first quarter of 1998.  The Company
intends to create new products using the above strategy and to launch products
in the marketplace in 1998 and beyond.  The current financial condition of the
Company, however, may preclude it from successfully accomplishing its goal.

COMPETITION

     The Company is engaged in the highly competitive healthy food marketplace.
There are numerous companies with financial and business resources far greater
than Vitafort's, currently marketing healthy and fat free foods.  The Company
seeks to compete based on the unique taste, texture and quality of its products
and by obtaining recognition for its brands.

     The Vitafort brands compete within different categories and with different
products depending upon the class of trade and placement within retail outlets.
The chart below details the Company's product lines and identifies the
competitors with the classes of trade.


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
VITAFORT BRAND                CLASS OF TRADE          PRINCIPAL COMPETITION               MARKET NICHE
---------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------
<S>                       <C>                       <C>                          <C>
Juliette's Private        Main grocery sections,    There is no known direct     Appeal to those consumers who
  Collection              natural food stores       competition for boxed low    are not willing to sacrifice
Chocolate Truffles        and discount drug         fat chocolate cream          the taste of real chocolates,
                          stores within the U.S.    candies.                     but demand a nutritional
                                                                                 profile that provides lower
                                                                                 fat than traditional
                                                                                 chocolates.
---------------------------------------------------------------------------------------------------------------
Fudgets                   Main grocery cookie       Snackwell's Brownies         The Company decided to
                          section                   Pepperidge Farms             discontinue all but one SKU.
                                                    Brownies
                                                    Greenfield's Brownies
                                                    Frookies Brownies
---------------------------------------------------------------------------------------------------------------
Toast `N Jammers Low      Specialty Food            Health Valley Healthy        Toast `N Jammers may have a
 Fat Toaster Pastries     sections of               Tarts, and Natures'          competitive edge in taste and
                          supermarkets and          Choice Toaster Pastries      all natural ingredients.
                          specialty stores.
---------------------------------------------------------------------------------------------------------------
Jammers Fat Free          Health food stores and    Health Valley Cookies,       The Company is repositioning
 Cookies and Brownies     health food sections      Westbrae Cookies, Heaven     the brand to strengthen its
                          of supermarkets           Scent Cookies, Barbara's     future franchise.
                                                    Cookies, Pamela's
                                                    Cookies, Frookies Cookies
                                                    & Brownies, Greenfield's
                                                    Brownies
---------------------------------------------------------------------------------------------------------------
7-Grainers Fat Free       Health food stores and    Health Valley Crackers,      Vitafort plans to reposition
 Crackers                 health food sections      Hain Crackers, Barbara's     the brand with unique new
                          within supermarkets       Crackers.                    product entries toward the
                                                                                 end of 1998.
---------------------------------------------------------------------------------------------------------------
</TABLE>

                                       7
<PAGE>
 
ENVIRONMENTAL REGULATION AND SEASONALITY

     Management believes that the costs associated with compliance with
environmental regulations do not at this time impose a significant burden upon
the Company's operations.  Any change in that burden, however, could adversely
impact the Company.  Management does not believe that the Company's business is
seasonal to any significant extent.

EMPLOYEES

     As of June 11, 1998, the Company had 11 employees of whom 3 were executive
officers, 2 were engaged in sales and marketing, and 6 were clerical and
administrative.

ITEM 2:   DESCRIPTION OF PROPERTY

     The Company's principal executive office consists of 3,921 rentable square
feet located at 1800 Avenue of the Stars, Los Angeles, California, which is
leased pursuant to a three-year lease which expired August 31, 1997.  The base
rent under said lease was $69,000 for the first year of the term; $72,000 for
the second year of the term; and, $75,000 for the third year of the term. The
Company is now leasing the same space on a month-to-month basis at a rate of
$6,250 per month.

ITEM 3:   LEGAL PROCEEDINGS

     In December 1994, Lloyd Gaunt, who invested an aggregate of $75,000 in
certain of the Company's private placements, initiated an action in Superior
Court, Orange County, California against his stockbroker, two national brokerage
firms, several companies in which he had invested, and, certain of those
companies' officers.  Included among the defendants were the Company and its
then Chief Executive Officer.  The complaint seeks damages in an unspecified
amount in excess of $500,000 and punitive damages in an unspecified amount in
excess of $5,000,000.  The Court has dismissed the class action claims as to the
Company and granted a motion that the claims against the brokerage firms and
associated persons must be submitted to arbitration.   The plaintiff has
appealed that ruling.  The Company denies any liability to the plaintiff and
intends to vigorously defend this action.  The Company notes that the plaintiff
sold a portion of the securities he purchased from the Company, realizing a
profit; that the balance of the securities became salable under Rule 144; and
that, if sold, the plaintiff `s losses on the Company's securities might be as
little as $15,000.

     In connection with the acquisition of assets of Auburn Farms, Inc.,
("AFI"), the Company acquired the intellectual property and certain claims of
AFI which it was asserting against AFI's co-packer, New Life Bakers ("New Life")
and against a customer of New Life, Barbara's Bakery ("Barbara's"). In May 1996,
the Company filed an action in federal court alleging Lanham Act violations,
misappropriation of trade secrets, unfair competition, conspiracy and related
claims arising out of New Life and Barbara's misappropriation of Auburn Farms'
principal products.   Although no trial date has been set, the Company expects
the case to proceed to a jury trial in the first half of 1999.

     On March 25, 1998, New Life and Barbara's purported to purchase from AFI's
bankruptcy estate certain claims against Barbara's and New Life for $300,000.
The purchased claims do not include any of the claims previously acquired by the
Company.  The Company expects New Life and Barbara's to raise by motion the
effect of the March 25, 1998 bankruptcy purchase.  The Company has been advised
by outside litigation counsel that evidence supports the Company's claim for
damages in excess of $3 million for the destruction of AFI's business and
intellectual property rights.  The Company may be obligated to pay a portion of
any recovery to the Company against New Life to AFI's bankruptcy estate and/or
its creditors.

                                       8
<PAGE>
 
The Company intends to pursue this litigation vigorously. There is no assurance
given that the Company will receive any recovery.

     On October 9, 1996, a complaint was filed in Superior Court, the County of
Los Angeles, in an action entitled "Eloy Louis Ellis vs. Vitafort, Inc., a
Delaware Corporation; Mark Beychok and Does 1-50 inclusive."  The complaint
alleges Breach of Oral Contract, Breach of Written Contract, and other similar
claims arising out of the consulting relationship that previously existed
between the Company and Mr. Ellis.  The Complaint seeks damages in an
unspecified amount.  The court has dismissed the complaint against Mark Beychok
without leave to amend.  Mr. Ellis recently filed an amended complaint against
the Company.  The Company is defending the action vigorously and trial is
scheduled for March 31, 1998.

     The Company filed a counter-claim against Ellis charging violations of
Section 16(b) of the Securities Exchange Act of 1934 (short swing profits).
Ellis sold stock in violation of that section and, therefore, the profits,
estimated at $20,000, belong to the Company.  In March 1998, the court ruled in
favor of the Company in this matter and awarded it $21,260.

     On June 2, 1998, the parties resolved both the Ellis issues.  Under the
terms of the agreement, the settlement is treated as confidential and the public
response has been agreed to as follows:  "The matter has been resolved."

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

      During the quarter ended June 30, 1997, the Company obtained written
consent of the holders of a majority of its issued and outstanding common
shares, which the Company has the authority to issue, to increase the authorized
number of shares from 9,000,000 shares to 30,000,000 shares.  The holders of
3,218,102 common shares gave their consent to the proposal; the holders of
182,761 common shares did not consent; and the holders of 20,655 common shares
abstained from voting based on the written consents received by the Company's
transfer agent through July 7, 1997.

                                       9
<PAGE>
 
                                    PART II

ITEM 5.   MARKET FOR THE COMPANY'S COMMON EQUITY
          AND RELATED STOCKHOLDER MATTERS

     The Company's common stock, redeemable warrants (each of which entitles the
holder to purchase one-twentieth of one share of common stock at a price of
$2.375 or $47.50 per share through the close of business on October 31, 1997, or
an earlier redemption date) and units (each of which is comprised of three
shares pre-reverse split and .15 shares post reverse split of common stock and
two redeemable warrants)  traded on the National Association of Securities
Dealers, Inc., Automatic Quotation System ("NASDAQ") from December 19, 1989, the
effective date of the Company's Registration Statement on Form S-18, until
August 27, 1992.  At that time, the Company fell below the net asset requirement
for continued listing and was subsequently disqualified.  Since such date, the
Company's securities have traded on the Electronic Bulletin Board maintained by
NASDAQ.  Prior to December 19, 1989, there was no market for the Company's
securities.  The table below sets forth the high and low closing bid prices for
the common stock, redeemable warrants and units during the period January 1,
1995 to December 31, 1996, as reported on the Electronic Bulletin Board; and, as
adjusted to take into effect a one-for-twenty reverse stock split effected on
October 4, 1996. The quotations represent inter-dealer quotations without
adjustment for retail mark-ups, mark-downs or commissions and may not represent
actual transactions:
<TABLE>
<CAPTION>
 
PERIOD                      COMMON STOCK            WARRANTS              UNITS
                          HIGH         LOW       HIGH       LOW      HIGH       LOW
<S>                   <C>            <C>        <C>       <C>       <C>       <C>
 
1st Quarter 1995           $16.875    $11.250    $0.188    $0.063    $4.000    $1.500
 
2nd Quarter 1995           $13.750    $ 5.625    $0.125    $0.063    $4.000    $0.250
 
3rd Quarter 1995           $ 8.125    $ 3.125    $0.188    $0.188    $1.125    $0.250
 
4th Quarter 1995           $ 8.438    $ 1.875    $0.188    $0.188    $1.125    $0.250
 
1st Quarter 1996           $14.063    $ 5.938    $0.050    $0.010    $1.625    $0.250
 
2nd Quarter 1996           $ 7.188    $ 4.688    $0.010    $0.010    $1.000    $1.000
 
3rd Quarter 1996           $ 6.250    $ 2.813    $0.010    $0.010    $1.000    $0.500
 
4th Quarter 1996           $ 4.063    $ 0.875    $0.010    $0.010    $0.500    $0.500
 
1st Quarter 1997           $ 2.297    $ 0.875    $0.010    $0.010    $0.500    $0.500
 
2nd Quarter 1997           $ 1.625    $ 0.625    $0.010    $0.010    $0.500    $0.500
 
3rd Quarter 1997           $ 1.844    $ 0.813    $0.010    $0.010    $0.500    $0.500
 
4th Quarter 1997           $ 1.750    $ 0.750    $0.010         *    $0.500    $0.500
</TABLE>

* Less than $ 0.010

     The above amounts have been retroactively adjusted for a 1 for 20 reverse
stock split, which occurred on October 4, 1996.

                                       10
<PAGE>
 
     On March 24, 1998, the closing bid price for the common stock, as reported
by the NASDAQ Electronic Bulletin Board, was $1.37.  The Company has been
advised that there are no current quotations available for the Warrants or
Units.

     At the close of business on March 17, 1998 there were approximately 400
holders of record of the common stock and approximately 40 holders of record of
the redeemable warrants.
 
     The Company has not paid any dividends on its common stock since inception
and intends to retain any future earnings for the development of its business.
Future dividends on the common stock, if any, will be dependent upon the
Company's earnings, financial condition, the dividend priority of any preferred
shares and other relevant factors as determined by its Board of Directors.

     Prior to 1993, the Company fell below the net asset requirement to maintain
listing privileges on the NASDAQ and was, therefore, disqualified.

     No dividends were paid on Series B Convertible Preferred Stock during 1996
or 1997.  Cumulative unpaid dividends on the Series B Convertible Preferred
Stock as of December 31, 1997 and 1996 totaled $25,000 and $20,000 respectively.
During August 1996, the holder of 500 of the then 1,500 issued and outstanding
shares of Series B Convertible Preferred Stock converted his shares and all
accrued dividends thereon into 2,500 shares of Common Stock (as adjusted for the
reverse stock split effected in October 1996).  The conversion of the Series B
Preferred Shares was in accordance with the formula set forth in the Certificate
of Designation for such security and the accrued dividends were converted at the
market price for the Common Stock at the date of the conversion. All unpaid
dividends on the preferred stock must be paid before dividends can be paid on
the Common Stock.

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

 CAUTIONARY STATEMENT FOR PURPOSES OF "SAFE HARBOR PROVISIONS" OF THE PRIVATE
                    SECURITIES LITIGATION REFORM ACT OF 1995

EXCEPT FOR HISTORICAL FACTS, ALL MATTERS DISCUSSED IN THIS REPORT, WHICH ARE
FORWARD LOOKING, INVOLVE A HIGH DEGREE OF RISKS AND UNCERTAINTIES.  POTENTIAL
RISKS AND UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, COMPETITIVE PRESSURES
FROM OTHER FOOD COMPANIES AND WITHIN THE GROCERY INDUSTRY, THE IMPACT OF QUALITY
PROBLEMS EXPERIENCED IN 1996, THE LACK OF ADEQUATE CAPITAL TO FUND CONTINUING
OPERATIONS, ECONOMIC CONDITIONS IN THE COMPANY'S PRIMARY MARKETS AND OTHER
UNCERTAINTIES DETAILED FROM TIME TO TIME IN THE COMPANY'S SECURITIES AND
EXCHANGE COMMISSION FILINGS.

YEARS ENDED DECEMBER 31, 1997 AND 1996

RESULTS OF OPERATIONS

     The 1997 year can best be characterized as one of regrouping and re-
energizing.  The first half of the year was spent in attempting to salvage
deteriorating customer and broker relationships resulting from product returns
due to mold, the inability to ship complete orders as a result of liquidity
problems created, in no small way, by the mold problem, and the broker
dissatisfaction and their lack of commissions from a lack of paid sales.  In
addition, management focus was clearly on the preparation for the arbitration
involving Keebler.  That effort was rewarded when the arbitration finally
resulted in the Company receiving $6,750,000 in cash in July 1997.  See Note 16
to the Consolidated Financial Statements for a detailed explanation of the costs
associated with the recovery.

     The second half of 1997 was devoted to repairing the damages done to the
Company's customers and brokers.  These efforts involved detailed reconciliation
of customer accounts, discussions by senior management with the merchandising
managers of these customers to resolve any major disputes, and the final

                                       11
<PAGE>
 
settlement of a business relationship, with at least an understanding going
forward of how future transactions in general would be handled.

     In product development, the Company began, after June 1997, to focus on
products to be introduced in the last quarter of 1997 and in 1998.  The first
product was a reformulation of the existing toaster pastry products marketed
under the name Toast'N Jammers, plus the addition of two new frosted flavors
named Apple Cobbler and Cinnamon Toast.  The reformulation was developed as a
result of a new flavor house supplying raw ingredients that the Company believed
provided a superior tasting product.  The new flavors increased the line to a
total of eight:  frosted and unfrosted strawberry, cherry and blueberry, plus
apple cobbler and cinnamon toast.  The new formulation was introduced after
Thanksgiving and the customer response to the flavors has been excellent.
Additionally, the Company began the reformulation of its chocolate truffles
marketed under the name Juliette's Private Collection.  The Company decided to
reformulate the chocolate truffles because the centers of the truffles were
becoming prematurely hard.  This change in texture was not foreseen in the
original formula, but was the cause of customer complaints.  The reformulation,
which was tested during the end of 1997 and incorporated in the product produced
and shipped during the end of the year, allows the center to remain softer than
before during the entire shelf life of the product.   The reformulation was
completed in the last quarter of 1997 and the first two truckloads of product
were shipped around Christmas.  Other products under development are scheduled
for introduction in the first half of 1998.

     The Company used the remainder of 1997, after the Keebler award, to improve
its vendor relationships by negotiating multiple monthly payment schedules for
some of the Company's major creditors.  This process, which occurred over a
three month period, resulted in deferred payment schedules being negotiated for
over $650,000 of the Company's liabilities.

