<PAGE>
Pursuant to Rule 424(b)(3)
Registration No. 333-05306-D
[LOGO OF NATIONAL SECURITIES CORPORATION]
MINIMUM OFFERING OF 500,000 AND
MAXIMUM OFFERING OF 1,125,000 SHARES OF COMMON STOCK
---------------
This Prospectus relates to the offering (the "Offering") of shares (the
"Shares") of common stock, $0.001 par value per share ("Common Stock"), by
Osmotics Corporation (the "Company"). All of the Shares offered hereby are
being sold by the Company.
This Offering is on a minimum basis (the "Minimum Offering") of 500,000
Shares (the "Minimum Shares") and a maximum basis (the "Maximum Offering") of
1,125,000 Shares (the "Maximum Shares"). The Minimum Shares are being offered
on a "best efforts, all or none" basis and the remaining Shares are being
offered on a "best efforts" basis.
All funds received from subscribers for the Shares will be held in an escrow
account for the benefit of the subscribers by Continental Stock Transfer &
Trust Company (the "Escrow Agent") until an initial closing (a "Closing") of
the Minimum Offering or earlier termination of the Offering. The Offering will
expire on the earlier to occur of (i) 60 days from the date of this
Prospectus, (ii) termination of this Offering by the Company at any time 30
days following the effective date of the Registration Statement of which this
Prospectus forms a part or at any time upon 2 days notice to National
Securities Corporation ("National" or the "Placement Agent") after the Closing
of the Minimum Offering and (iii) the sale of all of the Shares offered
hereby, unless the Company and National agree to extend the Offering for an
additional 30-day period (the "Termination Date"). If the subscriptions for
the Minimum Offering are not received by the Termination Date, the Offering
will terminate and all funds will be returned promptly by the Escrow Agent
without interest and without any deduction therefrom. Pending each closing,
subscriptions to be accepted at such closing may be revoked, provided that
written notice of revocation is sent by certified or registered mail, return
receipt requested, and is received by the Company or the Placement Agent, as
applicable, at least two (2) business days before such closing. Refunds shall
then be promptly made without interest and without deduction. The Shares will
be delivered promptly to subscribers after each respective closing.
Prior to this Offering, there has been no public market for the Common
Stock, and there can be no assurance that such a market will develop after the
completion of this Offering or, if developed, that it will be sustained. See
"Plan of Distribution" for a description of the factors considered in
determining the initial public offering price. The Company anticipates that
the Common Stock will be quoted on the OTC Electronic Bulletin Board under the
symbol "OSMO".
---------------
THE SHARES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK
AND IMMEDIATE AND SUBSTANTIAL DILUTION. SEE "RISK FACTORS" COMMENCING ON
PAGE 8 AND "DILUTION" ON PAGE 22.
---------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
===============================================================================================================
PRICE TO PUBLIC UNDERWRITING COMMISSION(1) PROCEEDS TO COMPANY(2)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share................................. $6.00 $0.60 $5.40
- ---------------------------------------------------------------------------------------------------------------
Total Minimum............................. $3,000,000 $300,000 $2,700,000
Total Maximum............................. $6,750,000 $675,000 $6,075,000
===============================================================================================================
</TABLE>
(1) Excludes (i) additional compensation payable to the Placement Agent in the
form of a non-accountable expense allowance equal to 1.8% of the gross
proceeds of this Offering, and (ii) the value of five-year warrants (the
"Placement Agent's Warrants") to purchase up to an aggregate of 112,500
shares of Common Stock, at an exercise price of $9.90 per share, that will
be sold to the Placement Agent at a nominal price. The Placement Agent
will be issued one Placement Agent's Warrant for every 10 Shares sold in
this Offering. In addition, see "Plan of Distribution" for information
concerning indemnification and contribution arrangements with the
Placement Agent and other compensation payable to the Placement Agent.
(2) Before deducting estimated expenses of $860,000 payable by the Company,
excluding the non-accountable expense allowance payable to the Placement
Agent.
---------------
The Shares are being offered exclusively through the Placement Agent, on a
"best efforts" basis, and on an "all or none" basis as to the Minimum
Offering. The Placement Agent reserves the right to reject any order in whole
or in part and to withdraw, cancel or modify this Offering without notice.
NATIONAL SECURITIES CORPORATION
THE DATE OF THIS PROSPECTUS IS JUNE 5, 1997
<PAGE>
[PICTURE OF ANTIOXIDANT SKIN CARE DERM PRODUCT]
Antioxidant Skin Care Derms transdermal cosmetic patches that deliver the
antioxidant Vitamin C to the skin to help reduce the appearance of fine lines
and wrinkles.
[OSMOTICS LOGO]
Other products sold under the Osmotics label include skin cleansers, hydrating
facial mists, facial moisturizers and alpha hydroxy acid products.
[PICTURE OF OTHER COMPANY PRODUCTS]
IN CONNECTION WITH THIS OFFERING, THE PLACEMENT AGENT MAY EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE OTC ELECTRONIC BULLETIN BOARD
OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements and notes thereto appearing elsewhere in
this Prospectus. The Shares offered hereby involve a high degree of risk. See
"Risk Factors." Except where otherwise indicated, all share and per share data
in this Prospectus (including data with respect to options and warrants to
purchase shares of Common Stock) have been adjusted to reflect the
reincorporation of the Company from Colorado to Delaware pursuant to a merger
at an effective exchange ratio of one share of Common Stock of the Delaware
corporation for each 2.2 shares of common stock of the Colorado corporation and
associated changes in the Company's charter documents, to be effected before
the closing of this Offering. See "Description of Capital Stock." Solely for
the purpose of calculations in this Prospectus, the number of Shares assumed to
be offered for the Minimum Offering and the Maximum Offering is 500,000 and
1,125,000 shares of Common Stock, respectively.
THE COMPANY
Osmotics Corporation ("Osmotics" or the "Company") develops and markets
cosmetic skin care products. The Company's current principal products are based
on technology combining the Company's transdermal cosmetic delivery skin
patches ("Patches") with a special formulation of ascorbic acid (vitamin C), an
antioxidant. The products, which currently include the Osmotics label
Antioxidant Skin Care Derms, the Spa-Sante Systeme C label Patch and The
Wrinkle Patch, are intended to reduce the appearance of fine facial lines and
wrinkles. The Patches are placed on targeted wrinkles on a person's face to
saturate the skin with the antioxidant. Antioxidants contained in certain
current skin care lotions, creams or oils are exposed to the atmosphere and
lose their antioxidant effectiveness, if not absorbed into the skin within a
relatively short time after application, estimated by the Company to be
approximately 40 minutes. In contrast, the Company's vitamin C formulation is
protected by the Patch from the atmosphere and, therefore, can be absorbed over
the recommended 10 hour period of treatment. Further, Patches maintain the
purity of the vitamin C formulation and deliver the formulation to specific
problem areas of the skin. Drug and Cosmetic Industry Magazine honored the
Antioxidant Skin Care Derms in its December 1995 issue in the cosmetic skin
care treatment packaging category. The Company has filed a U. S. patent
application relating to certain aspects of its Patches.
One industry source has estimated that revenues in the United States skin
care products market were approximately $5.12 billion in 1994, representing
approximately 24.6% of total revenues in the United States personal care
products market. The same source projected that revenues in the United States
skin care products market would be approximately $6.46 billion in 1997 and
approximately $9.31 billion in 2001, representing a compound annual growth rate
from 1994 to 2001 of 8.9%. The Company believes that a portion of the estimated
future growth in revenues will come from the sale of skin care products
containing vitamin ingredients, such as the Company's vitamin C formulation.
The Company believes that the reasons for this continued growth of sales in the
skin care products market include fundamental changes now taking place in
demographic (aging population) and environmental factors, which are stimulating
the need for innovative, more effective skin care products. The U.S. Bureau of
Census has estimated that between 1993 and 2020, the number of individuals age
45 and over in the United States will increase by 59%, while those under age 45
in the United States will increase by only 7%. Further, the first of the
approximately 76 million "baby boomers" in the United States who were born
between 1946 and 1960 turned 50 in 1996. The Company believes that the need for
new skin care products will increase as the population ages because concern
with the effects of aging on the skin increases with age.