NET SALES

     The liquidity issues which created inventory availability problems and the
continued fallout from the mold significantly reduced sales in 1997 compared to
1996.  In 1997 sales were $1,995,317 compared to $5,285,149 in 1996, a reduction
of $3,289,832 or 62.2% of 1996 sales.  Fudgets and Caketts, marketed under the
name Vitafort and the products associated with the mold, represented $3,751,858
of 1996 sales or 71.0% of the total , while in 1997 the products represented
$754,408 or 37.8% of total 1997 sales.  The decline of $2,997,450 for these
products represents almost the entire reduction between 1996 and 1997.  In
addition, sales of Auburn Farms brands products decreased by $300,624 due to the
problems discussed above which resulted in the Company not being able to ship
complete and timely orders.

GROSS PROFIT

     Gross profit in 1997 was $98,907 or 5.0% of sales, compared to a gross loss
of $1,584,971 in 1996, an increase of $1,683,878 from 1996 to 1997.  The
improvement of gross profit in 1997 over 1996 is due, in large part, to products
returned in 1996, sales of  products in 1996 at less than list price, and
product that was destroyed in 1996 because it was not saleable.  The product
returns due to mold continued  to be a source of margin erosion.  In addition,
the lack of customer acceptance of the Company's Fudgets and Caketts manifested
itself in reduced customer sales of other products.  The Company also began
experiencing serious customer complaints resulting in chargebacks of Auburn
Farms and Nature's Warehouse products, which in some cases were shipped to the
customer prior to the acquisition of Auburn Farms brands and reformulations by
the Company.  When the Company acquired the trademarks, brands, and other
intellectual properties of Auburn Farms/Nature's Warehouse ("Auburn Farms") in
May 1996, Auburn Farms was experiencing significant returns due to products
becoming hard and uneatable, especially the cookies.  The Company continued to
experience such returns but minimized the future potential risk by reducing the
manufacturing lot size thereby increasing the inventory turnover and sending
fresher product to the customers.  Finally, the reduced volume of sales
translated to increased inventory levels since some of the co-packers have
minimum production quantities.  The increase in inventory levels created further
margin erosion as the Company was then forced to sell the products at prices
which, for the most part, were at or slightly above inventory cost.  For the
Company to achieve higher gross margins, it must increase its sales volume to
eliminate selling inventory with short expiration periods, which requires
selling to liquidators at less than normal list price.

                                       12
<PAGE>
 
OPERATING EXPENSES

RESEARCH AND DEVELOPMENT

     In 1997, product development expenses were $337,806 compared to $737,044
for the same period in 1996, a reduction of $399,238 or 54%.  The decrease is
due in part to the reduced emphasis in the first half of 1997 because of the
financial difficulties of the Company.  Also, the Company made the decision to
work in conjunction with its co-packers in developing new products or enhancing
existing products.  These joint efforts resulted in reduced cost to the Company
plus the added benefit of having the co-packer who will be the ultimate
manufacturer, also be an integral part of the development process and thus "take
ownership" of the program along with the Company.  The reduction in staff,
$102,790, the closing of the office in Petaluma, California, $185,755, and the
reduction in travel, $107,920, accounted for approximately $396,000 of the total
reduction between 1997 and 1996.

SALES AND MARKETING

     The lack of sales is reflected in the reduction in sales and marketing
expenses from $3,029,480 in 1996 down to $1,239,460 in 1997, a reduction of
$1,790,020 or 59.1%.  The reduction in promotion, advertising, and product
introduction fees of $1,436,873 between 1996 and 1997 are due in large part to
the Company's decision to defer new product development and related expenditures
and to use advertising and promotion dollars only where there is likely to be
measurable value.  The other cost reductions in staffing and related expenses,
$69,255, and travel, $207,626, are primarily the result of the problems in the
first half of the year associated with the liquidity issue and the continued
customer complaints.

GENERAL AND ADMINISTRATIVE

     The effort expended in the Keebler arbitration and in improving the
systems, procedures, and administrative functions is evident by the fact that
the general and administrative expenses were $2,672,946 in 1997 and $2,721,321
in 1996, a reduction of $48,375.  The emphasis on Keebler and the settlement of
the other various legal cases reduced overall legal expenses by $28,964 after
taking into account the payment by Keebler of $767,000 against the legal fees
and costs as part of the overall settlement.  In addition, the liquidity
problems in the first part of 1997 and the decision by the Company not to
replace certain administrative staff positions resulted in a reduction in
payroll and related expenses, including consulting, of $43,611 in 1997 compared
to 1996.  While this reduction is consistent with the Company's effort to reduce
expenses, as the business level increases in the future, such continued cost
saving measures will be difficult to maintain.

INCOME TAXES

    As of December 31, 1997, the Company had unused Federal and California net
operating loss carryforwards of approximately  $19,600,000 and $6,400,000,
respectively, available to offset future Federal taxable income and future
California taxable income.  In addition, the Company had unused research and
experimental credits of $44,000 and $26,000 for Federal and California state
purposes.  The unused net operating loss and credit carryforwards expire in
various amounts through the year 2012.  In contrast to Federal net operating
losses, only 50% of the California net operating losses incurred subsequent to
December 31, 1986 may be carried forward.  The California net operating losses
will expire in various amounts through the year 2002.
 
    Net deferred tax assets of approximately $7,605,000 resulting from net
operating losses, tax credits and other temporary differences have been offset
by a valuation allowance since management cannot determine whether it is more
likely than not such assets will be realized.

     Due to restrictions imposed by the Internal Revenue Code regarding
substantial changes in ownership of companies with loss carryforwards, the
utilization of the above-mentioned net operating losses

                                       13
<PAGE>
 
may be limited as a result of changes in stock ownership. The annual utilization
of these losses is limited to an amount equal to the estimated fair value (for
income tax purposes) of the Company at the point of stock ownership change,
multiplied by the long-term tax-exempt rate then in effect. The annual
limitation has not been quantified at this time.

INTEREST INCOME AND EXPENSE

     Interest income was $78,070 in 1997 and $49,319 in 1996.  The loan proceeds
from the Keebler arbitration have been invested in short term government
securities which do not carry high interest rates, but are almost risk free.

     Interest expense was $214,690 in 1997 compared to $50,509 in 1996.  The
increase is due primarily to the lending arrangement with Coast Business Credit
which has a $15,000 per month minimum interest clause in the contract.  In 1997,
this amount represented $180,000 of the total interest expense.
<TABLE>
<CAPTION>
 
LIQUIDITY AND CAPITAL RESOURCES
                                                           DECEMBER 31,
                                                       1997           1996
                                                    -----------   ------------
<S>                                                 <C>           <C>
     Net Cash From (Used In) Operations             $1,790,893    ($5,523,462)
     Net Cash Used in Investing Activities            (214,095)      (172,896)
     Net Cash Provided By Financing Activities         433,371      4,568,819
     Working Capital (Deficit)                       1,503,938     (1,217,296)
</TABLE>

     Although the cash position had improved significantly at year end due to
the arbitration settlement, the Company is still under pressure to maintain and
improve its financial condition and has yet to generate profitable operations.

     The Company is continuing to repair the relationships with its brokers and
customers (distributors), but the effort involved is both time consuming on
management's part and costly in that the effort detracts time which could
otherwise be spent procuring orders.  Although the vendor relationships are now
stable, the Company may again jeopardize this area should the liquidity problem
again become extreme.

     The Company has suffered recurring losses from operations as of December
31, 1997.  Although the Company has raised additional capital after year-end
1997 (see Note 15 to the Consolidated Financial Statements), it has not
generated sufficient revenue-producing activity to sustain its operations.  The
Company's independent certified public accountants have included a modification
to their opinion which indicates there is substantial doubt about the Company's
ability to continue as a going concern.  See "Note 2" to the Consolidated
Financial Statements for additional information.  The Company is attempting to
raise additional capital to meet future working capital requirements, but may
not be able to do so.  Should the Company not be able to raise additional
capital, it may have to severely curtail operations.

     The Company is reducing its cost of sales by centralizing the warehousing
of its products in a single location and negotiating lower rates with existing
manufacturers or by selecting another competent less expensive producer.  In
addition, the Company increased prices on the majority of its products effective
August 1, 1997 and changed its terms of sale to F.O.B. the Company's warehouse.
The Company also eliminated the cash discount for prompt payment since most
customers were taking the discount beyond the terms.  The Company has also
introduced reformulated products at the end of 1997 and plans to introduce new
products in 1998.  These steps, coupled with improvements in subcontract
manufacturing quality control

                                       14
<PAGE>
 
and quality assurance and monitoring improvements in Company internal control
and communications with respect to product returns and deductions, should
improve the Company's prospects to achieve profitability.

         
    
    The Company is currently negotiating the acquisition of Global International
Sourcing, Inc., ("Global") a Nevada corporation, by acquiring the stock of the
corporation from its sole shareholder. Global is a company with international
contacts to provide natural and low fat food products for Vitafort to sell into
the United States market at a cost significantly below those found in the United
States for similar products. The Company advanced $193,818 to Global as of
December 31, 1997 to meet Global's operating expenses and fund inventory
purchases for future sales. The Company believes that the acquisition cost will
not be a material amount. Global was formed in October 1997 and its financial
position and results of operations are not material compared to the Company's
financial position at December 31, 1997 or its results of operations for the
year ended December 31, 1997.    

    As of December 31, 1997, the Company had unused Federal and California net
operating loss carryforwards of approximately  $19,600,000 and $6,400,000,
respectively, available to offset future Federal taxable income and future
California taxable income.  In addition, the Company had unused research and
experimental credits of $44,000 and $26,000 for Federal and California state
purposes.  The unused net operating loss and credit carryforwards expire in
various amounts through the year 2012.  In contrast to Federal net operating
losses, only 50% of the California net operating losses incurred subsequent to
December 31, 1986 may be carried forward.  The California net operating losses
will expire in various amounts through the year 2002.

     Net deferred tax assets of approximately $7,605,000 as of December 31, 1997
resulting from net operating losses, tax credits and other temporary differences
have been offset by a valuation allowance since management cannot determine
whether it is more likely than not such assets will be realized.

     Due to restrictions imposed by the Internal Revenue Code regarding
substantial changes in ownership of companies with loss carryforwards, the
utilization of the above-mentioned net operating losses may be limited as a
result of changes in stock ownership.  The annual utilization of these losses is
limited to an amount equal to the estimated fair value (for income tax purposes)
of the Company at the point of stock ownership change, multiplied by the long-
term tax-exempt rate then in effect.  The annual limitation has not been
quantified at this time.

CREDIT FACILITY

     In August 1996, the Company entered into a revolving credit facility with
Coast Business Credit, that provides a credit line of up to $4,000,000 subject
to certain covenants.  Advances made to the Company under the facility are based
on a certain percentage of eligible accounts receivable, as defined, and a
certain percentage of eligible inventory, as defined.  The amount of inventory
advances under the facility cannot exceed $500,000.  The initial term of the
facility ends August 1998, with automatic renewals thereafter for one year
periods.  Advances under the facility bear an interest rate at the Bank of
America NT plus 3%, and are secured by a first priority lien on all of the
Company's assets.  Minimum interest charges are currently $15,000 per month.
The Company paid $40,000 to the institution upon execution of the agreement, and
$40,000 to a facilitator in connection with the placement of the loan.

     The Company is using the proceeds of advances under the facility to help
meet its current working capital requirements.  The amount due, under this
credit facility, was $440,022 on December 31, 1996, and $60,757 on December 31,
1997.

     As of December 31, 1996 and subsequently, the Company was in violation of
certain covenants in that it had not maintained minimum tangible net worth of at
least $1,500,000 and minimum working capital of $1,000,000.  If the Lender had
exercised its rights under the Agreement, it could have requested customer
payments be made directly to it, sold the finished goods inventory at auction,
and seized and sold the fixed assets of the Company until the obligation had
been satisfied. The Company classified the entire loan as a current liability as
of December 31, 1996.  On September 30, 1997, due to receipt of the award from
the Keebler arbitration, the Company was no longer in violation of the loan
covenants.  As of December 31,

                                       15
<PAGE>
 
1997, the Company was not in violation of any covenants of the credit facility.
No assurance is given that the Company will not be in violation of any covenants
in the future.

IMPACT OF INFLATION

     The Company believes that inflation has not had a material impact on its
operations.  However, substantial increases in material costs could adversely
affect the operations of the Company for future periods.

YEAR 2000

     The Company's accounting software currently does not utilize a four digit
year field;  however, the Company has been assured by the software manufacturer
and independent consultants that all necessary modifications for the year 2000
have been or will be made and tested timely.  The Company does not expect the
cost of these modifications will have a material effect on its financial
position or results of operations.  The Company currently does not interact
electronically with either customers, suppliers or other entities that could be
impacted by Year 2000 issues.

RECENT NEW ACCOUNTING STANDARDS

DISCLOSURE OF INFORMATION ABOUT CAPITAL STRUCTURE

     Statement of Financial Accounting Standard No. 129, "Disclosure of
Information about Capital Structure," ("SFAS 129") issued by the FASB is
effective for financial statements with fiscal years ending after December 15,
1997.  The new standard reinstates various securities disclosure requirements
previously in effect under Accounting Principles Board Opinion No. 15, which has
been superceded by SFAS No. 128.  The Company adopted SFAS No. 129 on December
15, 1997 and it did not have any effect on its financial position or results of
operations.

REPORTING COMPREHENSIVE INCOME

     Statement of Financial Accounting Standard No. 130, "Reporting
Comprehensive Income," ("SFAS 130") issued by the FASB is effective for
financial statements with fiscal years ending after December 15, 1997.  Earlier
application is permitted.  SFAS 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general-
purpose financial statements.  The Company adopted SFAS 130 on January 1, 1998
and it did not have any effect on its financial position or results of
operations.

DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION

     Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131") issued by the
FASB is effective for financial statements with fiscal years ending after
December 15, 1997. SFAS 131 requires that public companies report certain
information about operating segments, products, services and geographical areas
in which they operate and their major customers.  The Company does not expect
adoption of SFAS 131 to have any effect on its financial position or results of
operations; however, disclosures with respect to the aforementioned items may be
increased.

                                       16
<PAGE>
 
REPORTING ON THE COST OF START-UP ACTIVITIES

     Statement of Position 98-5, "Reporting on the Costs of Start-Up
Activities."  ("SOP 98-5") issued by the Accounting Standards Executive
Committee is effective for financial statements with fiscal years beginning
after December 15, 1998.  SOP 98-5 requires that the costs of start-up
activities should be expensed as incurred.  At the time of adopting this SOP,
the initial application should be reported as the cumulative effect of a change
in accounting principles.  At March 31, 1998 and December 31, 1997, the Company
capitalized product introduction costs of $14,250 and $10,711, respectively.
These costs are considered as start-up activities under SOP 98-5.  The Company
does not believe that the adoption of this SOP will have a material effect on
its financial position, results of operations or cash flows.

ITEM 7:   FINANCIAL STATEMENTS

     SEE "INDEX TO CONSOLIDATED FINANCIAL STATEMENTS" BEGINNING ON PAGE F-1

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

     On February 5, 1997, the Registrant dismissed the firm of KPMG Peat
Marwick, LLP ("KPMG") as the Registrant's independent auditor, effective
immediately.  The Registrant then selected BDO Seidman, LLP ("BDO") to act as
the Company's independent auditor for the fiscal year ended December 31, 1996.
The foregoing actions of the Registrant were ratified by its Board of Directors.

     The report of KPMG on the Company's financial statements for the year ended
December 31, 1995, did not contain an adverse opinion or a disclaimer of
opinion, nor was it qualified or modified as to uncertainty, audit scope or
accounting principles.

     During the two years ended December 31, 1995, and during the subsequent
period from January 1, 1996 through February 5, 1997, there were no
"Disagreements" (as such term is defined under the Federal Securities laws) with
KPMG on any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure, which Disagreements, if not resolved
to the satisfaction of KPMG, would have caused that firm to make a reference to
the subject matter of the Disagreements in connection with their report.

     During the two years ended December 31, 1995, and during the period from
January 1, 1996 through February 5, 1997, the Registrant was not (i) advised by
KPMG that the Registrant did not have internal controls necessary to develop
reliable financial statements; (ii) advised by KPMG that it was no longer able
to rely on management's representations or that it was unwilling to be
associated with financial statements prepared by management; (iii) advised by
KPMG of a need to expand the scope of its audit; or (iv) advised by KPMG that
information had come to its attention that materially impacted the fairness or
the reliability of any audit report or financial statement issued or to be
issued, or caused them to be unwilling to rely on management's representations
or be associated with the Registrant's financial statements (collectively
"Reportable Events").

     During the year ended December 31, 1995, and the period from January 1,
1996 to January 31, 1997, neither the Registrant, nor anyone on its behalf,
consulted BDO on (i) the application of accounting principles to a specified
transaction, either completed or proposed; the type of audit opinion that might
be rendered on the Registrant's financial statements; or (iii) any matter that
was either the subject of a Disagreement or a Reportable Event.

                                       17
<PAGE>
 
ITEM 9:   DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
          PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

          The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
          Name                      Age                Positions Held
          ------------------------  ---   ----------------------------------------
          <S>                       <C>   <C>
 
          Mark Beychok               41   President, CEO and a Director
          Donald Wohl                62   Director
          Paul G. Cowen              64   Director
          Benjamin Tabatchnick       45   Director
          Jack B. Spencer            53   Chief Operating Officer, Chief Financial
                                          Officer
          John Coppolino             37   Executive Vice President
</TABLE>

     MARK BEYCHOK was elected President and a Director of the Company in
     ------------                                                       
September of 1993, and has been Chief Executive Officer since February 1995.
Mr. Beychok is a private investor with fifteen years experience in the food
industry as an owner and operator of various food manufacturing, marketing and
distribution companies.  Mr. Beychok graduated in 1979 from the Haas Business
School at the University of California (Berkeley).

     DONALD WOHL was elected a Director of the Company in November of 1993.  Mr.
     -----------                                                                
Wohl is a private investor and financial consultant who has been advising small
growth companies for over 30 years.  Mr. Wohl is also on the board of Koo Koo
Roo, Inc., a NASDAQ listed company which operates a chain of restaurants.

     PAUL G. COWEN was elected a director in January 1998.  Mr. Cowen was the
     -------------                                                           
founder of Paul Cowen Associates in 1984, a major factor in the retained
executive recruiting industry.  Prior to that, Mr. Cowen was in senior marketing
and sales positions at Xerox and Vivitar.  Mr. Cowen has a BA from Ohio
University and an MS from Indiana University.

     BENJAMIN TABATCHNICK was elected a Director of the Company in February
     --------------------                                                  
1997.  Since January 1990, Mr. Tabatchnick has owned and operated Tabatchnick's
Fine Foods (and predecessors), a privately held concern, which manufactures and
distributes its own trademarked line of frozen soups, and manufactures frozen
and refrigerated foods for others on a contract basis.

     JACK B. SPENCER became Chief Financial Officer and Chief Operating Officer
     ---------------                                                           
in June 1997.  Mr. Spencer has owned and operated Sunrise Consulting, Ltd., a
private concern specializing in restructuring, reorganizing, and rehabilitating
companies since 1990.  Mr. Spencer has a BA in Economics from DePauw University
(Indiana) and an MBA from Washington University (Missouri).

     JOHN COPPOLINO began as Director of Sales in 1994 and became Executive Vice
     --------------                                                             
President during September 1997.  Mr. Coppolino was a vice president for LC
Marketing from 1993 to 1994.  Mr. Coppolino has over ten years experience in the
food industry, including experience as a food broker and in product manufacture.
Mr. Coppolino graduated from the Pennsylvania State University School of
Business in 1983 with a degree in Business Logistics.

                                       18
<PAGE>
 
ITEM 10:  EXECUTIVE COMPENSATION
 
     On December 1, 1993, the Company entered into a three-year employment
agreement with Mark Beychok which provided for an annual base salary of
$150,000, the grant of an option to purchase 100,000 shares of common stock at
$5.00 per share (as adjusted for the reverse stock split effected in 1996), and
$1,000,000 of life insurance, the proceeds of which will be split equally
between the employee's beneficiary and the Company.  In December 1995, in
recognition of Mr. Beychok's deferral of his compensation during 1995 and his
assuming additional responsibilities within the Company, Mr. Beychok's
employment agreement was amended to grant him an additional 62,500 five-year
options with an exercise price of $3.00 (as adjusted for the reverse stock split
effected in 1996), a price equal to the offering price in the Company's then on-
going private placement.  In November 1995, Mr. Beychok agreed to convert his
accrued salary to stock and options on the same terms as the Company's on-going
equity bridge financing.  The Company's Board of Directors approved this
transaction in December 1995.  In such connection, Mr. Beychok converted $45,821
of accrued salary into 19,092 shares; 9,547 options with an exercise price of
$4.50; and 9,547 options with an exercise price of $6.00.  In September 1997,
Mr. Beychok entered into a new employment agreement ("Agreement") with the
Company for three years.  Under the Agreement, Mr. Beychok receives an annual
base salary of $150,000 and was granted options for 450,000 shares of stock at
an exercise price of $0.87 per share.  Such options vest 75,000 each on
September 3, 1997, March 3, 1998, September 3, 1998, March 3, 1999, September 3,
1999, and March 3, 2000.  In May 1997 the price of all options other than those
related to the private placement were repriced to $0.91.  In September 1997 Mr.
Beychok was given a successful litigation reward of $51,535 plus 100,000 shares
of common stock at fair market value of $1.00.

     In August 1996, the Company entered into an employment agreement with John
Coppolino, which was dated January 1, 1996.  Under his agreement, which is for a
one year term, with two one year renewal terms at the option of the Company, Mr.
Coppolino received an initial salary of $102,000; and, is entitled to annual
increases of 5-6% based on increases in the cost of living.  Mr. Coppolino's
employment agreement provided for the grant of 225,000 options, expiring
December 31, 2000 for the purchase of common stock at $3.00 (as adjusted for the
reverse stock split effected in October 1996).  Of these options: (i) 56,250
have vested (ii) 56,250 have lapsed and (iii) 56,250 will vest on each of
January 1, 1998 and January 1, 1999, subject to the Company meeting certain
performance criteria.  In May 1997 the Board of Directors reduced the option
price of all unlapsed options to $0.91 and removed the vesting requirement.  In
September 1997, Mr. Coppolino entered into a new employment agreement
("Agreement") with the Company for  two years.  Under the Agreement, Mr.
Coppolino receives an annual base salary of $120,000, and was granted options
for 300,000 shares of stock at an exercise price of $0.87 per share.  Such
options vest 75,000 each on September 3, 1997, March 3, 1998, September 3, 1998,
and March 3, 1999.  In September 1997, Mr. Coppolino was given a successful
litigation reward of $25,000, forgiveness of debt of $25,000, plus 25,000 shares
of common stock at $1.00, being the fair market value at the date of the award.

     In June 1997, the Company entered into a two year employment agreement with
Jack B. Spencer under which Mr. Spencer will serve the Company as its Chief
Operating Officer and Chief Financial Officer.  The agreement provides for
compensation to Mr. Spencer in the amount of $125,000 per annum and the grant of
an aggregate of 300,000 five year incentive stock options with an exercise price
of $ 0.91 per share (such being the market price of the common stock on the date
the agreement was executed).  The options vest as to 109,890 shares on September
15, 1997 and 109,890 shares on June 16, 1998, and 80,220 shares on June 16,
1999.  Mr. Spencer's employment agreement provides that if Mr. Spencer's
employment by the Company is terminated without cause after September 15, 1997,
then Mr. Spencer shall be entitled to six months severance pay.  Mr. Spencer's
employment agreement also provides that upon the occurrence of certain events
constituting a change in control of the Company, as defined therein, followed by
certain changes in Mr. Spencer's duties, Mr. Spencer shall be entitled to
receive a severance equal to one and one half times his then current annual
salary plus certain other benefits designed, in part, to offset any special
taxes that might be imposed upon Mr. Spencer in connection with such payments.

     The following table sets forth certain information with respect to the
compensation paid by the Company to Messrs. Beychok, Spencer and Coppolino (the
"named individuals") during 1997, 1996 and 1995:

                                       19
<PAGE>
 
                           SUMMARY COMPENSATION TABLE
                           --------------------------
<TABLE>
<CAPTION>
PRINCIPAL POSITION                                                    ALL OTHER ANNUAL
& NAME                          YEAR       SALARY         OTHER         COMPENSATION
<S>                           <C>         <C>         <C>             <C>
 
CEO / President
Mark Beychok                  1997         $150,000    $ 12,500  (1)        $102,467 (2)
                              1996          137,500      12,500  (3)           8,864 (4)
                              1995           40,000     110,000  (5)          14,212 (6)
COO / CFO
Jack B. Spencer               June 1997    $ 67,708    $      0             $ 68,875 (7)
                              1996                -           -                    -
                              1995                -           -                    -
 
Executive Vice President
John Coppolino                1997         $120,000    $ 20,750  (8)        $ 59,000 (9)
                              1996           87,500      14,500  (10)          9,000 (11)
                              1995                -           -                    -
</TABLE>

(1)  A portion of Mr. Beychok's salary was deferred in 1996 and paid in 1997.
(2)  Comprised of $9,584 car allowance, accrued vacation of $41,348,  plus
     $51,535 as a successful litigation reward.
(3)  A portion of Mr. Beychok's salary was deferred in 1996 and paid in 1997.
(4)  Comprised of $8,204 car allowance and $660 in medical insurance benefits.
(5)  A portion of Mr. Beychok's salary was deferred during 1994 and applied as
     an offset against a note payable in 1995.  A portion of Mr. Beychok's
     salary was deferred in 1995 and the majority converted to common stock and
     options during 1995 and early 1996.
(6)  Comprised of $10,912 car allowance and $3,300 in medical insurance
     benefits.
(7)  Comprised of $3,250 car allowance, plus 75,000 shares of common stock for
     joining the Company at $0.875 per share.
(8)  A portion of Mr. Coppolino's salary, $15,500, and car allowance, $5,250,
     were deferred in 1996 and paid in 1997.
(9)  Comprised of $9,000 car allowance and  $50,000 as a successful litigation
     reward.
(10) Mr. Coppolino deferred a portion of his salary and exercised stock options
     in 1996.
(11) Comprised of $9,000 car allowance.

STOCK OPTION PLAN

     The Company adopted its 1989 Stock Option Plan (the "1989 Plan") pursuant
to which 12,500 shares of common stock (as adjusted for the reverse stock split
effected in 1996) were reserved for issuance upon the exercise of options.
Options granted under the 1989 Plan may, at the discretion of the Board, be
incentive stock options ("ISO's") within the meaning of Section 422A of the
Internal Revenue Code of 1986, as amended ("Code"), or non-incentive stock
options.  In June 1991, the Board of Directors approved an increase in the
number of options available for grant under the 1989 Plan to 50,000 (as adjusted
for the reverse stock split effected in 1996).  No options are outstanding under
this plan.

     In 1995, the Company adopted  the 1995 Stock Option Plan (the "1995 Plan")
pursuant to which 2,000,000 shares of Common Stock (as adjusted for the reverse
stock split effected in 1996) were reserved for issuance upon the exercise of
options.  The 1995 Plan is similar to the 1989 Plan in many respects and in the
discussion below, each is referred to as a "Plan" and they are collectively
referred to as the "Plans".

                                       20
<PAGE>
 
     Under the terms of the Plans, all directors, officers and key employees of,
and consultants to, the Company and all its subsidiaries are eligible for option
grants.  The Board determines, at its discretion, which persons will receive
option grants, the number of shares subject to each option, the exercise price,
which may not be less than the par value of the shares subject to the option,
except that in the case of ISO's, the exercise price must be at least one
hundred percent (100%) of the fair market value of the optioned shares on the
date of grant, or one hundred and ten percent (110%) of such fair market value
if the optionee is the owner of more than ten percent (10%) of the total
combined voting power of all classes of voting stock of the Company (a "10%
Holder"), and the term (which may not be more than ten (10) years from the date
of grant, or five (5) years in the case of an ISO granted to a 10% holder)
thereof. The Plans permit options granted thereunder to be exercised by the
tender of shares of common stock having a fair market value equal to the
exercise price of such option.

     Options granted under the Plans may, at the discretion of the Board, be
exercisable upon the tender of cash equal in amount to the aggregate par value
of the shares covered by such options, together with a one-year note bearing
interest at the "applicable federal rate" (as defined in the Code) and providing
for a required prepayment upon any disposition of the acquired shares.
Presently, the Board does not have a stock option committee.

     During 1995 Mr. Beychok was granted an aggregate of 687,500 options under
the 1995 Plan with an exercise price of $3.00 (as adjusted for the reverse stock
split effected in October 1996).  The exercise price of these options was
reduced to $0.91 in May 1997 (the current price of these options).

     The following chart sets forth the options granted to directors and
officers in 1997:

<TABLE>
<CAPTION> 
----------------------------------------------------------------------------------------------------------------------------
                                 Number of         Percent of                                      Potential realized value 
                                securities           total                                          at assumed annual rate 
                                underlying        options/SARs       Exercise                         of appreciation for 
                                 options/          granted to         of base                             option term 
                                   SARs           employees in         price      Expiration               
Name                              granted         fiscal year        ($/Share)       Date              5%             10%
---------------------------------------------------------------------------------------------------------------------------- 
<S>                           <C>               <C>                 <C>           <C>              <C>             <C>
Mark Beychok, CEO                 100,000             2.8%            $0.875       12/31/02          111,675         140,920
----------------------------------------------------------------------------------------------------------------------------
Mark Beychok, CEO                 100,000             2.8%            $ 0.91       06/16/02          116,142         146,556
----------------------------------------------------------------------------------------------------------------------------
Mark Beychok, CEO                 450,000            12.8%            $ 0.87       09/19/02          499,664         630,515
----------------------------------------------------------------------------------------------------------------------------
Jack B. Spencer, COO/CFO          300,000             8.5%            $ 0.91       06/13/02          348,425         439,669
----------------------------------------------------------------------------------------------------------------------------
John Coppolino                    100,000             2.8%            $ 0.91       06/16/02          116,142         146,556
----------------------------------------------------------------------------------------------------------------------------
John Coppolino                    300,000             8.5%            $ 0.87       09/19/02          333,109         420,343
----------------------------------------------------------------------------------------------------------------------------
Donald Wohl                       100,000             2.8%            $0.875       12/31/02          111,675         140,920
----------------------------------------------------------------------------------------------------------------------------
Benjamin Tabatchnick               50,000             1.4%            $0.875       02/17/02           55,837          70,460
----------------------------------------------------------------------------------------------------------------------------
</TABLE>

     The following chart sets forth certain information with respect to
options/warrants outstanding at December 31, 1997 to the named individuals:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------
                                                                Number of Securities      Value of Unexercised
                                                                Underlying                In-the-Money
                                                                Unexercised               Options/SAR's at
                              Shares                            Options/SARs at FY-       FY-End
                              Acquired on         Value         End Exercisable/          Exercisable/
Name                          Exercise            Realized      Unexercisable             Unexercisable
-------------------------------------------------------------------------------------------------------------- 
<S>                           <C>                 <C>           <C>                       <C>
Mark Beychok                     -0-               $ -0-        1,088,031/300,000           $ -0- / $ -0-
--------------------------------------------------------------------------------------------------------------
Jack B. Spencer                  -0-               $ -0-        109,890/190,110             $ -0- / $ -0-
--------------------------------------------------------------------------------------------------------------
John Coppolino                   -0-               $ -0-        421,500/150,000             $ -0- / $ -0-
--------------------------------------------------------------------------------------------------------------
Donald Wohl                      -0-               $ -0-        250,000/0                   $ -0- / $ -0-
--------------------------------------------------------------------------------------------------------------
Benjamin Tabatchnick             -0-               $ -0-        150,000/0                   $ -0- / $ -0-
--------------------------------------------------------------------------------------------------------------
</TABLE>

                                       21
<PAGE>
 
ITEM 11:  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth the ownership of the common stock by each
director and by entities or persons known to the Company to own beneficially in
excess of 5% of such stock and by all officers and directors as a group, as of
March 20, 1998.  Except as otherwise indicated, all stockholders have sole
voting and investment power with respect to the shares listed as beneficially
owned by them, subject to the rights of spouses under applicable community
property laws.