The Company's objectives are to be the leader in the marketing of skin care
products that deliver antioxidants by means of skin patches, to remain the
leader in that market segment and to expand its product line of other skin care
products and compete in the cosmeceuticals market. The Company currently
markets cleansers, moisturizers, alpha hydroxy acid and lipsticks in the
upscale market under the Osmotics label product line, and skin creams and
hydrating moisture sprays in The Wrinkle Patch label product line. The Company
intends to develop and market additional product line extensions in the future.
3
<PAGE>
The Company first sold skin care products under the Osmotics label, including
Antioxidant Skin Care Derms, in April 1995 to certain Saks Fifth Avenue stores.
The Company commenced marketing its Spa-Sante label Patch in March 1996 through
spas, beauty salons and estheticians, and commenced marketing The Wrinkle Patch
in October 1995 through a direct sale catalog. The Company offers The Wrinkle
Patch label products to several direct sale catalogs, through TV home shopping
channels, through an infomercial and through the World Wide Web. The Company
also supplies skin patches to third parties for inclusion in products to be
sold by the third parties under their own labels in certain foreign markets.
The Company may seek to have its products marketed under additional private
labels.
Outside the United States, the Company launched Osmotics label products,
including Antioxidant Skin Care Derms, in the United Kingdom in May 1996 at six
House of Fraser stores located throughout the United Kingdom. In the fall of
1996, the Company launched products in Paris, France at a Galeries Lafayette
store, in Geneva, Switzerland at eight Pharmacies Principale stores and also
introduced products into Brazil and Equador. In January 1997, the Company
launched products in France at Au Printemps, Samaritaine, Bon Marche, BHV and
Perfumerie Sephora stores. In May 1997, the Company launched products in over
50 additional pharmacies in Switzerland. The Company expects to launch products
in additional countries in Canada, South America, Europe and Asia during 1997.
The predecessor entity to the Company was incorporated in Colorado in August
1993. Before the closing of this Offering, the Company intends to reincorporate
in Delaware by merging into a newly formed corporation incorporated in Delaware
in July 1996. The Company's principal executive offices are located at 1125
17th Street, Denver, Colorado 80202. Its telephone number is (303) 293-2087. In
this Prospectus, the terms "Company" and "Osmotics" refer to the Company and
its predecessors.
RISK FACTORS
The Shares offered hereby involve a high degree of risk. This Prospectus
contains forward-looking statements, including those discussed under
"Business," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Use of Proceeds." These forward-looking statements
involve a number of risks and uncertainties, including, but not limited to,
those discussed under "Risk Factors." The Company's actual results may differ
significantly from the results discussed in the forward-looking statements. See
"Risk Factors."
4
<PAGE>
THE OFFERING
<TABLE>
<C> <S>
Common Stock Offered by the Company......... This Offering is on a minimum
basis of 500,000 shares of
Common Stock and a maximum basis
of 1,125,000 shares of Common
Stock.
Common Stock Outstanding Before this Offer-
ing(1)..................................... 1,478,299 shares
Common Stock to be Outstanding After the
Minimum Offering(1)........................ 1,978,299 shares
Common Stock to be Outstanding After the
Maximum Offering(1)........................ 2,603,299 shares
Certain terms............................... The Minimum Offering is being
offered by the Placement Agent
on a "best efforts, all or none"
basis and the remaining shares
of Common Stock are being
offered by the Placement Agent
on a "best efforts" basis, until
the earlier of (i) 60 days after
the date of this Prospectus,
(ii) termination of this
Offering by the Company at any
time upon 30 days notice to
National or at any time after
the Closing of the Minimum
Offering and (iii) the sale of
all the Shares being offered
hereby, unless the Company and
the Placement Agent agree to
extend this Offering for an
additional 30-day period.
Proposed OTC Electronic Bulletin Board Sym-
bol........................................ OSMO
Use of Proceeds............................. For repayment of indebtedness
and general corporate purposes,
including marketing and sales
expenditures and working
capital. See "Use of Proceeds."
Risk Factors and Dilution................... The purchase of Shares offered
hereby involves a high degree of
risk and immediate and
substantial dilution.
Prospective investors should
review carefully and consider
the information set forth under
"Risk Factors" and "Dilution."
The Shares should not be
purchased by investors who
cannot afford the loss of their
entire investment. See "Risk
Factors."
</TABLE>
- --------
(1) Based upon shares issued and outstanding as of March 31, 1997. Does not
include 272,000 shares of Common Stock issuable upon exercise of options
outstanding as of March 31, 1997 granted to directors, officers, employees
of, and consultants to, the Company, at a weighted average exercise price
of $2.42 per share; (ii) 150,000 shares of Common Stock issuable upon
exercise of options to be granted concurrently with the effective date of
this Offering, at an exercise price equal to 110% of the initial public
offering price of the Shares offered hereby; (iii) 200,000 additional
shares of Common Stock reserved for future grants under the Company's 1997
Directors Stock Option Plan and 1997 Equity Incentive Plan; (iv) 73,036
shares of Common Stock issuable upon exercise of other options and warrants
outstanding as of March 31, 1997, at an exercise price of $1.10 per share;
(v) an estimated approximately 158,333 shares of Common Stock issuable upon
exercise of the Bridge Warrants at an exercise price of $0.022 per share;
and (vi) 50,000 shares of Common Stock issuable upon exercise of the
Placement Agent's Warrants if the Minimum Offering is sold and 112,500
shares of Common Stock issuable upon exercise of the Placement Agent's
Warrants if the Maximum Offering is sold, at an exercise price equal to
$9.90 per share.
5
<PAGE>
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE
MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
------------- ------------
1995 1996 1996 1997
----- ------ ----- -----
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues................................... $ 328 $1,255 171 859
Loss from operations............................. (790) (1,401) (179) (418)
Net loss......................................... (811) (1,842) (190) (546)
Net loss per share(1)............................ (.68) (1.27) (0.15) (0.36)
Shares used in computing net loss per share(1)... 1,187 1,446 1,299 1,515
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1997
-------------------------------
AS ADJUSTED AS ADJUSTED
FOR MINIMUM FOR MAXIMUM
ACTUAL OFFERING(2) OFFERING(3)
------ ----------- -----------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents..................... $ 83 $ 728 $4,035
Current assets................................ 856 1,501 4,809
Current liabilities........................... 2,447 766 766
Total assets.................................. 1,503 1,595 4,903
Notes and capital lease payable............... 1,031 47 47
Total stockholders' equity (deficit).......... (982) 790 4,098
</TABLE>
- --------
(1) For an explanation of the determination of the number of shares used in per
share calculations, see Note 2 of Notes to the Company's financial
statements appearing at the end of this Prospectus (the "Financial
Statements").
(2) Adjusted to give effect to the issuance of the Minimum Shares offered
hereby at an initial public offering price of $6.00 per Share, and after
deducting estimated Placement Agent's commissions and estimated offering
expenses and after the application of the net proceeds therefrom. Assumes
no exercise of the Placement Agent's Warrants. See "Capitalization," "Use
of Proceeds" and "Plan of Distribution."
(3) Adjusted to give effect to the issuance of the Maximum Shares offered
hereby at an initial public offering price of $6.00 per Share, and after
deducting estimated Placement Agent's commissions and estimated offering
expenses and after the application of the net proceeds therefrom. Assumes
no exercise of the Placement Agent's Warrants. See "Capitalization," "Use
of Proceeds" and "Plan of Distribution."
----------------
The Osmotics(R) name logo and Antioxidant Skin Care Derms(R) are registered
U.S. trademarks of the Company. The Company has U.S. trademark applications
pending for AKA RED(TM), WRINKLE PATCH(TM), THE NIGHTIME MIRACLE(TM) and
SYSTEME C(TM). All other trademarks or trade names referred to in this
Prospectus are the property of their respective owners.