<TABLE>
<CAPTION>
NAME AND ADDRESS                             NUMBER OF SHARES     PERCENTAGE OF
OF BENEFICIAL OWNER                           OF COMMON STOCK       BENEFICIAL
IDENTITY OF GROUP                           BENEFICIALLY OWNED      OWNERSHIP
-----------------------------------------   -------------------   --------------
<S>                                         <C>                   <C>
Mark Beychok (1)                               1,088,031 (2)          13.1 %
                                                                     
Donald Wohl (1)                                  250,000 (3)           3.0 %
                                                                     
Paul G. Cowen (1)                                 50,000 (4)            .6 %
                                                                     
Benjamin Tabatchnick (1)                         150,000 (4)           1.8 %
                                                                     
John Coppolino (1)                               571,500 (5)           6.9 %
                                                                     
Jack Spencer (1)                                 109,890 (6)           1.3 %
                                                                     
ALL DIRECTORS AND OFFICERS AS A GROUP.                               
(6 persons) (2)(3)(4)(5) and (6)               2,219,421              26.6 %
</TABLE>
(1)  The address of these persons is 1800 Avenue of the Stars, Suite 480, Los
     Angeles, California 90067.

(2)  Includes (i) 62,500 shares underlying a currently exercisable option with
     an exercise price of $0.91 per share, which expires on December 16, 2000;
     (ii) 15,000 shares underlying a currently exercisable option with an
     exercise price of $0.91 per share which expires on September 29, 1998;
     (iii) 100,000 shares underlying a currently exercisable option with an
     exercise price of $0.91 per share which expires on November 15, 1998; (iv)
     150,000 shares underlying the currently exercisable portion of a stock
     option, expiring December 16, 2000, which has an exercise price of $0.91
     per share; (v) 3,703 shares underlying a currently exercisable option with
     an exercise price of $4.50 per share which expires January 7, 1998;  (vi)
     3,703 shares underlying a currently exercisable option with an exercise
     price of $6.00 per share which expires July 7, 1998; (vii) 403,125 shares
     underlying the currently exercisable portion of a stock option, expiring
     December 16, 2000, which has an exercise price of $0.91 per share; (viii)
     100,000 shares underlying a currently exercisable option with an exercise
     price of $0.91 which expires on June 16, 2002; (ix) 100,000 shares
     underlying a currently exercisable option with an exercise price of $.875
     which expires on December 31, 2002; and (x) 150,000 shares underlying a
     currently exercisable option with an exercise price of $0.87 which expires
     September 1, 2002 and does not include 300,000 shares underlying options
     which are not currently exercisable with an exercise price of $0.87
     expiring September 1, 2002.

(3)  Includes (i) 150,000 shares underlying the currently exercisable portion of
     a stock option, expiring December 16, 2000, which has an exercise price of
     $0.91 per share; and (ii) 100,000 shares underlying a presently exercisable
     option with an exercise price of $0.875 which expires on December 31, 2002.
     Does not include any shares owned by ATCOLP INVESTMENT PARTNERS, a
     California limited partnership in which Mr. Wohl is the general partner.

(4)  Each of Messrs. Tabatchnick and Cowen holds a currently exercisable option
     for the purchase of 50,000 shares at $0.875 granted in 1998. Mr.
     Tabatchnick holds a currently exercisable option for an additional 50,000
     shares at $0.875 granted in 1997, and has entered into a consulting
     agreement which

                                       22
<PAGE>
 
     provides for the issuance of 50,000 shares, subject to forfeiture if
     certain performance standards relating to sales into certain markets are
     not met.

(5)  Includes (i) 1,375 shares underlying a currently exercisable option with an
     exercise price of $4.50, which expired January 7, 1998; (ii) 1,375 shares
     underlying a currently exercisable option with an exercise price of $6.00,
     which expires July 7, 1998; (iii) 168,750 shares underlying a currently
     exercisable option with an exercise price of $0.91 per share, which expires
     on December 16, 2000; (iv) 100,000 shares underlying a currently
     exercisable option with an exercise price of $0.91 which expires on June
     16, 2002;  (v) 150,000 shares underlying a currently exercisable option
     with an exercise price of $0.87 which expires on September 1, 2002; and
     does not include (vi) 150,000 shares with an exercise price of $0.87 which
     are not currently exercisable expiring September 1, 2002.

(6)  Includes 109,890 shares underlying a currently exercisable option with an
     exercise price of $0.91, expiring June 13, 2002; and does not include
     190,890 shares underlying options which are not currently exercisable with
     an exercise price of $0.91 expiring June 13, 2002.

ITEM 12:  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The Company has employment agreements with Mark Beychok, Jack Spencer and
John Coppolino, and had employment agreements, consulting agreements and
settlement agreements with certain of its former officers.  See "Management -
Executive Compensation."

     In April, 1997, the Company agreed in principle with ATCOLP INVESTMENT
PARTNERS, a California Limited Partnership (the "Lender), in which Donald Wohl,
a Director of the Company, is the general partner, for a loan in the amount of
$300,000 (the "Loan"), to fund the payment of legal fees in connection with the
Company's arbitration against The Keebler Company. See Note 16:  Litigation
Recovery, Net of Costs.  The loan was evidenced by a note which bears interest
at the lesser of 15% per annum or the highest rate allowed by law with recourse
solely to the net proceeds of the arbitration, if any.  If the Company did not
realize any net proceeds from the arbitration, the Loan would be canceled and
the Lender would receive a warrant for the purchase of 400,000 shares of the
Company's Common Stock at $.01 per share.  If the Loan was repaid through the
application of the net proceeds of the arbitration, the Lender would receive
warrants for the purchase of 200,000 shares of Common Stock at $.01 per share
and a percentage of net proceeds of the arbitration equal to 15% of the first
$1,000,000 of net proceeds, but not less than $100,000; 20% of the net proceeds
greater than $1,000,000 and less than $3,000,000; and, 25% of net proceeds above
$3,000,000.  The Loan was approved by the disinterested members of the Company's
Board of Directors, and was on terms no less favorable to the Company than were
available from non-affiliated lenders.  A second proposal, from another source,
contained terms which would have required the Company to pay $2,050,000 in fees
based on the actual award, repay the $300,000 advance, and be granted a warrant
for 1,000,000 shares of the Company's common stock at an exercise price of
$1.00.  The loan amount of $300,000 was repaid upon settlement of the litigation
in June 1997 and receipt of funds in July 1997, plus $1,236,883 in conformity
with the agreed upon formula, plus a warrant for 200,000 shares of the Company's
common stock at a $0.01 per share.  See Note 16 to the Consolidated Financial
Statements for the recording of the entire transaction.

The Company entered into a one year consulting agreement with Benjamin
Tabatchnick, a Director of the Company, on April 1, 1997.  Mr. Tabatchnick, in
exchange for 50,000 shares of the Company's common stock plus 2% of the new
sales endeavors in the school and food service business areas, agreed to assist
the Company in developing programs, formulations, marketing and sales in the
above mentioned business areas.

                                       23
<PAGE>
 
                                    PART IV

ITEM 13:         EXHIBITS LIST
                 -------------
 
(a) The following exhibits are submitted herewith:

     3.l    Certificate of Incorporation of Registrant(i)
     3.2    By-laws of Registrant(i)
     3.3    Agreement and Plan of Merger between the Registrant and
               Vitafort International Corporation, a California corporation(i)
     3.4    Certificate of Designation Series A Preferred Stock(v)
     3.5    Certificate of Designation Series B Preferred Stock(v)
     3.6    Certificate of Amendment to the Certificate of Incorporation,
               November 1991(v)
     3.7    Certificate of Designation Series C Preferred Stock(v)
     3.8    Certificate of Amendment to the Certificate of Incorporation, filed
               February 8, 1994 (vi)
     3.9    Certificate of Designation - Series D Preferred Stock(vi)
     3.10   Certificate of Amendment to the Registrant's Certificate of
               Incorporation, filed November, 1995. Incorporated by reference to
               Exhibit 4.10 filed with the Registrant's Registration Statement
               on Form S-8 filed January 25, 1996 File Number 33-300435 (the 
               "January 1996 S-8").
     3.11   Certificate of Elimination - Series A Preferred Stock.  Incorporated
               by reference to Exhibit 4.24 to the Registrant's Registration
               Statement on Form S-8 Filed May 22, 1996 File Number 333-04271
               (the "May 1996 S-8").
     3.12   Certificate of Elimination - Series D Preferred Stock.  Incorporated
               by reference to Exhibit 4.25 to the May 1996 S-8.
     3.13   Certificate of Amendment to the Registrant's Certificate of
               Incorporation, filed October 4, 1996.  Incorporated by reference
               to Exhibit 4.29 to the Registrant's Registration Statement on
               Form S-8 Filed December 12, 1996, File Number 333-17763 (the
               "December 1996 S-8").
     3.14   Amended Certificate of Designation of the Registrant's 1997 Series A
               Preferred Stock filed May 1997
     3.15   Amended Certificate of Designation of the Registrant's 1997 Series A
               Preferred Stock filed March 1998(ix)
     4.1    Specimen Stock Certificate.  Incorporated by reference to
               Exhibit 4.1 Filed with the Registrant's Annual Report on Form
               10K-SB for the Year ended December 31, 1996 (the "1996 10K-SB")
     4.2    Specimen Redeemable Common Stock Purchase Warrant(i)
     4.3    Form of Warrant Agreement(i)
     4.4    Proposed form of Underwriters Warrant Agreement(i)
     4.5
     4.6    Warrant Extension Agreement, December 18, 1992(v)
     4.7    Warrant Extension Agreement, December 18, 1994(vi)
     4.8    Warrant Extension Agreement, January 18, 1995(vi)
     4.9    Warrant Extension Agreement, April 3, 1995(vi)
     4.10   Warrant Extension Agreement, May 3, 1995.  Incorporated by reference
               to Exhibit 4.18 to the January 1996 S-8.
     4.11   Warrant Extension Agreement, June 15, 1995.  Incorporated by
               reference to Exhibit 4.19 to the January 1996 S-8.
     4.12   Warrant Extension Agreement, July 17, 1995.  Incorporated by
               reference to Exhibit 4.20 to the January 1996 S-8.
     4.13   Warrant Extension Agreement, August 16, 1995. Incorporated by
               reference to Exhibit 4.21 to the January 1996 S-8.
     4.14   Warrant Extension Agreement, December 31, 1995.  Incorporated by
               reference to Exhibit 4.21 to the January 1996 S-8.

                                       24
<PAGE>
 
     4.15  Warrant Extension Agreement, April 30, 1996.  Incorporated by
               reference to Exhibit 4.23 to the May 1996 S-8.
     4.16  Warrant Extension Agreement, July 31, 1996.  Incorporated by
               reference to Exhibit 4.26 to the December 1996 S-8.
     4.17  Warrant Extension Agreement, September 30, 1996.  Incorporated by
               reference to Exhibit 4.27 to the December 1996 S-8.
     4.18  Warrant Extension Agreement, November 11, 1996.  Incorporated by
               reference to Exhibit 4.28 to the December 1996 S-8.
     4.19  Warrant Extension Agreement, April 15, 1997.  Incorporated by
               reference to Exhibit 4.19 to the 1996 10K-SB.
     4.20  Warrant Extension Agreement, October 31, 1997.(x)
     5.1   Opinion of Frank J. Hariton, Esq. (xi)
     10.1  Loan Agreement, dated August 19, 1988, between the Registrant and
               Bishop Capital, L.P. and promissory note in the principal amount
               of $150,000(i)
     10.2  License Agreement, dated April 25, 1986, between the Registrant and
               Crystal Geyser Water Registrant and  amendment, dated January 7,
               1988(i)
     10.3  Demand Promissory Note, dated July 10, 1987, from Registrant to
               Joseph R. Daly in the principal amount of $300,000 and
               Modification, dated October 11, 1989(i)
     10.4  License Agreement, dated as of October 9, 1987, between the
               Registrant and Good Health Beverage, Inc. and amendment, dated
               November 23, 1988(i)
     10.5  Product Development Agreement, dated as of January 21, 1988, between
               the Registrant and International Multifoods, Inc.(i)
     10.6  Beverage Agreement, dated as of October 31, 1988, between  the
               Registrant and PowerBurst Corporation(i)
     10.7  Amended and Restated Agreement, dated August 2, 1989, between the
               Registrant and Vitafort Far East Co., Ltd.(i)
     10.8  Agreement, dated August 11, 1989, between Barry Saltzman, MD. and
               Yoshio Tanaka(i)
     10.9  Lease, dated June 13, 1988, between Registrant and  Shelterpoint
               Equities, Ltd. for offices at 591 Redwood Highway, Mill Valley,
               California(i)
     10.10 Agreement, dated July 25, 1989, between Nutrifish Corporation and
               Mt. Lassen Trout Farms(i)
     10.11 Salmon Rondelles Joint Development and Marketing Agreement, dated as
               of September 18, 1989, between Nutrifish Corporation and
               Norwegian Seafoods, Inc.(i)
     10.12 Whole Salmon Joint Development and Marketing Agreement, dated as of
               September 26, 1989, between Nutrifish Corporation and Norwegian
               Seafoods, Inc.(i)
     10.13 Employment Agreement, dated September 13, between the Registrant and
               Barry K. Saltzman(i)
     10.14 Employment Agreement, dated September 13, between the Registrant
               and Jeffrey Lewenthal(i)
     10.15 The Registrant's 1989 Stock Option Plan(i)
     10.16 Stock Option Agreement, dated as of July 17, 1989 between the
               Registrant and Jeffrey Lewenthal(i)
     10.17 Secrecy Agreement, dated as of May 2, 1986, between the Registrant
               and Hoffman-LaRoche, Inc.(i)
     10.18 Joint Venture Agreement, dated September 29, 1989, between the
               Registrant and Agrolife Technologies, Inc.(i)
     10.19 Consulting Agreement, dated September 13, 1989, between the
               Registrant and Randall S. Reis(i)
     10.20 Loan Agreement, dated June 15, 1989, between Union Bank and Joseph
               R. Daly(i)
     10.21 Form of Employee Confidentiality Agreement.(ii)
     10.23 Form of Escrow Agreement by and among the Registrant, Gilford
               Securities Corp., and certain stockholders of  Registrant(i)
     10.24 Promissory Note, made November 21, 1989, by Nutrifish Corporation
               and payable to Joseph R. Daly(i)

                                       25
<PAGE>
 
     10.25  Right of First Refusal Agreement, dated November 21, 1989, between
               Nutrifish Corporation and Joseph R. Daly(i)
     10.26  Production License Agreement for Nutrifish Norwegian Salmon, dated
               February 2, 1990, between Nutrifish Corporation and Norwegian
               Seafoods, Inc.(ii)
     10.27  Test Market Agreement, dated December 19, 1989, between
               International Multifoods Corporation and the Registrant.(ii)
     10.28  Amendment, dated as of December 19, 1989, to the Product
               Development Agreement between International Multifoods
               Corporation and the Registrant.(ii)
     10.29  Consulting Agreement, dated February 21, 1990, between the
               Registrant and Joseph R. Daly.(ii)
     10.30  License Agreement between the Registrant and Nulaid Foods, Inc.,
               dated April 30, 1990.(ii)
     10.31  License Agreement between the Registrant and Vitafort Latin America,
               dated July 30, 1990.(ii)
     10.32  Termination Agreement between the Registrant and Jeffrey D.
               Lewenthal, dated September 12, 1990.(ii)
     10.33  Settlement Agreement and Full Release between Nicholas J. Caputo and
               Registrant, dated October 4, 1990.(ii)
     10.34  Employment Agreement between the Registrant and Stephen D. Clow,
               dated December 1, 1990.(ii)
     10.35  Employment Agreement between the Registrant and Frank A. Corsini,
               dated January 2, 1991.(ii)
     10.36  Stock Option Agreement between the Registrant and Stephen D. Clow,
               dated January 2, 1991.(ii)
     10.37  Stock Option Agreement between the Registrant and Frank A. Corsini,
               dated January 2, 1991.(ii)
     10.38  Letter Agreement, dated February 1, 1991, amending Consulting
               Agreement between the Registrant and Joseph R. Daly.(ii)
     10.39  Letter Agreement, dated March 12, 1991, between the Registrant and
               Joseph R. Daly regarding debt reorganization.(ii)
     10.40  Consulting Agreement between Norman Kretchmer, MD., Ph.D., and the
               Registrant, dated December 20, 1988.(ii)
     10.41  Settlement Agreement between the Registrant and PowerBurst
               Corporation, dated September 23, 1991.(ii)
     10.42  Subscription Agreement between the Registrant and Societe Anonyme
               Financier Industrielle et Garantie, dated November 1, 1991.
               Incorporated by reference to Exhibit 1 to the Registrant's Report
               on Form 8-K dated November 1, 1991.
     10.43  Exclusive Distribution Agreement between Registrant and Chicago Fish
               House, dated June 13, 1991.(ii)
     10.44  Larry Lucas Settlement Agreement, dated March 25, 1993.(v)
     10.45  Frank Corsini, Separation Agreement, dated May 18, 1993.(v)
     10.46  Agreement dated October 5, 1993 between the Registrant and Second
               Nature Technologies, Inc.(iii)
     10.47  Food and Beverage Technology Agreement(iii)
     10.48  Asset Purchase and Sale Agreement, dated as of June 7, 1993 by and
               among Crystal Clear Farms, Inc., a Maine corporation, the
               Registrant and Salmon Distribution Subsidiary, Inc. a Maine
               corporation which was formerly known as Crystal Clear Farms,
               Inc.(iv)
     10.49  Temporary Operating Agreement dated June 7, 1993 by and  among
               Samuel L. Thompson & Associates, Inc., a Maine  corporation, the
               Registrant and Crystal Clear Farms, Inc. a Maine corporation (now
               known as Salmon distribution Subsidiary, Inc.)(iv)
     10.50  Non-Competition Agreement dated July 27, 1993 by and between the
               Registrant and Crystal clear farms, Inc., a Maine
               corporation.(iv)
     10.51  Employment Agreement dated as of November 29, 1993, between the
               Registrant and Steven Westlund.  Incorporated by reference to
               exhibit 99.01 to Form S-8 filed by the Registrant on March 4,
               1994 (the "1994 S-8").