6
<PAGE>
NOTICE TO CALIFORNIA INVESTORS
Each purchaser of Shares in California must meet one of the following
suitability standards: (1) any person who (a) has a net worth (excluding home,
furnishings and automobiles) of $250,000 or more and gross annual income of
$65,000 or more, or (b) has a net worth (excluding home, furnishings and
automobiles) of $500,000 or more; (2) any person who is an accredited investor
within the meaning of Regulation D under the Securities Act of 1933, as amended
(the "Securities Act"); (3) any entity that is a bank, savings and loan
association, trust company, insurance company, investment company registered
under the Investment Company Act of 1940, pension and profit sharing trust,
corporation or other entity, which together with the corporation's or other
entity's affiliates, has a net worth on a consolidated basis according to its
most recent regularly prepared statements (which shall have been reviewed, but
not necessarily audited, by outside accountants) of not less than $14,000,000
and subsidiaries of the foregoing; or (4) any person (other than a person
formed for the sole purpose of purchasing the Shares being offered hereby) who
purchases at least $1,000,000 aggregate amount of the Shares hereby offered.
7
<PAGE>
RISK FACTORS
An investment in the Shares offered hereby involves a high degree of risk.
In addition to the other information in this Prospectus, the following factors
should be considered carefully in evaluating an investment in the Shares. This
Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in such forward-looking statements. Factors that may cause
such a difference include, but are not limited to, those discussed below and
elsewhere in this Prospectus.
Limited Operating History; History of Operating Losses; Going Concern
Opinion; Accumulated Deficit. The Company was organized in August 1993 and has
only a limited operating history upon which evaluation of its prospects can be
made. The Company has never been profitable and, at March 31, 1997, had a
working capital deficit of approximately $1,591,000 and an accumulated deficit
of approximately $3,279,000. In addition, the report of the Company's
independent public accountants accompanying the Financial Statements notes
that the Company's recurring losses from operations and net capital deficiency
raise substantial doubt about the Company's ability to continue as a going
concern, absent completion of this Offering. The Company began shipping its
first product, Antioxidant Skin Care Derms, in April 1995, and the Company's
limited operating history makes the prediction of future operating results
difficult. The Company does not believe that prior growth rates are
necessarily indicative of future operating results. Future operating results
will depend on many factors, including demand for the Company's products, the
level of product and price competition, the Company's success in expanding the
number of stores through which its products are sold and its other
distribution channels, the ability of the Company to develop and market line
extensions of its present products, the ability of the Company to control
costs, general economic conditions and other factors. There can be no
assurance that the Company will ever generate significant revenues or achieve
or sustain profitability. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Product and Customer Concentration. Approximately 36% of the Company's
revenues from its inception in August 1995 to March 31, 1997 have been derived
from sales of products to Saks Fifth Avenue stores located in the United
States. Revenues from sales to Saks Fifth Avenue Stores accounted for
approximately 88% and 37% of the Company's revenues for the years ended
December 31, 1995 and 1996, respectively, and approximately 15% of the
Company's revenues for the three months ended March 31, 1997. Revenues from
sales to Self Care Catalog, Matchbox Agency, Neiman Marcus and House of Fraser
stores accounted for approximately 12%, 1%, 0% and 0% of the Company's
revenues, respectively, for the year ended December 31, 1995, 16%, 2%, 11% and
18% of the Company's revenues, respectively, for the year ended December 31,
1996 and 11%, 36%, 18% and 0% of the Company's revenues, respectively, for the
three months ended March 31, 1997. There can be no assurance that Saks Fifth
Avenue, Neiman Marcus, Self Care Catalog, Matchbox Agency or House of Fraser
stores will continue to purchase products from the Company.
The Company currently expects that revenues attributable to Antioxidant Skin
Care Derms and other Osmotics label products will account for a significant
portion of the Company's revenues in 1997. As a result, the Company's future
operating results are dependent upon market acceptance of these products in
both domestic and international retail outlets. There can be no assurance that
the Company's products will achieve market acceptance or that the Company will
be successful in marketing its products. A decline in demand for, or market
acceptance of, Antioxidant Skin Care Derms, as a result of competition or
other factors, would have a material adverse effect on the Company's business,
operating results and financial condition. See "Business--Products."
Fluctuations in Quarterly Results; Seasonality. The Company's quarterly
operating results have varied in the past and may in the future vary
significantly, depending on factors such as the size and timing of customer
orders, price and other competitive conditions in the cosmetics industry and
the timing of new product announcements and releases by the Company and its
competitors. The Company operates with little order backlog, and substantially
all of its revenues in each quarter result from sales made in that quarter.
Accordingly, revenues for any future quarter are difficult to predict. It is
likely that in some future quarter the Company's
8
<PAGE>
operating results will be below the expectations of public market analysts and
investors. In such event, the price of the Common Stock would likely be
materially adversely affected.
The Company believes that demand by retail department stores located in the
United States for cosmetic products, including those of the Company, is
generally greatest during the fall season and lowest during the summer months.
Since a large component of the Company's revenues are derived from sales to
retail department stores, the Company may in the future experience such
seasonality in its revenues. The Company intends to introduce additional
products, sell its products through additional distribution channels and sell
products in additional geographic regions. Each of these actions may have
different seasonal trends and may affect overall seasonality of the Company's
operating results. See "--Product and Customer Concentration" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Future Additional Capital Requirements; No Assurance Future Capital Will be
Available. The Company's capital requirements will depend on numerous factors,
including the resources the Company devotes to the development, manufacture
and marketing of its products, including the launch of new product lines or
the launch of products into new distribution channels, both domestic and
international; market acceptance and demand for its products; and other
factors. While the timing and amount of such capital requirements cannot be
predicted with certainty, the Company believes that the net proceeds of the
Minimum Offering, together with cash on hand, cash expected to be received
upon payment of outstanding accounts receivable at March 31, 1997, and cash
expected to be generated from operations, will be sufficient to pay existing
liabilities including notes payable and the Bridge Notes, but may be
insufficient to satisfy other anticipated cash requirements for the 12 months
after the date of this Prospectus, and that the Company may need to obtain
additional funds during such 12-month period through public or private debt or
equity financings, collaborative relationships, bank facilities or other
arrangements. If the Maximum Shares are sold in this Offering, the Company
believes that the net proceeds of the Maximum Offering, together with cash on
hand, cash expected to be received upon payment of outstanding accounts
receivable at March 31, 1997, and cash expected to be generated from
operations, will provide adequate funding for the Company's anticipated cash
requirements through at least 12 months after the date of this Prospectus.
Even if the Maximum Shares are sold in this Offering, there can be no
assurance that the Company will not require additional funding sooner than
expected or that such additional funding, if needed, will be available on
terms attractive to the Company, or at all. Any additional equity financing
may be dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. See "Use of Proceeds" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
Use of Proceeds. If the Minimum Shares and the Maximum Shares are sold in
this Offering, approximately 67.7% and 23.7%, respectively, of the estimated
net proceeds of this Offering are expected to be used to repay existing
outstanding notes of the Company issued in the Bridge Financing and other
outstanding notes, and other outstanding consultants' fees, and approximately
11.3% and 26.7%, respectively, of the estimated net proceeds of this Offering
are expected to be used for working capital and general corporate purposes.
See "Use of Proceeds" and "Capitalization--Recent Financing Transactions."
Management of Growth. The Company's recent, and anticipated future, growth
has placed, and is expected to continue to place, a strain on the Company's
administrative, financial and operational resources. The size of the Company's
professional staff has increased from nine full-time employees at December 31,
1995 to 12 such employees at March 31, 1997. In addition, at December 31, 1995
and 1996 and March 31, 1997, there were four, 11 and 17 persons, respectively,
working in retail stores for whom the Company was responsible for all or a
portion of their salary. Of those 11 and 17 persons, 5 and 13, respectively,
were in the United States. The Company plans to hire additional employees in
1997, including a Controller and additional administrative, sales and
marketing personnel. The Company's ability to manage its growth effectively
will require it to continue to improve its operational, financial and
management controls, reporting systems and procedures, to install new
management information and control systems and to train, motivate and manage
employees. If the Company is unable to manage growth effectively and new
employees are unable to achieve adequate performance levels, the Company's
business, operating results and financial condition could be adversely
affected. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
9
<PAGE>
Competition. The cosmetics, skin care and personal care business is highly
competitive. Increased competition could result in price reductions, reduced
transaction size, fewer customer orders and reduced gross margins, any of
which could have a material adverse effect on the Company's business,
operating results and financial condition. The Company believes that the
principal competitive factors affecting the cosmetics market include product
uniqueness, product performance, the effectiveness of sales and marketing
efforts and company reputation. There can be no assurance that the Company
will compete successfully in the future with respect to these or other
factors.
The Company believes that no other company is currently marketing products
using skin patch technology to deliver antioxidants to a person's skin for
cosmetic purposes, although certain products using gauze pads to deliver
antioxidants are presently sold by certain of the Company's competitors. The
Company believes that other products currently utilizing transdermal delivery
systems are sold primarily in prescription pharmaceutical markets for other
than cosmetic use. However, the FDA recently approved the marketing of a
consumer product, without the need for a prescription, for transdermal
delivery of nicotine using a patch. There can be no assurance that products
using skin patch technology to deliver antioxidants to a person's skin for
cosmetic purposes do not exist or are not under development by others.
Certain skin creams, lotions and oils currently sold by cosmetics companies,
including the Cellex-C brand antioxidant serum, compete with the Company's
comparable products. Additionally, Avon Products markets a vitamin C formula
under the brand name Anew, which Avon claims, among other things, minimizes
the appearance of fine lines and wrinkles. Some of the Company's current, and
many of the Company's potential, competitors have significantly greater
financial, marketing, product development, testing and other resources than
the Company and sell their products more widely than the Company. As a result,
they may have the capacity to respond more quickly to changes in customer
requirements or to devote greater resources to the development, testing,
promotion and sale of their products than the Company. It is possible that new
competitors may emerge and rapidly gain significant market share.
Additionally, it is possible current or new competitors might introduce
competitive products which also utilize skin patch technology or other
technology that produces results similar or superior to the Company's Patches
or which are sold at a lower price than the Company's products in similar
distribution channels. There can be no assurance that the Company will be able
to compete successfully against current and future competitors or that
competitive pressures faced by the Company will not have a material adverse
effect on its business, operating results and financial condition. See
"Business--Competition."
Changes in the Retail Industry. A significant portion of the Company's
revenues to date have been derived from the sale of products to certain Saks
Fifth Avenue stores located in the United States. The Company also sells
products to other retailers located in the United States and other countries.
The retail industry has periodically experienced consolidation and other
ownership changes. Major retailers in the United States and in foreign markets
may in the future consolidate, undergo restructurings or realign their
affiliations, which could decrease the number of stores that sell the
Company's products, increase the ownership concentration within the retail
industry or change the way in which the Company markets products. While such
changes in the retail industry to date have not had a material adverse effect
on the Company's business, operating results or financial condition, there can
be no assurance as to the future effect of any such changes. See "Business--
Sales and Marketing."
Brand Loyalty of Consumers of Cosmetics. The Company believes that consumers
of cosmetics products are increasingly less loyal to a particular brand name
and, as a result, are less likely to purchase multiple types of products
within a brand's product line unless those products satisfy specific needs of
the consumers. The Company believes that this trend may have aided the
Company's introduction of its Patches, but there can be no assurance that this
trend will aid the Company in the introduction of products in the future. See
"Business--Strategy."
Protection of Intellectual Property. The Company currently relies primarily
on a combination of trademark laws, trade secrets, confidentiality procedures
and contractual provisions to protect its technology. The Osmotics name logo
and Antioxidant Skin Care Derms are registered U.S. trademarks of the Company.
The
10
<PAGE>
Company has U.S. trademark applications pending for AKA RED, WRINKLE PATCH,
THE NIGHTIME MIRACLE and SYSTEME C. The United States Patent and Trademark
Office (the "PTO") has rejected the Company's U.S. trademark application for
Spa-Sante. The Company has trademark applications pending in Japan for
OSMOTICS, Spa Sante, The Wrinkle Patch and SYSTEME C, in Korea for OSMOTICS
and the Osmotics label, Spa Sante, The Wrinkle Patch and SYSTEME C, in the
European Community for OSMOTICS and the Osmotics logo and in Ecuador for
OSMOTICS. There can be no assurance that any of these marks for which
registration applications are pending will be registered.
The Company filed one United States patent application in 1994 and filed a
continuation in part of that patent application in 1995. The PTO has rejected
all claims in these applications, alleging that the claimed inventions were
obvious. In response, the Company filed a continuation in part application in
1996, accumulating subject matter of both prior patent applications and
addressing, among other things, the use of the Patches as a method to deliver
antioxidants. The PTO issued an initial office action in April 1997 which
rejected all the claims of the 1996 continuation in part application on the
basis that references not previously relied upon in the examination of the two
earlier applications. The Company plans to respond in due course by arguing in
favor of patentability. The Company also has filed an application under an
international treaty designating various foreign countries for which the
Company preserved certain rights in the event it files patent applications in
any of those countries. The Company also intends to file additional patent
applications in the PTO on various features of its products in the future, if
appropriate. However, there can be no assurance that any patents will issue in
any country with respect to currently pending applications or any future
patent applications.
The validity and breadth of claims in patents involve complex legal and
factual questions and, therefore, may be highly uncertain. No assurance can be
given that any issued patent or patents based on the pending patent
applications or any future patent application will exclude competitors or
provide competitive advantages to the Company or that others will not claim
rights in or ownership of the Company's rights which it regards as
proprietary. Furthermore, there can be no assurance that others have not
developed or will not develop similar products, duplicate any of the Company's
products or design around any patents that may be issued in the future to the
Company. Since patent applications in the United States are maintained in
secrecy until patents issue, the Company also cannot be certain that others
did not first file applications for inventions covered by the Company's
pending patent applications, nor can the Company be certain that it will not
infringe any patents that may issue to others on such applications.
Despite the Company's efforts to protect its rights, unauthorized parties
may attempt to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Policing unauthorized use
of the Company's products may prove to be difficult, and, while the Company is
unable to determine the existence or amount of other products which now or in
the future illegally duplicate the Company's products, such other products can
be expected to be a persistent problem. In addition, the laws of many
countries do not protect the Company's rights which it regards as proprietary
to as great an extent as do the laws of the United States. There can be no
assurance that the Company's means of protecting its rights will be adequate
or that the Company's competitors will not independently develop similar
products.
To date, the Company has not been notified that the Company's products
infringe the proprietary rights of third parties, but there can be no
assurance that third parties will not claim infringement by the Company with
respect to current or future products. Any such claims, with or without merit,
could be time-consuming, result in costly litigation, cause product shipment
delays or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on
terms acceptable to the Company or at all, which could have a material adverse
effect upon the Company's business, operating results and financial condition.
See "Business--Intellectual Property and Other Proprietary Rights."
Dependence on Key Personnel. The Company's future success will depend in
large part upon its ability to attract, retain and motivate highly skilled
employees. The loss of any of the Company's senior management or other key
research, development, sales and marketing personnel, particularly if lost to
competitors, could have a material adverse effect on the Company's business,
operating results and financial condition, including its ability
11
<PAGE>
to attract employees. In particular, the loss of Steven S. Porter, the
Company's President, Chief Executive Officer and Chairman of the Board, or
Francine E. Porter, the Company's Executive Vice President, Secretary and
Treasurer, would have a material adverse effect on the Company's development
and marketing efforts. The Company intends to obtain key man life insurance
policies covering Steven Porter and Francine Porter at the closing of this
Offering. See "Business--Sales and Marketing" and "Business--Employees."