                                       26
<PAGE>
 
     10.52  Stock Option Agreement dated as of November 29, 1993 between the
               Registrant and Steven Westlund. Incorporated by reference to
               exhibit 99.02 to the 1994 S-8.
     10.53  Stock Option Agreement dated as of September 15, 1993 between the
               Registrant and Steven Westlund.  Incorporated by reference to
               exhibit 99.03 to 1994 S-8.
     10.54  Employment Agreement dated as of November 29, 1993 between the
               Registrant and Peter Benz.  Incorporated by reference to exhibit
               99.04 to 1994 S-8.
     10.55  Stock Option Agreement dated as of November 29, 1993 between the
               Registrant and Peter Benz. Incorporated by reference to exhibit
               99.05 to 1994 S-8.
     10.56  Employment Agreement dated as of November 29, 1993 between the
               Registrant and Mark Beychok. Incorporated by reference to exhibit
               99.06 to the 1994 S-8.
     10.57  Stock Option Agreement dated as of November 29, 1993 between the
               Registrant and Mark Beychok. Incorporated by reference to exhibit
               99.07 to the 1994 S-8.
     10.58  Stock Option Agreement dated as of September 15, 1993 between the
               Registrant and Mark Beychok. Incorporated by reference to exhibit
               99.08 to the 1994 S-8.
     10.59  Consulting Agreement dated as of November 29, 1993 between the
               Registrant and Herman Jacobs.  Incorporated by reference to
               exhibit 99.09 to the 1994 S-8.
     10.60  Stock Option Agreement dated as of November 29, 1993 between the
               Registrant and Herman Jacobs.  Incorporated by reference to
               exhibit 99.10 to the 1994 S-8.
     10.61  Vitafort International Corporation 90 Day Operating Plan.
               Incorporated by reference to exhibit 99.21 to the 1994 S-8.
     10.62  Stock Option Agreement, dated September 15, 1993, between the
               Registrant and Stanley J. Pasarell.  Incorporated by reference to
               exhibit 99.22 to the 1994 S-8.
     10.63  Separation and Release Agreement, dated as of December 1, 1994,
               between the Registrant and Peter Benz.(vi)
     10.64  Letter Agreement, dated September 14, 1995, between the Registrant
               and Peter T. Benz.  Incorporated by reference to the like
               numbered exhibit to the Registrant's Form 10-KSB for the year
               ended December 31, 1995.
     10.65  Consulting Agreement and Mutual Release, dated as of March 1, 1995,
               between the Registrant and Steven R. Westlund.  Incorporated by
               reference to the like numbered exhibit to the Registrant's Form
               10-KSB for the year ended December 31, 1995.
     10.66  Letter Agreement, dated November 30, 1995, between the Registrant
               and Steven Westlund. Incorporated by reference to the like
               numbered exhibit to the Registrant's Form 10-KSB for the year
               ended December 31, 1995.
     10.67  The Vitafort International Corporation 1995 Stock Option Plan.
               Incorporated by reference to exhibit 99.01 to the January 1996 S-
               8.
     10.68  Form of Option granted to directors under The Vitafort International
               Corporation 1995 Stock Option Plan and schedule of grants to
               directors.  Incorporated by reference to exhibit 99.02 to the
               January 1996 S-8.
     10.69  Employee Option granted to Mark Beychok under The Vitafort
               International Corporation 1995 Stock Option Plan.  Incorporated
               by reference to exhibit 99.03 to the January 1996 S-8.
     10.70  Amendment, dated December 16, 1995, to the Employment Agreement
               between the Registrant and Mark Beychok.  Incorporated by
               reference to exhibit 99.10 to the January 1996  S-8.
     10.71  Option Agreement, dated December 16, 1995, between the Registrant
               and Mark Beychok.  Incorporated by reference to exhibit 99.11 to
               the January 1996 S-8.
     10.72  Conversion Agreement, dated as of December 30, 1995, between the
               Registrant and Mark Beychok.  Incorporated by reference to
               exhibit 99.20 to the January 1996 S-8.
     10.73  Class A Option Agreement, dated as of December 30, 1995, between the
               Registrant and Mark Beychok.  Incorporated by reference to
               exhibit 99.21 to the January 1996 S-8.
     10.74  Class B Option Agreement, dated as of December 30, 1995, between the
               Registrant and Mark Beychok.  Incorporated by reference to
               exhibit 99.22 to the January 1996 S-8.
     10.75  Conversion Agreement, dated as of March 26, 1996, between the
               Registrant and John Coppolino.  Incorporated by reference to
               Exhibit 9.18 to the May 1996 S-8.

                                       27
<PAGE>
 
     10.76  Class A Option Agreement, dated as of March 26, 1996, between the
               Registrant and John Coppolino.  Incorporated by reference to
               Exhibit 9.19 to the May 1996 S-8.
     10.77  Class B Option Agreement, dated as of March 26, 1996, between the
               Registrant and John Coppolino.  Incorporated by reference to
               Exhibit 9.20 to the May 1996 S-8.
     10.78  Employment Agreement, between the Registrant and John Coppolino.
               Incorporated by reference to Exhibit 10.78 to the 1996 Form 10-
               KSB.
     10.79  Foreclosure Purchase Agreement related to the Acquisition of assets
               of Auburn Farms, Inc.  Incorporated by reference to Exhibit 1 to
               the Registrant's Form 8-K, dated May 2, 1996.
     10.80  Loan and Security Agreement, dated August 15, 1996, between the
               Registrant and Coast Business Credit, a division of Southern
               Pacific Thrift & Loan Association.  Incorporated by reference to
               Exhibit 1 to the Registrant's Form 8-K, dated August 15, 1996.
     10.81  Agreement, dated as of July 10, 1996, between the Registrant and
               Second Nature Technologies, Inc.  Incorporated by reference to
               Exhibit 10.81 to the 1996 Form 10-KSB.
     10.82  Employment Agreement dated June 16, 1997 between Jack B. Spencer and
               the Registrant. Incorporated by reference to Exhibit 10.12 of the
               Registrant's Form SB-2 filed July 23,1997
     10.83  Agreement, dated April 1997, between the Registrant and ATCOLP
               Investment Partners, a California Limited Partnership.
               Incorporated by reference to the Registrant's Form SB-2 filed
               July 23, 1997
     10.84  Employment Agreement dated September 1997 between the Registrant and
               Mark Beychok. (x)
     10.85  Employment Agreement dated September 1997 between the Registrant and
               John Coppolino.(x)
     10.86  Subscription Agreement with Global International Sourcing, Inc., a
               Nevada corporation (xii)
     16.2   Letter on change in certifying accountant. (xi)
     22.    Subsidiaries of the Registrant:
               Global International Sourcing, Inc.
     23.2   Consent of BDO Seidman, LLP (filed herewith)
     23.3   Consent of Frank J. Hariton, Esq. (xi)

(i)    Incorporated by reference to the same numbered exhibit to the
          Registrant's Registration Statement on Form S-18, file number 33-
          31883.
(ii)   Incorporated by reference to the same numbered exhibit to the
          Registrant's December 31, 1990 and 1989 Form 10-K's.
(iii)  Incorporated by reference to exhibits 1 & 2 to the Registrant's September
          30, 1993 Form 10-QSB.
(iv)   Incorporated by reference to exhibits 1 through 4 to the Registrant's
          August 7, 1993 Form 8-K.
(v)    Incorporated by reference to the same numbered exhibit to the
          Registrant's December 31, 1993 Form 10-KSB.
(vi)   Incorporated by reference to the same numbered exhibit to the
          Registrant's December 31, 1994 Form 10-KSB.
(vii)  Incorporated by reference to the same numbered exhibit to the
          Registrant's December 31, 1995  Form 10-KSB.
(viii) Incorporated by reference to the same numbered exhibit to the
          Registrant's December 31, 1996 Form 10-KSB.
(ix)   Incorporated by reference to the same numbered exhibit to the
          Registrant's December 31, 1997 Form 10-KSB.
(x)    Incorporated by reference to the same numbered exhibit to the
          Registrant's January 14, 1998 Form SB-2/A2.
(xi)   Incorporated by reference to the same numbered exhibit to the
          Registrant's June 24, 1998 Form SB-2/A3.
(xii)  Incorporated by reference to the same numbered exhibit to the
          Registrant's July 10, 1998 Form SB-2/A4.

                                       28
<PAGE>
 
(b)  REPORTS ON FORM 8-K
     There were no reports on Form 8-K filed during the fourth quarter ended
December 31, 1997.

                                       29
<PAGE>
 
SIGNATURES

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

VITAFORT INTERNATIONAL CORPORATION


By:    /s/ Mark Beychok
   -------------------------------
       Mark Beychok, President

LOS ANGELES, California
Date:  August 13, 1998


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

<TABLE>
<CAPTION>

NAME                           TITLE(S)                  DATE
----                           --------                  ----
<S>                            <C>                       <C>
 
  /s/ Mark Beychok             Director, President and    August 13, 1998
---------------------------    Chief Executive Officer
Mark Beychok                   (Principal Executive)
                               
                                
  /s/ Jack B. Spencer         Chief Operating Officer /   August 13, 1998
---------------------------   Chief Financial Officer
Jack B. Spencer               (Principal Accounting
                              and Financial Officer)

 
  /s/ Donald Wohl             Director                    August 13, 1998
---------------------------
Donald Wohl                   
 

  /s/ Paul G. Cowen           Director                    August 13, 1998
---------------------------
Paul G. Cowen            


  /s/ Benjamin Tabatchnick    Director                    August 13, 1998
---------------------------                                              
Benjamin Tabatchnick
</TABLE> 

                                       30
<PAGE>
 
              VITAFORT INTERNATIONAL CORPORATION AND SUBSIDIARIES
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE> 
<S>                                                                  <C> 
Report of Independent Certified Public Accountants                   F-2

Consolidated Balance Sheets - December 31, 1997 and 1996             F-3

Consolidated Statements of Operations -
          Years Ended December 31, 1997 and 1996                     F-5

Consolidated Statements of Stockholders' Equity (Deficit) -
          Years Ended December 31, 1997 and 1996                     F-6

Consolidated Statements of Cash Flows -
          Years Ended December 31, 1997 and 1996                     F-7

Summary of Accounting Policies                                       F-9

Notes to Consolidated Financial Statements                           F-13
</TABLE> 

                                      F-1
<PAGE>
 
               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS


Board of Directors and Stockholders
VITAFORT INTERNATIONAL CORPORATION
AND SUBSIDIARIES
Los Angeles, California

We have audited the accompanying consolidated balance sheets of Vitafort
International Corporation and Subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, shareholders' equity
(deficit) and cash flows for each of the two 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 audit.

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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Vitafort
International Corporation and Subsidiaries at December 31, 1997 and 1996, and
the consolidated results of their operations and cash flows for each of the two
years then ended, in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has suffered recurring losses from operations,
including a loss from operations of $4,151,305 for the year ended December 31,
1997. The Company has also previously had working capital shortages. These and
other factors 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 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

 
Los Angeles, California
March 30, 1998                                                  BDO SEIDMAN, LLP

                                      F-2
<PAGE>
 
              VITAFORT INTERNATIONAL CORPORATION AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS

<TABLE>    
<CAPTION>
                                                                              DECEMBER 31,            DECEMBER 31,
                                                                                  1997                    1996
                                                                              ------------            ------------
<S>                                                                           <C>                     <C>
ASSETS (Note 6)

Current assets:
   Cash and cash equivalents                                                    $2,199,036              $  188,867
   Accounts receivable - trade, net of allowance for doubtful
      accounts of $25,743 and $79,994 as of December 31, 1997
      and 1996, respectively                                                       412,289                 230,789
   Notes receivable                                                                 10,000                  56,000
   Other receivables                                                                     -                   4,464
   Inventory (Note 3)                                                              247,611                 361,196
   Prepaid expenses and other current assets (Note 4)                              269,268                 271,731
                                                                                ----------              ----------
         Total current assets                                                    3,138,204               1,113,047
                                                                                ----------              ----------

Equipment (Note 7):
   Manufacturing equipment                                                         290,912                 290,912
   Furniture and office equipment                                                  105,160                 105,160
   Computer equipment                                                              193,571                 173,294
                                                                                ----------              ----------
                                                                                   589,643                 569,366

   Less accumulated depreciation                                                   347,493                 231,592
                                                                                ----------              ----------
         Net equipment                                                             242,150                 337,774
                                                                                ----------              ----------

Other Assets:
   Advances to Global International Sourcing (Note 15)                             193,818                       -

   Intangible assets, net of accumulated amortization of
      $73,163 and $95,561 as of December 31, 1997 and 1996, 
      respectively                                                                 338,091                 385,693
                                                                                ----------              ----------
Total Other Assets                                                                 531,909                 385,693
                                                                                ----------              ----------
                                                                                $3,912,263              $1,836,514
                                                                                ==========              ==========
</TABLE>     

   See accompanying summary of accounting policies and notes to consolidated
                             financial statements.

                                      F-3
<PAGE>
 
              VITAFORT INTERNATIONAL CORPORATION AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS


<TABLE>    
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)                                     DECEMBER 31,    DECEMBER 31,
                                                                                       1997            1996
                                                                                   ------------    ------------
<S>                                                                                <C>             <C>
Current liabilities:
  Note payable - bank (Note 6)                                                     $     60,757    $    440,022
  Notes payable - other (Note 6)                                                        283,898               -
  Accounts payable - trade                                                              909,315       1,510,982
  Accrued expenses (Note 5)                                                             342,437         341,480
  Current maturities of long-term debt (Note 7)                                          37,859          37,859
                                                                                   ------------    ------------
     Total current liabilities                                                        1,634,266       2,330,343
 
Commitments and contingencies (Notes 11 and 13)
 
Stockholders' equity (deficit) (Notes 9, 10 and 15):
  Series A, 6% Cumulative Convertible Preferred Stock,
   $0.01 par value; 750 shares authorized; 750 shares 
   issued and outstanding at December 31, 1997 and none 
   at December 31, 1996; aggregate liquidation preference 
   of $750,000 at December 31, 1997                                                           8               -
  Series B, 10% Cumulative Convertible Preferred Stock,
   $.01 par value; authorized 110,000 shares; issued
   and outstanding 1,000; aggregate liquidation 
   preference of $50,000                                                                     10              10    
  Series C, Convertible Preferred Stock, $.01 par value;
   authorized 450 shares; issued and outstanding 50 shares;
   aggregate liquidation preference of $50,000                                                1               1
 
  Common stock, $.0001 par value, authorized 30,000,000 shares;
    issued and outstanding 6,683,853 and 4,908,664                                        8,863           8,686

  Additional paid-in capital                                                         23,152,312      20,547,953
  Accumulated deficit                                                               (20,883,197)    (21,050,479)
                                                                                   ------------    ------------
     Total stockholders' equity (deficit)                                             2,277,997        (493,829)
                                                                                   ------------    ------------
                                                                                   $  3,912,263    $  1,836,514
                                                                                   ============    ============
</TABLE>     
   See accompanying summary of accounting policies and notes to consolidated
                             financial statements.