Risks Associated with International Sales. Sales of the Company's products
outside of the United States have represented an increasingly greater portion
of total revenues. The Company intends to expand the sales of its products in
Europe and South America and to launch the sales of its products in Asia,
which efforts will require significant management attention and financial
resources. The Company has committed and continues to commit resources to
developing international sales. There can be no assurance that the Company's
efforts to develop international sales will be successful, and the failure of
such efforts could have a material adverse effect on the Company's business,
operating results and financial condition. International sales are subject to
a number of risks, including differing regulatory requirements which might
require the Company, among other things, to modify the formulation and
packaging of its products, unexpected changes in regulatory requirements,
longer payment cycles, import and export restrictions and tariffs, shipping
delays, difficulties in staffing and managing foreign operations, the burden
of complying with a variety of foreign laws, greater difficulty in accounts
receivable collection, potentially adverse tax consequences, currency
fluctuations and political and economic instability. Additionally, the
protection of intellectual property may be more difficult to enforce outside
of the United States. In the event that the Company is successful in expanding
its international operations, the imposition of exchange or price controls or
other restrictions on foreign currencies could materially adversely affect the
Company's business, operating results and financial condition. As the Company
increases its international sales, its total revenues may also be affected to
a greater extent by seasonal fluctuations resulting from lower sales that
typically occur during the summer months in Europe. See "Business--Strategy"
and "Business--Sales and Marketing."
Suppliers; Manufacturing Limitations. The Company currently obtains
ingredients, packaging and final formulations from several third party
suppliers and has not entered into a written agreement with any such supplier.
Although the Company believes that all ingredients are presently obtainable
and has identified additional third parties that could also supply such
ingredients, there can be no assurance that the Company will continue to be
able to obtain such ingredients, packaging or formulations from third parties
at all or in sufficient quantities and on terms and conditions acceptable to
the Company. The Company relies on a different third party contract
manufacturer to assemble components into finished products. The Company has
entered into a written agreement respecting confidentiality, but not supply
requirements or otherwise, with this manufacturer. The Company believes that
if this manufacturer were unexpectedly to stop assembling components into
finished products for the Company, there would be a temporary adverse effect
on the Company's ability to produce products on a timely basis, but that one
or more other contract manufacturers could be identified. The Company neither
has nor plans to acquire the equipment and facilities necessary to manufacture
its current and future products and is and will be dependent upon third party
contract manufacturers for such production. There can be no assurance that the
Company will continue to be able to obtain contract manufacturing on
commercially acceptable terms for products in the quantities currently
obtainable or that may be required in the future. Further, there can be no
assurance that manufacturing or quality control problems will not arise at the
manufacturing plant of the Company's present contract manufacturer. In
addition, if the Food and Drug Administration (the "FDA") were to determine
that any of the Company's cosmetic products, including products that contain
active sunscreen ingredients and are labeled with a sun protection factor, are
also drugs, those products would have to be manufactured in accordance with
the FDA's current good manufacturing practice ("GMP") requirements for
finished pharmaceuticals. The Company's present contract manufacturer produces
the Company's finished products at a GMP manufacturing facility, but there can
be no assurance of compliance or that, if the Company had to contract with a
different third party manufacturer, the GMP requirements, if applicable, would
be met. See "Business--Manufacturing."
Government Regulation. The Company and its cosmetic products are subject to
regulation by the FDA and the Federal Trade Commission (the "FTC") in the
United States, as well as by various other federal, state and local
authorities. Such regulation relates primarily to the ingredients, packaging,
labeling, advertising and marketing of the Company's products. Cosmetics do
not require premarket notification to, or premarket approval
12
<PAGE>
by, the FDA, but must be properly labeled and manufactured. Failure to comply
with FDA requirements in such matters can result in severe civil and criminal
penalties, including seizure of product, injunction against production,
distribution, sales and marketing, and prosecution. The FTC oversees the
advertising of cosmetic products, and prohibits false or misleading
advertising. The FTC has a number of remedies available to it, including
preliminary injunctive relief based on its mere "reason to believe" that an
advertisement is false or misleading.
If the FDA were to determine that any of the Company's products are new
drugs (as well as or instead of cosmetics), the Company would not be able to
market such products without obtaining FDA approval of new drug applications
submitted by the Company or, alternatively in the case of certain over-the-
counter ("OTC") drug products, without complying with an FDA OTC monograph
setting out permissible ingredients and indications (claims), among other
requirements. The approval process for new drugs is lengthy, expensive and
uncertain. Securing FDA approvals requires the submission of extensive
preclinical (laboratory and animal) and clinical safety and effectiveness data
to the FDA, together with detailed manufacturing, labeling and other
supporting information. Gathering the requisite data and preparing the
requisite applications for marketing permits usually takes many years. The FDA
review process of such applications typically is lengthy, and there could be
no assurance as to when, if ever, the FDA approvals would be obtained. Such
determinations by the FDA could, depending on the products affected, have a
material adverse effect on the Company's business, operating results and
financial condition and on the market price of the Common Stock. There can be
no assurance that the Company's current or future products will not be
regulated by the FDA as new drugs, nor can there be any assurance that any
future requirements will not have a material adverse effect on the Company's
business, financial condition or results of operations or on the market price
of the Common Stock. See "Business--Government Regulation."
Risk of Product Liability; Limited Product Liability Insurance. The testing,
marketing and sale of cosmetic products entails an inherent risk of
allegations of product liability, and there can be no assurance that
substantial product liability claims will not be asserted against the Company.
The Company has obtained limited amounts of insurance for product liability
claims. However, there can be no assurance that the Company will be able to
obtain or maintain insurance on acceptable terms for its development, testing
and commercial activities or that any insurance obtained will provide adequate
protection against potential liabilities.
Control by Existing Stockholders. If the Minimum Offering or the Maximum
Offering is completed, the directors, executive officers and principal
stockholders of the Company and their affiliates will, in the aggregate,
beneficially own approximately 50.1% and approximately 38.8%, respectively, of
the Company's outstanding Common Stock, including shares issuable upon
exercise of outstanding options or warrants that are exercisable by such
persons before May 30, 1997. As a result, these stockholders, acting together,
will possess significant influence on stockholders of the Company, election of
the Company's Board of Directors and the approval of significant corporate
transactions. Such control could delay, defer or prevent a change in control
of the Company, impede a merger, consolidation, takeover or other business
combination involving the Company, or discourage a potential acquirer from
making a tender offer or otherwise attempting to obtain control of the
Company. See "Management" and "Principal Stockholders."
Exercise of Warrants and Options. As of March 31, 1997, 272,000 shares of
Common Stock were issuable upon exercise of outstanding employee, officer,
director or consultant stock options at a weighted average exercise price of
$2.42 per share and 73,036 shares of Common Stock were issuable upon exercises
of other outstanding options and warrants (excluding the Bridge Warrants) at a
weighted average exercise price of $1.10 per share. Further, upon the
effective date of this Offering, (i) 150,000 shares of Common Stock will be
issuable upon exercise of options to be granted concurrently with the
effective date of this Offering, at an exercise price equal to 110% of the
initial public offering price of the Shares offered hereby, (ii) 200,000
additional shares will be reserved for future grants under the Company's 1997
Directors Stock Option Plan and 1997 Equity Incentive Plan, (iii) an estimated
approximately 158,333 shares will be issuable upon exercise of the Bridge
Warrants at an exercise price of $.022 per share and (iv) 50,000 shares will
be issuable upon exercise of the Placement Agent's Warrants if only the
Minimum Shares are sold in this Offering and 112,500 shares will be issuable
upon exercise of the Placement Agent's Warrant if the Maximum Shares are sold
in this Offering, at an exercise price
13
<PAGE>
equal to $9.90 per share. For the life of such options and warrants, the
holders thereof will have the opportunity to profit from a rise in the market
price of the Common Stock without assuming the risk of ownership of the shares
of Common Stock issuable upon exercise of such options and warrants, with the
resulting dilution in the interest of the Company's stockholders by reason of
exercise of such options and warrants at a time when the exercise price is
less than the market price for the Common Stock. Further, the terms on which
the Company could obtain additional capital during the life of such options
and warrants may be adversely affected. The holders of such options and
warrants may be expected to exercise such options and warrants at a time when
the Company would, in all likelihood, be able to obtain any needed capital by
a new offering of its securities on more favorable terms than those provided
for by those options and warrants.