                                      F-4
<PAGE>
 
              VITAFORT INTERNATIONAL CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>    
<CAPTION>
                                                                           DECEMBER 31,
                                                                       1997           1996
                                                                   -----------     -----------
<S>                                                                <C>             <C>

Net revenues                                                       $ 1,995,317     $ 5,285,149

Cost of sales                                                        1,896,410       6,870,120
                                                                   -----------     -----------
              Gross profit (loss)                                       98,907      (1,584,971)
                                                                   -----------     -----------

Operating expenses:
          Research and development                                     337,806         737,044
          Sales and marketing                                        1,239,460       3,029,480
          General and administrative                                 2,672,946       2,721,321
                                                                   -----------     -----------

              Total operating expenses                               4,250,212       6,487,845
                                                                   -----------     -----------

              Loss from operations                                  (4,151,305)     (8,072,816)

Interest income                                                         78,070          49,319
Interest expense                                                      (214,690)        (50,509)
Other income (expense)                                                  15,210         (45,650)
Litigation recovery, net of costs (Note 16)                          4,748,946               -
                                                                   -----------     -----------
            Income (loss) before income taxes                          476,231      (8,119,656)

State income taxes (Note 8)                                              3,200           3,159
                                                                   -----------     -----------

              Net Income (loss)                                        473,031      (8,122,815)

Deemed dividends to preferred shareholders                             305,749               -
                                                                   -----------     -----------

Net income (loss) allocable to common shareholders                 $   167,282     $(8,122,815)
                                                                   ===========     ===========

Basic net income (loss) per common share                           $       .03     $     (1.58)
                                                                   ===========     ===========

Diluted net income (loss) per share                                $       .03     $     (1.58)
                                                                   ===========     ===========

Basic weighted average shares of common stock                        5,831,404       5,133,665
                                                                   ===========     ===========

Diluted weighted average shares of common stock                      6,343,397       5,133,665
                                                                   ===========     ===========
</TABLE>     

   See accompanying summary of accounting policies and notes to consolidated
                             financial statements.

                                      F-5
<PAGE>
 
              VITAFORT INTERNATIONAL CORPORATION AND SUBSIDIARIES
           
           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                    YEARS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>    
<CAPTION> 
                                                       Series A              Series B
                                                      Cumulative            Cumulative             Series C
                                                      Convertible           Convertible           Convertible  
                                                    Preferred Stock       Preferred Stock       Preferred Stock
                                                    ---------------       ---------------       ---------------     Subscribed
                                                   Shares     Amount     Shares     Amount     Shares     Amount       Stock
                                                   ------     ------     ------     ------     ------     ------    -----------
<S>                                                <C>        <C>        <C>        <C>        <C>        <C>       <C> 
Balance, January 1, 1996                                -         $0      1,500        $15         50         $1    $ 3,418,196

Common stock issued from subscriptions                  -          -          -          -                     -     (3,418,196)
Common stock issued in private placement,
   net of commissions and offering costs                -          -          -          -                     -              -
Common stock issued in private placement                -          -          -          -                     -              -
Conversion of preferred stock to 
   common stock                                         -          -       (500)        (5)                    -              -
Common stock--consulting                                -          -          -          -                     -              -
Exercise of stock options                               -          -          -          -                     -              -
Net loss                                                -          -          -          -                     -              -
                                                   ------     ------     ------     ------     ------     ------    -----------
Balance, December 31, 1996                              -         $0      1,000        $10         50         $1              -

Common stock issued in private placement,
   net of commissions
Common stock issued as settlement of
   contract dispute
Series A Preferred issued in connection 
   with private placement, net of
   commissions and expenses                           750          8
Payment of accounts payable obligations
   with stock
Exercise of warrants
Exercise of stock options
Preferred stock dividends
Net income
                                                   ------     ------     ------     ------     ------     ------    -----------
Balance, December 31, 1997                            750         $8      1,000        $10         50         $1              -
                                                   ======     ======     ======     ======     ======     ======    ===========

</TABLE>     

<TABLE> 
<CAPTION> 
                                                                           Additional
                                                       Common Stock          Paid-In         Accumulated
                                                    Shares       Amount      Capital           Deficit             Total
                                                   ---------     ------    -----------      ------------        -----------
<S>                                                <C>           <C>       <C>              <C>                 <C>
Balance, January 1, 1996                           1,911,185     $3,823    $11,382,120      $(12,927,664)       $ 1,876,491

Common stock issued from subscriptions             1,129,474      1,992      3,116,204                 -           (300,000)
Common stock issued in private placement,
   net of commissions and offering costs           1,020,000      2,040      3,497,801                 -          3,499,841
Common stock issued in private placement              80,000          8        399,992                 -            400,000
Conversion of preferred stock to 
   common stock                                        2,500          5         59,694                 -             59,694
Common stock--consulting                             579,957        447      1,377,197                 -          1,377,644
Exercise of stock options                            185,548        371        714,945                 -            715,316
Net loss                                                   -          -              -        (8,122,815)        (8,122,815)
                                                   ---------     ------    -----------      ------------        -----------
Balance, December 31, 1996                         4,908,664     $8,686    $20,547,953      $(21,050,479)       $  (493,829)

Common stock issued in private placement,
   net of commissions                                500,000         50        449,950                              450,000
Common stock issued as settlement of
   contract dispute                                   70,000          7         78,743                               78,750
Series A Preferred issued in connection 
   with private placement, net of
   commissions and expenses                                                    672,992                              673,000
Payment of accounts payable obligations
   with stock                                        662,589         66        638,297                              638,363
Exercise of warrants                                 200,000         20        139,980                              140,000
Exercise of stock options                            342,600         34        318,648                              318,682
Preferred stock dividends                                                      305,749          (305,749)                 -
Net income                                                                                       473,031            473,031
                                                   ---------     ------    -----------      ------------        -----------
Balance, December 31, 1997                         6,683,853     $8,863    $23,152,312      $(20,883,197)       $ 2,277,997
                                                   =========     ======    ===========      ============        ===========
</TABLE> 
   
    See accompanying summary of accounting policies and notes to financial 
                                  statements.

                                      F-6
<PAGE>
 
              VITAFORT INTERNATIONAL CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>     
<CAPTION>
                                                                                                   DECEMBER 31,
Increase (Decrease) in Cash and Cash Equivalents                                             1997            1996
                                                                                          -----------     -----------
<S>                                                                                       <C>             <C>
Cash flows from operating activities:
   Net Income (Loss)                                                                      $   473,031     $(8,122,815)
   Adjustments to reconcile net loss to net cash and cash equivalents 
   provided by (used in) operating activities:
      Depreciation and amortization                                                           163,503         119,459
      Allowance for doubtful accounts                                                         (54,251)              -
      Warrants issued for services (Note 16)                                                  138,000               -
      Operating expenses paid with common stock                                                     -       1,377,644
      Change in operating assets and liabilities:
         (Increase) decrease in:
             Accounts receivable - trade, net                                                (127,249)       (191,366)
             Inventory                                                                        113,585         319,680
             Other                                                                                  -         (55,760)
             Prepaid and other assets                                                           2,463          93,386
             Notes receivable                                                                  46,000         (36,222)
             Other receivables                                                                  4,464         143,510
         Increase (decrease) in:
             Accounts payable and accrued expenses                                          1,031,347         979,022
             Other current liabilities                                                              -        (150,000)
                                                                                          -----------     -----------
                Cash and cash equivalents provided by (used in) operating activities        1,790,893      (5,523,462)
                                                                                          -----------     -----------
 
Cash flows from investing activities:
   Purchase of equipment                                                                      (20,277)       (172,896)
   Advances to Global International                                                          (193,818)              -
                                                                                          -----------     -----------
 
                Cash and cash equivalents used in investing activities                       (214,095)       (172,896)
                                                                                          -----------     -----------
Cash flows from financing activities:
   Proceeds from line of credit                                                               838,426         599,715
   Repayment of line of credit                                                             (1,217,691)       ( 75,000)
   Proceeds from notes payable                                                                307,871               -    
   Repayment of notes payable                                                                (625,695)       (171,053)
   Proceeds from issuance of stock                                                          1,123,000       3,499,841
   Exercise of stock options and warrants                                                       7,460         715,316
                                                                                          -----------     -----------
 
                Cash and cash equivalents provided by financing activities                    433,371       4,568,819
                                                                                          -----------     -----------
 
                Increase (decrease) in cash and cash equivalents                            2,010,169      (1,127,539)
 
Cash and cash equivalents at beginning of year                                                188,867       1,316,406
                                                                                          -----------     -----------
 
Cash and cash equivalents at end of year                                                  $ 2,199,036     $   188,867
                                                                                          ===========     ===========
</TABLE>       

                                      F-7
<PAGE>
 
              VITAFORT INTERNATIONAL CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>      
<CAPTION> 
                                                                                                   DECEMBER 31,
                                                                                                1997           1996
                                                                                                ----           ----
<S>                                                                                       <C>             <C> 
Supplemental disclosures of cash flow information:
   Cash paid during the year for:
      Interest                                                                            $  215,126      $  50,509
      Income taxes                                                                             3,200          2,854
 
Supplemental disclosure of non-cash operating, investing and 
   financing activities:
   Issuance of common stock for:
      Conversion of accounts payable to equity                                            $1,030,335      $       -
      Conversion of accrued interest                                                               -         59,694
      Conversion of preferred stock to common stock                                                -         14,999
      Payment of consulting contract                                                               -       (300,000)
   Conversion of accounts payable to notes payable                                           601,723              -
-------------------------------------------------------------------------------------------------------------------
</TABLE>       

     See accompanying summary of accounting policies and notes to financial
                                  statements.

                                      F-8
<PAGE>
 
              VITAFORT INTERNATIONAL CORPORATION AND SUBSIDIARIES
                         SUMMARY OF ACCOUNTING POLICIES



BASIS OF CONSOLIDATION

          The accompanying consolidated financial statements of Vitafort
International Corporation (the "Company") include the accounts of the Company
and its subsidiaries:  Nutrifish Corporation (90.5% owned as of December 31,
1997 and 1996); Hollywood Partners, Inc. (formerly Vitafort Distributors, Inc.);
and Crystal Clear Farms.  All subsidiaries were inactive in 1997.  All material
intercompany accounts and transactions have been eliminated.


USE OF ESTIMATES

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


RECLASSIFICATION AND PRESENTATION

          Certain 1996 amounts have been reclassified to conform to the 1997
presentation.


CASH AND CASH EQUIVALENTS

          Cash and cash equivalents are investments with original maturities of
three months or less and short-term, highly liquid investments that are both
readily convertible to known amounts of cash and are so near their maturity that
they present insignificant risk of changes in value because of changes in
interest rates.

   
INVENTORY     
   
          Inventory consists of merchandise available for sale, packaging
supplies and raw materials, and are stated at the lower of cost (first-in,
first-out) or market.     


EQUIPMENT

          Equipment is comprised of manufacturing equipment, furniture, office
equipment and computer equipment and is recorded at cost.  Depreciation is
computed on a straight-line basis over the estimated useful life not in excess
of five years.


PREPAID AND OTHER CURRENT ASSETS

          Prepaid and other current assets, which include product introduction
expenses, are recorded at cost and amortized over the economic life thereof, but
not in excess of twelve months.

                                      F-9
<PAGE>
 
ADVERTISING

          General costs are expenses as incurred or prepaid until the
advertisement is published, at which time the related costs are expensed.


OTHER INTANGIBLE ASSETS

          Intangible assets are composed of acquisition costs of Auburn Farms
and Natures Warehouse trademarks and debt issuance costs and are recorded at
cost.  The acquisition costs associated with trademarks are being amortized on a
straight-line basis over twenty years.  All other intangible assets are being
amortized on a straight-line basis over periods not exceeding five years.

          These costs are reviewed by management periodically and written down
to the value of the future benefit expected to be derived.


REVENUE

          Product sales and related costs are recognized when the Company's
products are shipped from the commercial warehouse used by the Company or the
contract manufacturer to the customer.


IMPAIRMENT OF LONG-LIVED ASSETS

          Statement of Financial Accounting Standards No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
("SFAS No. 121") establishes guidelines regarding when impairment losses on
long-lived assets, which include plant and equipment and certain identifiable
intangible assets, should be recognized and how impairment losses should be
measured.  The Company periodically reviews such assets for possible impairment
and expected losses, if any, are recorded currently.


INCOME (LOSS) PER SHARE

          Statement of Financial Accounting Standards No. 128, "Earnings per
Share" ("SFAS 128") issued by the FASB is effective for financial statements
with fiscal years and interim periods ending after December 15, 1997. SFAS 128
provides for the calculation of Basic and Diluted earnings per share. Basic
earnings per share includes no dilution and is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding for the period.  Diluted earnings per share reflects the potential
dilution of securities that could share in the earnings of an entity, such as
stock options, warrants or convertible debentures.  The Company adopted SFAS 128
on December 15, 1997 and it had no effect on income (loss) per share.

                                      F-10
<PAGE>
 
INCOME TAXES

          Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases.  Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled.  A valuation allowance is provided when management
cannot determine whether or not it is more likely that the net deferred tax
asset will be realized.  The effect on deferred tax assets and liabilities of a
change in the rates is recognized in income in the period that includes the
enactment date.


STATEMENT OF CASH FLOWS

          For purposes of the statements of cash flows, the Company considers
cash and cash equivalents to include cash on hand and cash equivalents with
original maturities of three months or less.


FAIR VALUE OF FINANCIAL INSTRUMENTS

          The fair value of the Company's debt instruments is based on the
quoted market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities.


STOCK COMPENSATION

          As of January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123").  SFAS 123 allows an entity to elect to continue to measure compensation
cost under Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" (APB No. 25), but requires pro forma disclosures of net
earnings and earnings per share as if the fair-valued-based method of accounting
had been applied.  In accordance with FASB 123, the Company elected to continue
to measure compensation cost under APB No. 25, and comply with the pro forma
disclosure requirements.


DISCLOSURE OF INFORMATION ABOUT CAPITAL STRUCTURE

          Statement of Financial Accounting Standard No. 129, "Disclosure of
Information about Capital Structure," ("SFAS 129") issued by the FASB is
effective for financial statements with fiscal years ending after December 15,
1997.  The new standard reinstates various securities disclosure requirements
previously in effect under Accounting Principles Board Opinion No. 15, which has
been superceded by SFAS No. 128.  The Company adopted SFAS No. 129 on December
15, 1997 and it did not have any effect on its financial position or results of
operations.


REPORTING COMPREHENSIVE INCOME

          Statement of Financial Accounting Standard No. 130, "Reporting
Comprehensive Income," ("SFAS 130") issued by the FASB is effective for
financial statements with fiscal years ending after December 15, 1997.  Earlier
application is permitted.  SFAS 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general-
purpose financial statements.  The Company does not expect adoption of SFAS 130
to have any effect on its financial position or results of operations.

                                      F-11
<PAGE>
 
DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION

          Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("SFAS 131") issued by
the FASB is effective for financial statements with fiscal years ending after
December 15, 1997. SFAS 131 requires that public companies report certain
information about operating segments, products, services and geographical areas
in which they operate and their major customers.  The Company does not expect
adoption of SFAS 131 to have any effect on its financial position or results of
operations; however, disclosures with respect to the aforementioned items may be
increased.

                                      F-12
<PAGE>
 
              VITAFORT INTERNATIONAL CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 - THE COMPANY

          Vitafort International Corporation (the "Company") was incorporated on
September 28, 1989 in the State of Delaware to succeed to the business of a
California corporation of the same name which was organized on February 7, 1986.
The Company is presently engaged in formulating and marketing fat-free foods.