Effect of Certain Charter Provisions and Agreements; Anti-Takeover Effects
of Delaware Law. Upon completion of the Minimum Offering, the Company's Board
of Directors will have the authority to issue up to 10,000,000 shares of
Preferred Stock and to determine the prices, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote or action by the stockholders. The rights of the holders of Common Stock
will be subject to, and may be adversely affected by, the rights of the
holders of any Preferred Stock that may be issued in the future. The issuance
of Preferred Stock could adversely affect the voting power of holders of
Common Stock and the likelihood that such holders will receive dividend
payments and payments upon liquidation. Additionally, issuance of Preferred
Stock, while providing flexibility in connection with possible acquisitions
and other corporate purposes, could have the effect of making it more
difficult for a third party to acquire a majority of the outstanding voting
stock of the Company. The Company has no current plans to issue shares of
Preferred Stock. See "Description of Capital Stock."
As is permitted by the Delaware General Corporation Law (the "DGCL"), the
Company's charter documents provide that the Company will indemnify its
directors and officers, and advance certain expenses to such persons in
connection with certain legal proceedings, to the maximum extent permitted by
the DGCL. The Company will also enter into indemnity agreements with each of
its current directors and executive officers. Insofar as indemnification for
liabilities arising under the Securities Act may be permitted to directors,
officers and controlling persons of the Company pursuant to the foregoing
provisions, or otherwise, the Company has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.
See "Management--Indemnification of Directors and Executive Officers and
Limitation of Liability."
Limits on Secondary Trading; Possible Illiquidity of Trading Market. The
Company anticipates that the Common Stock will be quoted on the OTC Electronic
Bulletin Board (the "Bulletin Board"), which is a significantly less liquid
market than the Nasdaq SmallCap Market or other stock exchanges. If at a
future date, the Company becomes able to satisfy the quantitative and other
listing requirements for listing of the Common Stock on the Nasdaq SmallCap
Market or another stock exchange, the Company may apply for such listing,
although there can be no assurance that the Company will apply for any such
listing or that its application would be accepted. As a result of the Common
Stock being quoted on the Bulletin Board, an investor may find it more
difficult to dispose of, or to obtain accurate quotations as to the price of,
the Common Stock than if the Common Stock were listed on the Nasdaq SmallCap
Market or another stock exchange. In addition, depending on several factors
including the future market price of the Common Stock, the Common Stock could
become subject to the so-called "penny stock" rules that impose additional
sales practice and market making requirements on broker-dealers who sell
and/or make a market in such securities, which could affect the ability or
willingness of broker-dealers to sell and/or make a market in the Common Stock
and the ability of purchasers of the Common Stock to sell their shares in the
secondary market.
Under the blue sky laws of most states, public sales of Common Stock after
this Offering by persons other than the Company in "nonissuer transactions"
must either be qualified under applicable blue sky laws, or exempt from such
qualification requirements. By virtue of conditions imposed by the Department
of Corporations of the State of California as a condition of qualifying the
offer and sale of Common Stock in this Offering in California, purchasers of
Common Stock in this Offering in California must meet certain investor
suitability standards and will not be able to resell shares of Common Stock
publicly (and there cannot be any public trading of the Common Stock in
California) for at least 90 days after the closing of this Offering. At that
time, the Company
14
<PAGE>
intends to apply for an exemption under applicable California law permitting
secondary trading, and if the exemption is granted, secondary trading in
California may commence. However, the availability of such exemption for
secondary trading in California depends upon satisfaction of a number of
conditions, including a requirement that the Company have a class of equity
securities held by 500 or more persons and have total assets exceeding
$1,000,000, and there can be no assurance that after the closing of this
Offering the Company will have 500 or more holders of its Common Stock.
Blue sky authorities in other states may seek to impose other restrictions
on the secondary trading of Common Stock in those states. In several states,
secondary trading of the Common Stock may be permitted by virtue of an
exemption so long as information about the Company is published in a
recognized manual such as manuals published by Moody's Investor Service or
Standard & Poor's Corporation. The Company has applied for listing in a
recognized manual and will attempt to be listed in a recognized manual before
the closing of this Offering or as soon thereafter as practicable. As a result
of these or other restrictions that might be imposed, sales of Common Stock by
purchasers in this Offering, existing stockholders and future stockholders may
be restricted or prohibited in particular states as a result of applicable
blue sky laws. Purchasers of Common Stock should consult with their broker,
counsel and other advisers to determine whether there are any resale
restrictions on public resale of their Common Stock in the states in which
they reside. These restrictions may have the effect of reducing or eliminating
the liquidity of the Common Stock in one or more states and could adversely
affect the market price of the Common Stock.
The National Securities Markets Improvements Act of 1996 ("NSMIA"), among
other things, prohibits states from preventing secondary trading of securities
such as the Common Stock in transactions that are exempt from federal
registration requirements under Section 4(1) of the Securities Act. Section
4(1) of the Securities Act exempts from federal registration requirements
transactions by persons other than an issuer, underwriter or dealer, as those
terms are defined in the Securities Act. To the Company's knowledge, however,
the preemptive effect of NSMIA on regulation of secondary trading in
California and other states has not been definitively addressed by the courts
or applicable administrative agencies, and thus some uncertainty continues to
exist concerning the restrictions that California or other states may impose
upon secondary trading of the Common Stock.
No Prior Public Market; Possible Volatility of Stock Price. Before this
Offering, there has been no public market for the Common Stock, and there can
be no assurance that any broker-dealer will act as a market maker for the
Common Stock or that an active public market for the Common Stock will develop
or be sustained after this Offering. The initial public offering price for the
Common Stock was determined by negotiation among the Company and the Placement
Agent based upon a number of factors and may not be an indication of the
market price of the Common Stock following this Offering. See "Plan of
Distribution" for a discussion of the factors considered in determining the
initial public offering price of the Common Stock. The trading prices of the
Common Stock could be subject to wide fluctuations in response to quarterly
variations in operating results, announcements of new products by the Company
or its competitors, changes in financial estimates by securities analysts,
sales of a large number of shares of Common Stock in the market and other
events or factors. In addition, the Company believes that the stock market has
experienced volatility that has affected the market prices of equity
securities of many cosmetics companies and that sometimes has been unrelated
or disproportionate to the operating performance of such companies. These
broad market fluctuations may adversely affect the market price of the Common
Stock.
Shares Eligible for Future Sale. Sales of a substantial number of shares of
Common Stock in the public market following this Offering could adversely
affect the market price for the Common Stock. The number of shares of Common
Stock available for sale in the public market is limited by restrictions under
the Securities Act and lock-up agreements providing that the holders of such
shares will not directly or indirectly sell, contract to sell, grant any
option to purchase or otherwise transfer or dispose of any securities of the
Company (subject to certain exceptions) until one year from the closing of
this Offering without the prior written consent of the Placement Agent.
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<PAGE>
Based on shares issued and outstanding as of March 31, 1997, as a result of
the foregoing lock-up agreements and securities law restrictions, 37,500
shares of Common Stock, and up to an additional 30,000 shares of Common Stock,
other than the Shares offered hereby will be eligible for resale without
restriction immediately after the Closing of this Offering pursuant to Rule
144 or Rule 144(k), 6,818 shares of Common Stock will be eligible for resale
commencing 90 days after the date of this Prospectus pursuant to Rule 144,
11,363 shares of Common Stock will be eligible for resale commencing 120 days
after the date of this Prospectus pursuant to Rule 144, and approximately
1,392,618 additional shares of Common Stock will be eligible for resale,
pursuant to either Rule 701, Rule 144 or Rule 144(k), beginning one year from
the effective date of the Registration Statement relating to this Offering
with respect to 68,045 shares and one year from the Closing of this Offering
with respect to the remaining shares. The Company also intends to register on
a registration statement on Form S-8, following the Closing of this Offering,
a total of 622,000 shares of Common Stock (assuming no exercise of options or
warrants after March 31, 1997) subject to certain outstanding options or
reserved for issuance under the Company's 1997 Equity Incentive Plan and 1997
Directors Stock Option Plan. Additional shares of Common Stock issuable upon
the exercise of certain outstanding options and warrants will become eligible
for public sale as a result of registration rights agreements with the Company
or the Company otherwise agreeing to register such shares. See "Description of
Capital Stock--Registration Rights" and "Shares Eligible for Future Sale."