NOTE 2 - LIQUIDITY AND GOING CONCERN

          For the past several years, the Company has suffered recurring losses
from operations, including $4,151,305 for the year ended December 31, 1997.
Although the Company has raised additional capital after year-end 1997 (see Note
15), it has not generated sufficient revenue-producing activity to sustain its
operations.  Accordingly, there is substantial doubt regarding the Company's
ability to continue as a going concern.  The Company is attempting to raise
additional capital to meet future financial obligations, but may not be able to
do so.  Should the Company not be able to raise additional capital, it may have
to severely curtail operations.

          The Company has reduced its cost of sales by centralizing the
warehousing of its products in a single location and negotiated lower rates with
existing manufacturers or by selecting another competent less expensive
producer.  In addition, the Company increased prices on the majority of its
products effective August 1 of this year and changed its terms of sale to F.O.B.
the Company's warehouse.  The Company also eliminated the cash discount for
prompt payment since most customers were taking the discount beyond the terms.
The Company has also introduced reformulated products at the end of 1997 and
plans to introduce new products in 1998.  These steps, coupled with improvements
in subcontract manufacturing quality control and quality assurance, monitoring
improvements in Company internal control and communications with respect to
product returns and deductions, should improve the Company's prospects to
achieve profitability.


NOTE 3 - INVENTORY
   
          Inventory is stated at the lower of cost (first in, first out) or
market.  Market-based valuations are based upon estimates and assumptions, and
are generally limited to slow moving product offerings.  Inventory consists of
the following:     

<TABLE>
<CAPTION>
                                               December 31,
                                             1997        1996
                                           --------    --------
          <S>                              <C>         <C>
 
          Finished goods                   $ 30,188    $168,709
          Packaging and raw material        217,423     192,487
                                           --------    --------
                                           $247,611    $361,196
                                           ========    ========
</TABLE>

                                      F-13
<PAGE>
 
NOTE 4 - PREPAID AND OTHER CURRENT ASSETS

          Prepaid expenses and other current assets, as of December 31, 1997 and
1996, are detailed as follows:
<TABLE>
<CAPTION>
                                                     December 31,
                                                 1997           1996
                                               --------       --------
 <S>                                           <C>            <C>
 Deposits                                      $  1,100       $ 10,000
 Product introduction costs                      10,711        177,865
 Insurance                                       36,377         14,897
 Consulting                                     108,080              -
 Other prepaids                                 113,000         68,969
                                               --------       --------
  Total prepaid and other current assets       $269,268       $271,731
                                               ========       ========
</TABLE> 
 
NOTE 5 - ACCRUED EXPENSES
 
Accrued expenses consist of the following:

<TABLE> 
<CAPTION> 
                                                     December 31,
                                                 1997           1996
                                               --------       --------
 <S>                                           <C>            <C> 
 Accrued compensation                          $156,764       $ 90,753   
 Accrued interest payable                             -            436   
 Accrued legal fees                              40,112        120,811   
 Accrued consulting fees                          4,919         13,500   
 Other accrued expenses                         140,642        115,980
                                               --------       --------
 Total accrued expenses                        $342,437       $341,480
                                               ========       ========
</TABLE>

NOTE 6 - NOTES PAYABLE

          BANK
          ----
          In August 1996, the Company entered into a revolving credit facility
with a financing institution that provides a credit line of up to $4,000,000
subject to certain covenants.  Advances made to the Company under the facility
are based on a certain percentage of eligible accounts receivable, as defined,
and a certain percentage of eligible inventory, as defined.  The amount of
inventory advances under the facility cannot exceed $500,000.  The initial term
of the facility ends August 1998, with automatic renewals thereafter for one
year periods.  Advances under the facility bear an interest rate at the Bank of
America NT prime plus 3%, and are secured by a first priority lien on all of the
Company's assets.  Minimum interest charges are currently $15,000 per month.
The Company paid $40,000 to the institution upon execution of the agreement and
$40,000 to a facilitator in connection with the placement of the loan.  The
Company was in violation of certain covenants with respect to working capital
and tangible net worth requirements during the first half of 1997.  Upon receipt
of the Keebler award, the Company was no longer in violation of any of the
covenants.  No assurance can be given that the Company will not be in violation
of such covenants in the future.

          OTHER
          -----
          Notes payable - other, represents the current balance of the original
conversion of $601,723 of trade accounts payable.  These notes are unsecured and
payable in various monthly installments with a maximum 

                                      F-14
<PAGE>
 
repayment of approximately $64,000 in January 1998 (including interest at
various rates). The notes have various maturity dates through December 1998.

NOTE 7 - LONG-TERM DEBT
    
          The Company's long-term debt, which approximates fair value, as of
December 31, 1997 and 1996 consists of a 14% note payable in the amount of
$37,859, due in monthly installments of $4,033, secured by certain of the
Company's equipment. The entire amount is classified as a current liability.
Under the Debt Subordination Agreement between Coast Business Credit and the
long-term debt holders, payments on this note ceased until the loan with Coast
is fully paid.       


NOTE 8 - INCOME TAXES

          As the Company has incurred significant operating losses since
inception, its current tax provision has been limited to minimum California tax
payments.

          The difference between the Federal income tax rate and the effective
income tax rate on net income (loss) from continuing operations is as follows:

<TABLE>    
<CAPTION>
                                                 1997                     1996
                                                 ----                     ----
<S>                                       <C>      <C>            <C>      <C>
Estimated Federal income taxes             34.0%   $ 162,000      (34.0)%  $(2,760,000)
State income taxes, net of Federal
 income tax benefit                         6.0       28,000       (6.0)      (498,000)
Change in valuation allowance             (44.0)    (206,800)      39.1      3,172,000
Other, net                                  4.0       20,000        0.9         89,159
                                          -----    ---------      -----    -----------
                                            -  %   $   3,200         -  %  $     3,159
                                          =====    =========      =====    ===========
</TABLE>      
          The tax effects of temporary differences that give rise to deferred
tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                              1997          1996
                                                          -----------    -----------
<S>                                                       <C>            <C>
Deferred income tax assets:
   Net operating loss carryforwards                       $ 7,230,000    $ 7,259,000
   Tax credit carryforwards                                    70,000         70,000
   Allowance for bad debts                                     70,000         32,000
   Inventory reserves                                         200,000        473,000
   Other                                                       55,000         26,000
                                                          -----------    -----------
      Total gross deferred income tax assets                7,625,000      7,860,000
Deferred income tax liabilities                               (20,000)       (24,000)
                                                          -----------    -----------
                                                            7,605,000      7,836,000
Less valuation allowance                                   (7,605,000)    (7,836,000)
                                                          -----------    -----------
      Net deferred income taxes                           $         -    $         -
                                                          ===========    ===========
</TABLE>
    
          Net deferred tax assets of approximately $7,605,000 resulting from net
operating losses, tax credits and other temporary differences have been offset
by a valuation allowance since management does not believe that it is more
likely than not that such assets will be realized.       

                                      F-15
<PAGE>
 
          As of December 31, 1997, the Company had unused Federal and California
net operating loss carryforwards of approximately  $19,600,000 and $6,400,000,
respectively, available to offset against future Federal taxable income and
future California taxable income.  In addition, the Company had unused research
and experimental credits of $44,000 and $26,000 for Federal and California state
purposes.  The unused net operating loss and credit carryforwards expire in
various amounts through the year 2012.  In contrast to Federal net operating
losses, only 50% of the California net operating losses incurred subsequent to
December 31, 1986 may be carried forward.  The California net operating losses
will expire in various amounts through the year 2002.

          Due to restrictions imposed by the Internal Revenue Code regarding
substantial changes in ownership of companies with loss carryforwards, the
utilization of the above-mentioned net operating losses may be limited as a
result of changes in stock ownership.  The annual utilization of these losses is
limited to an amount equal to the estimated fair value (for income tax purposes)
of the Company at the point of stock ownership change, multiplied by the long-
term tax-exempt rate then in effect.  The annual limitation has not been
quantified at this time.


NOTE 9 - STOCKHOLDERS' EQUITY

CONVERTIBLE PREFERRED STOCK

          The Company entered into a subscription agreement in the amount of
$500,000 in April 1997 with an unrelated investor for 500 shares of 1997 Series
A Preferred Stock.  The preferred stock has a cumulative dividend rate of 6%
with no voting rights.  The conversion price is the lower of $1.25 per share or
a 30% discount to the market price at the time of conversion.  The preferred
stock is convertible at any time.  For accounting purposes, the original issue
discount of $214,286 is being treated as a deemed dividend.  The facilitator
received a 10% fee from the proceeds, as well as warrants to purchase 35,000
shares of common stock at an exercise price of $1.00 per share.  Cumulative
unpaid dividends amounted to $22,500 at December 31, 1997.
   
          The Company entered into a subscription agreement in the amount of
$250,000  in May 1997 with another investor for 250 shares of 1997 Series A
Preferred Stock.  The series has a cumulative dividend rate of 6%, no voting
rights, and is convertible at any time at the lower of $1.25 or a 30% discount
to the market price at the time of conversion.  For accounting purposes, the
original issue discount of $91,463 is being treated as a deemed dividend.  The
facilitator received a 10% fee from the proceeds and a warrant to purchase
17,500 shares of common stock at an exercise price of $1.00 per share.
Cumulative unpaid dividends amounted to $10,000 at December 31, 1997.     

          Each share of Series B 10% Cumulative Convertible Preferred stock is
convertible into 1.667 shares of common stock, and cumulative convertible
dividends of 10% per annum are payable annually commencing October 1992.  The
Series B 10% Cumulative Preferred stock has a liquidation preference of $50 per
share plus all accrued and unpaid dividends.  It is subject to optional
redemption by the Company at any time at $50 per share plus accrued and unpaid
dividends.  Cumulative unpaid dividends amounted to $25,000 and $20,000 at
December 31, 1997 and 1996, respectively.

          During 1996, the Company offered the holders of Series B Cumulated
Convertible Preferred Stock more favorable exchange rates to encourage
conversion of the shares to common stock.  As a result, in August 1996, the
holder of 500 shares of Series B Cumulative Convertible Preferred Stock
exchanged his shares and accumulated accrued and unpaid dividends for 2,500
shares of common stock.  The value of the inducement to the Series B holders was
not material.

                                      F-16
<PAGE>
 
          Each share of Series C Convertible Preferred Stock is convertible into
100 shares of common stock and 100 warrants. Series C Convertible Preferred
Stock does not carry any dividend rights. The warrants expired in June 1994.
Additionally, the Series C Convertible Stock has a dilutive conversion factor.
The Series C Convertible Preferred Stock has a liquidation preference of $1,000
per share after Series B Cumulative Convertible Preferred Stock, and to holders
of common stock.

          The shares of Series A, Series B and Series C Preferred stock are not
currently registered under the Securities Exchange Act of 1934.


COMMON STOCK

          The Company entered into a subscription agreement in February 1997
with an investor who purchased 500,000 shares of common stock at $1.00 per
share.  At funding, a 10% fee was paid to a facilitator and warrants were given
to that same facilitator to purchase 125,000 shares of common stock at a price
of $1.375 per share which was later reduced to $1.00.

          The Company issued 70,000 shares at a value of $1.125 per share as
settlement for a contract dispute.
    
          The Company issued 126,000 shares of common stock in March 1997 and 
350,589 shares of common stock in August 1997 under an S-8 filing as payment for
services rendered by various consultants and employees.  The shares of common 
stock were valued at the amount received by the consultants and employees upon 
sale of these shares.  As a result, the Company reduced the amount owed to these
consultants and employees by $461,782.       
    
          In August 1997, the Company issued 100,000 shares of common stock at
$.93 per share to a professional firm for previous services rendered.       
    
          The Company issued 61,000 shares of common stock at $.96 per share in 
September 1997 under an S-8 filing and 25,000 shares of restricted common stock 
at $1.00 per share in November 1997 as payment for $83,581 of services rendered 
by various employees and consultants.       

          The Company issued 20,000 shares at a value of $1.125 per share and
10,000 shares at a value of $1.06 per share upon the exercise of options granted
to a former employee as compensation for consulting services and past unpaid
accrued vacation.
    
          The Company issued 176,600 shares at $.875 per share and 6,000 shares
at $.91 per share upon the exercise of options granted under the Non-Incentive
Stock Option Plan. Non-officers of the Company paid the exercise price of such
options through the application of accrued payroll and other various expenses.
     
          During 1997, a consultant exercised options for 60,000 shares of 
common stock at $.93 per share and 40,000 shares of common stock at $1.00 per 
share as payment for services rendered.  No cash was received by the Company.  
     

                                      F-17
<PAGE>
 
    
          In July 1997, another consultant exercised options for 30,000 shares
of common stock at $1.00 per share as payment for services rendered. No cash was
received by the Company.       

          In January 1996, the Company completed its private placement offerings
of common stock. Total shares issued in these offerings were 1,121,667 at prices
of $3.00 to $6.00.  Total proceeds to the Company were $3,028,500, net of
expenses of $336,500.  At December 31, 1995, $1,530,249 was received
representing subscriptions for 635,000 common shares under this private
placement offering.

          In March 1996, the Company completed a private placement of 250,000
common shares receiving $1,350,000, net of expenses of $150,000.

          In April 1996, the Company completed a private placement of 283,333
common shares receiving $651,590, net of expenses of $118,410.
          
          During 1996 the Company issued 579,957 shares of common stock valued
at $1,377,644 to attorneys, consultants and employees as payment for services.

          During September 1995, pursuant to a contractual agreement, the
Company issued 100,000 shares of its common stock to a public
relations/financial consulting firm and authorized an additional 100,000 shares
to be issued to the consulting firm upon performance under the contract for
$600,000 of prepaid consulting fees.  In 1996, this contract was terminated.  As
a result, the final 100,000 shares representing $300,000 were never issued and
were eliminated from subscribed stock.

          On October 4, 1996, a 1 for 20 reverse stock split was effected.  All
share amounts in this report have been retroactively adjusted to reflect this
stock split.


NOTE 10 - STOCK OPTIONS

          The 1989 Stock Option Plan, as amended (the "Plan") reserved 50,000
shares of common stock (as adjusted for the reverse split effected in 1996) to
grant either nonqualified or incentive stock options. All directors, officers,
key employees and consultants to the Company or its subsidiaries are eligible
under the terms of the Plan. Such options may not be granted at less than 100%
of the fair market value at the date of grant (110% for an owner of 10% or more
of the outstanding stock). Upon termination of service, the options, which an
individual was entitled to exercise at the date of termination may be exercised
at any time within six months of such termination. If an employee is terminated
with cause, the options are canceled upon termination. As of December 31, 1997,
no options are outstanding under this plan.

          In 1995, the Company adopted the 1995 Stock Option Plan (the "1995
Plan") pursuant to which 2,000,000 shares of Common Stock (as adjusted for the
reverse stock split effected in 1996) were reserved for issuance upon the
exercise of options.  The 1995 Plan is similar to the 1989 Plan in many respects
and in the discussion below, each is referred to as a "Plan" and they are
collectively referred to as the "Plans".

          The Company has also granted stock options outside the Plans to other
individuals, such as employees and consultants,  in consideration for services
performed.  The options were granted at fair market  value and at various terms
and vesting periods.  The following table on the next page summarizes all option
activity for the years ended December 31, 1997 and 1996:

                                      F-18
<PAGE>
 
<TABLE>
<CAPTION>
                                                  Number of Common Stock Options       Weighted
                                                     1995 Stock    Other Stock          Average
                                                    Option Plan      Options             Price
                                                    -----------    -----------         --------
<S>                                                 <C>            <C>                 <C>
Outstanding as of January 1, 1996                    2,000,000        794,222            $2.73
Granted                                                 22,500         79,750             1.11
Exercised                                              (53,725)      (120,490)            1.47
Canceled                                              (423,775)       (42,250)            3.78
                                                     ---------      ---------            -----
 
Outstanding as of December 31, 1996                  1,545,000        711,232             3.54
Granted                                                185,600      3,343,500             0.93
Exercised                                             (182,600)      (160,000)            1.24
Canceled                                              (316,292)        (8,750)            2.02
                                                     ---------      ---------            -----
 
Outstanding as of December 31, 1997                  1,231,708      3,885,982            $1.55
                                                     =========      =========            =====
 
Exercisable as of December 31, 1997                  1,131,708      3,095,872            $1.69
                                                     =========      =========            =====
</TABLE>

          FASB Statement 123, "Accounting for Stock-Based Compensation,"
requires the Company to provide pro forma information regarding net income and
earnings per share as if compensation cost for the Company's stock option plans
had been determined in accordance with the fair value based method prescribed in
FASB Statement 123.  The Company estimates the fair value of each stock option,
using the Black-Scholes method, at the weighted-average assumption used for
grants in fiscal 1997 and 1996 dividend yield of zero percent; expected
volatility of 28 percent and 36 percent; risk-free interest rate of seven
percent; and expected lives of 5.1 and 5.0 years, respectively.