Placement Agent's Warrants. At the closing of this Offering, the Company
will sell to the Placement Agent for nominal consideration the Placement
Agent's Warrants to purchase up to 112,500 shares of Common Stock. The
Placement Agent will be issued one Placement Agent's Warrant for every 10
Shares sold in this Offering. The Placement Agent's Warrants will be
exercisable for a period of four years commencing 12 months after the date of
this Prospectus, at an exercise price equal to $9.90 per share. As long as the
Placement Agent's Warrants or other outstanding warrants remain unexercised,
the Company's ability to obtain additional capital might be adversely
affected. Moreover, the Placement Agent or other holders of outstanding
warrants may be expected to exercise such warrants at a time when the Company
would, in all likelihood, be able to obtain any needed capital by a new
offering of its securities on terms more favorable than those provided by the
warrants. Holders of the Placement Agent's Warrants and holders of other
warrants have certain registration rights with respect to shares of Common
Stock underlying those warrants. See "Description of Capital Stock--Other
Securities," "Description of Capital Stock--Registration Rights" and "Plan of
Distribution."
Immediate and Substantial Dilution. Investors participating in this Offering
will incur immediate, substantial dilution of $5.61 per share in the as
adjusted net tangible book value of the Common Stock from the Minimum
Offering. The purchasers of Shares will incur immediate, substantial dilution
of $4.43 per share in the as adjusted net tangible book value of the Common
Stock from the Maximum Offering. To the extent options and warrants to
purchase Common Stock are exercised, there will be further dilution. See
"Dilution."
Legal Proceedings. From October through December 1996, in additional
closings of the Bridge Financing, the Company issued Bridge Notes in the
aggregate principal amount of $250,000 and additional Bridge Warrants to
purchase an estimated approximately 41,667 shares of Common Stock. Such
issuances may not have complied with all applicable requirements to satisfy
exemptions from the registration or qualification requirements under
securities laws of the United States and certain states in which those
securities were issued. The Bridge Notes will, however, be repaid in full at
the closing of this Offering, and to date no purchaser has made a claim for
rescission or other remedies. As a result, the Company believes that even if
such transactions were found to have violated federal or state securities
laws, such violations would not have a material adverse effect on the
Company's business, operating results or financial condition, although there
can be no assurances that this would be the case.
A dispute exists between the Company and a third party under an infomercial
production and product management agreement concerning the Company's and the
third party's obligations and performance under that agreement. The Company is
also subject to various claims and business disputes in the ordinary course of
business; however, the Company is unaware of any present claims or disputes
which would have a material adverse effect on the Company's business,
operating results or financial condition. See "Business--Legal Proceedings."
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<PAGE>
USE OF PROCEEDS
The gross proceeds to the Company from the sale of the Shares offered by the
Company hereby if the Minimum Offering is sold will be $3,000,000 and if the
Maximum Offering is sold will be $6,750,000. The net proceeds to the Company
if the Minimum Offering is sold are estimated to be approximately $1,786,000
and if the Maximum Offering is sold are estimated to be approximately
$5,093,500, after deducting estimated placement agent's commissions of
$354,000 if the Minimum Offering is sold and $796,500 if the Maximum Offering
is sold and offering expenses of approximately $860,000. The Company currently
expects to use the estimated net proceeds as follows:
<TABLE>
<CAPTION>
MINIMUM OFFERING MAXIMUM OFFERING
------------------------- -------------------------
APPROXIMATE APPROXIMATE APPROXIMATE APPROXIMATE
DOLLAR PERCENTAGE OF DOLLAR PERCENTAGE OF
APPLICATION OF NET PROCEEDS AMOUNT NET PROCEEDS AMOUNT NET PROCEEDS
- --------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Repayment of outstanding
debt(1)................... $1,078,500 60.4% $1,078,500 21.1%
Payment of outstanding
consultants' fees(2)...... 130,000 7.3 130,000 2.6
Marketing and sales of the
Company's products(3)..... 375,000 21.0 2,525,000 49.6
Working capital and general
corporate purposes........ 202,500 11.3 1,360,000 26.7
---------- ----------
$1,786,000 $5,093,500
</TABLE>
- --------
(1) The Company intends to apply these proceeds to repay approximately
$950,000 payable under the notes issued in the Bridge Financing (which
have interest rates ranging from 12% to 15% per annum), $107,500 payable
under the notes issued in the 1995 Note Financing (which have an interest
rate of 10.0% per annum) and $21,000 relating to an unsecured promissory
note (which has an interest rate of 10.0% per annum). See
"Capitalization--Recent Financing Transactions" and "Certain
Transactions."
(2) The Company intends to apply these proceeds to pay certain outstanding
consultants' fees, royalties and commissions.
(3) The Company intends to apply these proceeds to the marketing of the
Company's products to upscale retail stores located in the United States,
the anticipated launch of products in other countries and the pursuit of
other marketing and sales opportunities. See "Business--Sales and
Marketing."
The foregoing represent estimates only, and the actual amounts expended by
the Company for these purposes and the timing of such expenditures will depend
on numerous factors. If more than the Minimum Shares are sold, the Company may
use a portion of the net proceeds to acquire businesses or companies
complementary to the Company's business, although the Company currently has no
specific plans or commitments to acquire any business or companies, from
affiliates of the Company or any other party. The terms of any such
acquisition from an affiliate of the Company will be no less favorable to the
Company than could be obtained from unaffiliated third parties. Pending use of
the net proceeds for the above purposes, the Company intends to invest such
funds in short-term, interest-bearing, investment-grade obligations and
federally insured certificates of deposit.
The Company's capital requirements to date have been provided through
private placements of Common Stock, notes payable and the Bridge Financing. At
March 31, 1997, the Company's current liabilities, including approximately
$474,000 of accrued Offering costs, exceeded its current assets by
approximately $1,600,000. The Company believes that the net proceeds from the
Minimum Offering, together with cash on hand, cash expected to be received
upon payment of outstanding accounts receivable at March 31, 1997, and cash
expected to be generated from operations, will be sufficient to pay existing
liabilities, including notes payable and the Bridge Notes, but may be
insufficient to satisfy other anticipated cash requirements for the 12 months
after the date of this Prospectus, and that the Company may need to obtain
additional funds during such 12-month period. There can be no assurance that
the Company will be able to obtain necessary additional funding on acceptable
terms. Failure to obtain necessary funding would have a material adverse
effect on the Company's business, operating
17
<PAGE>
results and financial condition. See "Risk Factors--Future Additional Capital
Requirements; No Assurance Future Capital Will be Available."
The Company believes that the estimated net proceeds from the Maximum
Offering, together with cash on hand, cash expected to be received upon
payment of outstanding accounts receivable at March 31, 1997, and cash
expected to be generated from operations will be sufficient to meet the
Company's anticipated cash requirements for at least 12 months from the date
of this Prospectus. Even if the Maximum Shares are sold in this Offering,
there can be no assurance that the Company will not require additional funding
sooner than expected or that such additional funding, if needed, will be
available on terms attractive to the Company, or at all. Failure to obtain
necessary funding would have a material adverse effect on the Company's
business, operating results and financial condition. See "Risk Factors--Future
Additional Capital Requirements; No Assurance Future Capital Will be
Available."
Prior to expenditure, the net proceeds will be invested in short-term
interest-bearing securities or money market funds.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock. The Company currently anticipates that it will retain all future
earnings for use in its business and does not anticipate paying any cash
dividends in the foreseeable future. The payment of any future dividends will
be at the discretion of the Company's Board of Directors and will depend upon,
among other things, future earnings, operations, capital requirements, the
general financial condition of the Company, general business conditions and
contractual restrictions on payment of dividends, if any.
18
<PAGE>
CAPITALIZATION
The following tables set forth, as of March 31, 1997, (1) the actual
capitalization of the Company, (2) the pro forma capitalization of the Company
to reflect the reincorporation of the Company in Delaware and concurrent
changes to the Company's authorized capital stock, and (3) further adjustment
of the pro forma capitalization to give effect to the sale of 500,000 Shares
offered in the Minimum Offering and 1,125,000 Shares offered in the Maximum
Offering, after deducting Placement Agent's commissions and other estimated
expenses of the Minimum Offering and the Maximum Offering, respectively.