          The weighted average fair value of options granted during 1997 and
1996 was $.39 and $.38, respectively.

          Under the accounting provisions of FASB Statement 123, the Company's
net income (loss) and income (loss) per share for 1997 and 1996 would have been
reduced to the pro forma amounts indicated below:

<TABLE>    
<CAPTION>
Net Income (Loss)                      1997          1996
-------------------------------------------------------------
<S>                                  <C>         <C>
      As reported                    $167,282    ($8,122,815)
      Pro forma                      $(68,466)   ($8,122,815)

Basic income (loss) per share
-----------------------------

      As reported                    $   0.03       ($  1.58)
      Pro forma                      $  (0.01)      ($  1.58)

Diluted income (loss) per share
-------------------------------

      As reported                    $   0.03       ($  1.58)
      Pro forma                      $  (0.01)      ($  1.58)
</TABLE>     

                                      F-19
<PAGE>
 
          Due to the fact that the Company's stock option programs vest over
many years and additionally awards may be made each year, the above pro forma
numbers are not indicative of the financial impact had the disclosure provisions
of FASB 123 been applicable to all years of previous grants.  The numbers above
do not include the effect of options granted prior to 1995 that vested in 1996
and 1997.

          The following table summarizes information about stock options
outstanding at December 31, 1997:

<TABLE>
<CAPTION>
                                         
                                         Options                                Options Exercisable
                                       Outstanding                              -------------------
                         Number      Weighted-Average                        Number           Weighted
     Range of          Outstanding      Remaining       Weighted-Average   Exercisable         Average
Exercisable Prices     At 12/31/97   Contractual Life    Exercise Price    at 12/31/97     Exercise Price
------------------     -----------   ----------------    --------------    -----------     --------------
<S>                    <C>           <C>                <C>                <C>             <C>
---------------------------------------------------------------------------------------------------------
  $ 0.80 - $ 2.80       4,197,010           1.8              $ 0.94         3,306,900          $ 0.95
--------------------------------------------------------------------------------------------------------- 
           $ 3.00         362,333           1.1                3.00           362,333            3.00
--------------------------------------------------------------------------------------------------------- 
  $ 3.30 - $ 7.50         520,597           0.6                4.67           520,597            4.67
--------------------------------------------------------------------------------------------------------- 
  $10.00 - $20.00          37,750          9.93               12.52            37,750           12.52
-----------------========================================================================================
           Totals       5,117,690           1.2              $ 1.55         4,227,580          $ 1.69
-----------------========================================================================================
</TABLE>
 
NOTE 11 - COMMITMENTS

LEASE AGREEMENT

          The Company was obligated under a lease agreement for its executive
offices through August 1997. From September 1997 forward, the Company is renting
the offices on a month-to-month basis at a rate of $6,250 per month.

          Rent expense for the years ended December 31, 1997 and 1996 including
parking, included in selling, general and administrative expenses, was $98,538
and $75,743, respectively.


EMPLOYMENT AGREEMENTS

          On December 1, 1993, the Company entered into a three-year employment
agreement with Mark Beychok which provided for an annual base salary of
$150,000, the grant of an option to purchase 100,000 shares of common stock at
$5.00 per share (as adjusted for the reverse stock split effected in 1996), and
$1,000,000 of life insurance, the proceeds of which will be split equally
between the employee's beneficiary and the Company.  In December 1995, in
recognition of Mr. Beychok's deferral of his compensation during 1995 and his
assuming additional responsibilities within the Company, Mr. Beychok's
employment agreement was amended to grant him an additional 62,500 five-year
options with an exercise price of $3.00 (as adjusted for the reverse stock split
effected in 1996), a price equal to the offering price in the Company's then on-
going private placement.  In November 1995, Mr. Beychok agreed to convert his
accrued salary to stock and options on the same terms as the Company's on-going
equity bridge financing.  The Company's Board of Directors approved this
transaction in December 1995.  In such connection, Mr. Beychok converted $45,821
of accrued salary into 19,092 shares; 9,547 options with an exercise price of
$4.50; and 9,547 options with an exercise price of $6.00.  In September 1997,
Mr. Beychok entered into a 

                                      F-20
<PAGE>
 
new employment agreement ("Agreement") with the Company for three years. Under
the Agreement, Mr. Beychok receives an annual base salary of $150,000 and was
granted options for 450,000 shares of stock at an exercise price of $0.87 per
share. Such options vest 75,000 each on September 3, 1997, March 3, 1998,
September 3, 1998, March 3, 1999, September 3, 1999, and March 3, 2000. In May
1997 the price of all options other than those related to the private placement
were repriced to $0.91. In September 1997 Mr. Beychok was given a successful
litigation reward of $51,535 plus 100,000 shares of common stock at fair market
value of $1.00.

          In August 1996, the Company entered into an employment agreement with
John Coppolino, which was dated January 1, 1996.  Under his agreement, which is
for a one year term, with two one year renewal terms at the option of the
Company, Mr. Coppolino received an initial salary of $102,000; and, is entitled
to annual increases of 5-6% based on increases in the cost of living.  Mr.
Coppolino's employment agreement provided for the grant of 225,000 options,
expiring December 31, 2000 for the purchase of common stock at $3.00 (as
adjusted for the reverse stock split effected in October 1996).  Of these
options: (i) 56,250 have vested (ii) 56,250 have lapsed and (iii) 56,250 will
vest on each of January 1, 1998 and January 1, 1999, subject to the Company
meeting certain performance criteria.  In May 1997 the Board of Directors
reduced the option price of all unlapsed options to $0.91 and removed the
vesting requirement.  In September 1997, Mr. Coppolino entered into a new
employment agreement ("Agreement") with the Company for  two years.  Under the
Agreement, Mr. Coppolino receives an annual base salary of $120,000, and was
granted options for 300,000 shares of stock at an exercise price of $0.87 per
share.  Such options vest 75,000 each on September 3, 1997, March 3, 1998,
September 3, 1998, and March 3, 1999.  In September 1997, Mr. Coppolino was
given a successful litigation reward of $25,000, forgiveness of debt of $25,000,
plus 25,000 shares of common stock at $1.00, being the fair market value at the
date of the award.

          In June 1997, the Company entered into a two year employment agreement
with Jack B. Spencer under which Mr. Spencer will serve the Company as its Chief
Operating Officer and Chief Financial Officer.  The agreement provides for
compensation to Mr. Spencer in the amount of $125,000 per annum and the grant of
an aggregate of 300,000 five year incentive stock options with an exercise price
of $ 0.91 per share (such being the market price of the common stock on the date
the agreement was executed).  The options vest as to 109,890 shares on September
15, 1997 and 109,890 shares on June 16, 1998, and 80,220 shares on June 16,
1999.  Mr. Spencer's employment agreement provides that if Mr. Spencer's
employment by the Company is terminated without cause after September 15, 1997,
then Mr. Spencer shall be entitled to six months severance pay.  Mr. Spencer's
employment agreement also provides that upon the occurrence of certain events
constituting a change in control of the Company, as defined therein, followed by
certain changes in Mr. Spencer's duties, Mr. Spencer shall be entitled to
receive a severance equal to one and one half times his then current annual
salary plus certain other benefits designed, in part, to offset any special
taxes that might be imposed upon Mr. Spencer in connection with such payments.


AUBURN FARMS TRADEMARK ACQUISITION

          The Company entered into a purchase agreement in 1996 whereby it
acquired the Auburn Farms trademark and other related trademarks.  Deferred
payments, which will be accounted for as royalties under the agreement, amount
to 3-1/2% of gross sales of products sold using these trademarks during the 30
months beginning May 1, 1996, with gradually reducing percentages over the next
successive three thirty-month periods.  Deferred payments under the agreement
made in 1996 were $45,612 and in 1997 were $18,801 and were expensed as
royalties during the year.


NOTE 12 - MAJOR CUSTOMERS

          The Company derived the following revenue from major customers, each
of which provided 10% or more of total revenues during the year ended December
31, 1997 and 1996:

                                      F-21
<PAGE>
 
<TABLE>
<CAPTION>

                              1997               1996
                              ----               ----
<S>                           <C>                <C>
K-Mart                        $      -           $606,199
A-1 International, Inc.        320,235                  -
                              --------           --------
Total                         $320,235           $606,199
                              ========           ========
</TABLE>

NOTE 13 - LITIGATION

          The Company is subject to pending claims and litigation, the most
significant of which are discussed below.

          In December 1994, Lloyd Gaunt, who invested an aggregate of $75,000 in
certain of the Company's private placements, initiated an action in Superior
Court, Orange County, California against his stockbroker, two national brokerage
firms, several companies in which he had invested; and, certain of those
company's officers.  Included among the defendants was the Company and its then
Chief Executive Officer.  The complaint seeks damages in an unspecified amount
in excess of $500,000 and punitive damages in an unspecified amount in excess of
$5,000,000. The Court has dismissed the class action claims as to the Company
and granted a motion that the claims against the brokerage firms and associated
persons must be submitted to arbitration.  The Plaintiff has appealed that
ruling.  The Company denies any liability to the plaintiff and intends to
vigorously defend this action. The Company notes that the plaintiff sold a
portion of the securities he purchased from the Company, realizing a profit;
that the balance of the securities became salable under Rule 144; and that, if
sold, the Plaintiff's losses might be as little as $15,000.

          In connection with the acquisition of assets of Auburn Farms, Inc.,
(AFI) under the FPA, the Company acquired certain rights of AFI against its co-
packer and against Barbara's Bakery. The Company is pursuing these rights, and
in May 1996, initiated an action alleging Lanham Act violations,
misappropriation of trade secrets, unfair competition and related claims. The
defendants have filed counterclaims against the Company, Auburn Farms and Mark
Beychok alleging various tort and contract claims. The litigation is in the
early stages and the Company intends to vigorously pursue the same, with trial
scheduled to begin September 14, 1998.
    
          On October 9, 1996, a complaint was filed in Superior Court, the
County of Los Angeles, in an action entitled "Eloy Louis Ellis vs. Vitafort,
Inc., a Delaware Corporation; Mark Beychok and Does 1-50 inclusive." The
complaint alleges Breach of Oral Contract, Breach of Written Contract, and other
similar claims arising out of the consulting relationship that previously
existed between the Company and Mr. Ellis. The Complaint seeks damages in an
unspecified amount. The court dismissed the complaint against Mark Beychok
without leave to amend. Mr. Ellis recently filed an amended complaint against
the Company. The Company is defending the action vigorously and trial was
scheduled for March 31, 1998.     
    
          The Company filed a counter-claim against Ellis charging violations of
Section 16(b) of the Securities Exchange Act of 1934 (short swing profits).
Ellis sold stock in violation of that section and, therefore, the profits,
estimated at $20,000, belong to the Company.  In March 1998, the court ruled in
favor of the Company in this matter and awarded $21,260.      

          On June 2, 1998, the parties resolved both the Ellis issues. Under the
terms of the agreement, the settlement is treated as confidential and the public
response has been agreed to as follows: "The matter has been resolved."

                                      F-22
<PAGE>
 
NOTE 14 - RELATED PARTY TRANSACTIONS

          The Company has entered into related party transactions during 1996
and 1997. See Notes 9, 10, 11 and 16 for further detailed information.


NOTE 15 - SUBSEQUENT EVENTS

          In March 1998, the Company entered into a subscription agreement in
the amount of $500,000 for 500 shares of Series A 1997 Preferred Stock.  The
preferred stock has a cumulative dividend rate of 6% with no voting rights.  The
conversion price is at a discount of 21.5% if the market price of the stock is
below $0.6875.  If the market price is above $0.6875, the exercise price is the
fair market value on the day of exercise; however, the holder receives warrants
in sufficient quantity to achieve a profit equal to the computed 21.5% discount.
The holder has agreed not to convert before August 10, 1998 in exchange for
these terms.
    
          The Company is currently negotiating the acquisition of Global
International Sourcing, Inc., ("Global") a Nevada corporation, by acquiring the
stock of the corporation from its sole shareholder. Global is a company with
international contacts to provide natural and low fat food products for Vitafort
to sell into the United States market at a cost significantly below those found
in the United States for similar products. The Company advanced $193,818 to
Global as of December 31, 1997 to meet Global's operating expenses and fund
inventory purchases for future sales. The Company believes that the acquisition
cost will not be a material amount. Global was formed in October 1997 and its
financial position and results of operations are not material compared to the
Company's financial position at December 31, 1997 or its results of operations
for the year ended December 31, 1997.


NOTE 16 - LITIGATION RECOVERY, NET OF COSTS

          On June 20, 1997, the Company received notice of the interim award
under the arbitration with the Keebler Company. The award was for $5,983,923 as
well as compensation for all legal fees and costs associated with the
arbitration proceedings. Based on the agreement with ATCOLP INVESTMENT PARTNERS
(the "Lender"), in which Donald Wohl, a Director of the Company, is the general
partner, the Company agreed to pay the Lender a sliding percentage of the
proceeds from the settlement in exchange for advancing $300,000 to the Company
to meet the litigation expenses. The Board of Directors, with Mr. Wohl
abstaining, considered two bids and found his to be the more reasonable of the
two.

          On July 15, 1997, the Company received $6,750,000 in full and final
settlement. Of that amount, $1,055,608 was paid for legal fees and costs, plus
$1,236,885 to ATCOLP INVESTMENT PARTNERS under the existing agreement and
$300,000 to repay the loan. Also, the Company issued a warrant for 200,000
shares of common stock to ATCOLP INVESTMENT PARTNERS as additional
consideration. The Company recorded $138,000 as additional fees to ATCOLP for
the warrant, that amount being the estimated fair value of non-registered
securities on that day. Additionally, the Company was able to cancel $140,829 in
debt due to the Keebler Company. The amount of the award, $5,983,000, has been
reported as income, under the heading litigation, net of costs, while the
difference between the $6,750,000 award and the $5,983,000 recovery, or
$767,000, has been treated as a reimbursement of expenses in the general and
administrative expenses for the year ended December 31, 1997.

                                      F-23
<PAGE>
 
NOTE 17 - EARNINGS PER SHARE

          The following table reconciles the numerators and denominators of the
basic and diluted earnings per share computation:
 
<TABLE>    
<CAPTION>
                                                                                  December 31,
                                                                              1997           1996
                                                                              -----          -----
<S>                                                                       <C>            <C>
BASIC EARNINGS (LOSS) PER SHARE
   Net income (loss)                                                      $   473,031     $(8,122,815)
   Deemed dividends                                                          (305,749)              -
                                                                          -----------     -----------

   Income (loss) available to common stockholders (numerator)             $   167,282     $(8,122,815)
                                                                          ===========     ===========

   Weighted average common shares outstanding (denominator)                 5,831,404       5,133,665
                                                                          ===========     ===========

   Basic earnings (loss) per share                                        $      0.03     $     (1.58)
                                                                          ===========     ===========

DILUTED EARNINGS (LOSS) PER SHARE
   Income (loss) available to common shareholders (numerator)             $   167,282     $(8,122,815)
                                                                          ===========     ===========

   Weighted average common shares outstanding                               5,831,404       5,133,665
   Weighted average options outstanding                                     2,511,516               -
   Weighted average convertible preferred stock                                 6,667               -
   Stock acquired with proceeds                                            (2,006,190)              -
                                                                          -----------     -----------
   Weighted average common shares and
    assumed conversions outstanding (denominator)                           6,343,397       5,133,665
                                                                          ===========     ===========

Diluted earnings (loss) per share                                         $      0.03     $     (1.58)
                                                                          ===========     ===========

</TABLE>     

          Options and warrants to purchase 958,565 and 2,256,232 shares of
common stock at various prices per share, at December 31, 1997 and 1996,
respectively, were not included in the computation of diluted earnings (loss)
per share because the effect would be antidilutive.

                                      F-24