<TABLE>
<CAPTION>
MARCH 31, 1997
------------------------------------------
AS ADJUSTED AS ADJUSTED
FOR MINIMUM FOR MAXIMUM
ACTUAL PRO FORMA OFFERING(1) OFFERING(2)
------- --------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Notes and capital lease
payable(3)(4)....................... $ 1,031 $ 1,031 $ 47 $ 47
Stockholders' equity(4):
Preferred stock, par value $.001
per share, no shares authorized
actual, 10,000,000 shares
authorized pro forma and as
adjusted, no shares issued or
outstanding pro forma and as
adjusted..........................
Common stock, no par value actual,
par value $.001 per share
pro forma and as adjusted:
Authorized shares--6,000,000
actual, 15,000,000 pro forma and
as adjusted.....................
Issued and outstanding shares--
1,478,299, 1,478,299, 1,978,299
and 2,603,299,
respectively(1)(2)(6)(7)........ 1,816 1 2 3
Additional paid-in capital(1)(2)... -- 1,815 3,686 6,993
Warrants(3)(7)..................... 481 481 475 475
Accumulated deficit................ (3,279) (3,279) (3,373) (3,373)
------- ------- ------- ------
Total stockholders' equity
(deficit)......................... (982) (982) 790 4,098
------- ------- ------- ------
Total capitalization........... $ 49 $ 49 $ 837 $4,145
======= ======= ======= ======
</TABLE>
- --------
(1) As adjusted to give effect to the issuance of the Minimum Shares offered
hereby at an initial offering price of $6.00 per share (after deducting
Placement Agent's commissions and other estimated expenses of this
Offering in aggregate of $1,214,000).
(2) As adjusted to give effect to the issuance of the Maximum Shares offered
hereby at an initial offering price of $6.00 per share (after deducting
Placement Agent's commissions and other estimated expenses of this
Offering in aggregate of $1,656,500).
(3) The Bridge Financing (see "--Recent Financing Transactions") is accounted
for as a borrowing and a sale of equity securities (the Bridge Warrants).
The $950,000 gross proceeds of the Bridge Financing is allocated between
the Bridge Notes and the Bridge Warrants based on their relative fair
values at the date of issuance. The Bridge Warrants are exercisable at a
nominal amount of $.022 per share. Consequently, their fair value was
deemed to be $950,000, the fair value of the Common Stock issuable upon
exercise of the Bridge Warrants. The estimated fair value of the Bridge
Notes is also $950,000, which is their principal amount and which will be
repaid upon closing of this Offering. The Bridge Warrants are reflected
above at a discounted amount of $475,000. At March 31, 1997, those Bridge
Notes are reflected in the balance sheet at $855,834 ($950,000, less
unamortized discount of $94,166).
(4) Loans to the Company (excluding the Bridge Notes) in the aggregate
principal amount of $128,500 outstanding at March 31, 1997, are also due
upon the Closing of this Offering.
19
<PAGE>
(5) Before the Closing of this Offering, the Company will reincorporate in
Delaware and change its authorized capital to consist of 15,000,000 shares
of $.001 par value common stock and 10,000,000 shares of $.001 par value
preferred stock.
(6) Based upon shares issued and outstanding as of March 31, 1997. Does not
include 272,000 shares of Common Stock issuable upon exercise of options
outstanding as of March 31, 1997 granted to directors, officers, employees
of, and consultants to, the Company, at a weighted average exercise price
of $2.42 per share; (ii) 150,000 shares of Common Stock issuable upon
exercise of options to be granted concurrently with the effective date of
this Offering, at an exercise price equal to 110% of the initial public
offering price of the Shares offered hereby; (iii) 200,000 additional
shares of Common Stock reserved for future grants under the Company's 1997
Directors Stock Option Plan and 1997 Equity Incentive Plan; (iv) 73,036
shares of Common Stock issuable upon exercise of other options and
warrants outstanding as of March 31, 1997, at an exercise price of $1.10
per share; (v) an estimated approximately 158,333 shares of Common Stock
issuable upon exercise of the Bridge Warrants at an exercise price of
$0.022 per share; and (vi) 50,000 shares of Common Stock issuable upon
exercise of the Placement Agent's Warrants if only the Minimum Shares are
sold in this Offering and 112,500 shares of Common Stock issuable upon
exercise of the Placement Agent's Warrants if the Maximum Shares are sold
in this Offering, at an exercise price equal to $9.90 per share.
(7) Options (which are included as "Warrants" in the above table) to purchase
73,036 shares of Common Stock, issued by the Company in connection with
certain loans to the Company, are exercisable only through the effective
date of an initial public offering. Because the exercise price of $1.10
per share under such options is significantly less than the estimated
initial public offering price of the Shares offered hereby, it is assumed
for the As Adjusted calculations that all such options will be exercised
for aggregate net proceeds to the Company of $80,344. However, the holders
of such options may allow any or all of the options to expire without
exercise.
RECENT FINANCING TRANSACTIONS
Common Stock Private Placements. From May 1, 1996 to June 30, 1996, the
Company sold a total of approximately 121,106 shares of Common Stock in a
private placement transaction to a limited number of investors at a price of
$4.40 per share. Such sales were made in reliance on Section 4(2) of the
Securities Act. See "Description of Capital Stock."
In November and December 1996, the Company sold a total of 70,000 shares of
Common Stock in a private placement transaction to two investors at $5.94 per
share. Such sales were made in reliance on Regulation S of the Securities Act.
In connection with such sales, the Company paid placement fees to the
Placement Agent of $49,897 and the net proceeds from such sales were $365,903.
Bridge Financing Transaction. In a July 1996 private placement, the Company
issued $500,000 principal amount of 12% nonconvertible promissory notes (the
"Bridge Notes") and warrants (the "Bridge Warrants") to acquire shares (the
"Bridge Shares") of Common Stock to a small number of sophisticated investors
(the "Bridge Investors"). The exercise price of the Bridge Warrant issued to
each Bridge Investor is $0.022 per Bridge Share. Net proceeds were
approximately $427,500. In additional closings ("Additional Closings") of the
Bridge Financing from October through December 1996, the Company issued
additional Bridge Notes in the aggregate principal amount of $250,000 and
additional Bridge Warrants. The Bridge Warrants issued in the Additional
Closings are not exercisable until one year following the effective date of
this Offering. Net proceeds from such Additional Closings was approximately
$250,000. In January 1997, the Company issued additional Bridge Notes in the
aggregate principal amount of $200,000 and additional Bridge Warrants, in
reliance on Regulation S of the Securities Act. The Bridge Warrants entitle
the holders to acquire a number of Bridge Shares equal to the principal amount
of the holder's Bridge Note ($950,000 in the aggregate) divided by the initial
public offering price of one Share. If this Offering is not consummated before
one year following the date of issuance of a Bridge Warrant, then that Bridge
Warrant will entitle the holder to acquire a number of Bridge Shares equal to
the principal amount of the holder's Bridge Note divided by $4.40 per share.
Interest on the outstanding
20
<PAGE>
principal balance of each Bridge Note accrues at a rate of 12% per annum until
six months following its issuance and 15% per annum thereafter until maturity.
Principal and interest under each Bridge Note is due in four equal quarterly
installments beginning nine months following its issuance, unless an initial
public offering becomes effective before that date, at which time principal
will be due five business days after the Company receives funds from such an
offering. The agent for the Bridge Investors, on behalf of all the Bridge
Investors, has agreed, until the earlier of July 31, 1997 or one business day
following the Closing of the Minimum Offering, not to declare any amounts
owing under the Bridge Notes to be due and payable. If an event of default
occurs with respect to the payment by the Company of any of these
installments, then holders of approximately 884,074 shares of Common Stock
have agreed to vote their shares in favor of the directors designated by a
representative of the Bridge Investors, and the Company has agreed in certain
circumstances to cause additional shares to become subject to the voting
agreement so that the representative of the Bridge Investors can elect a
majority of the directors of the Company. The Bridge Notes are secured by a
security interest, granted to a representative of the Bridge Investors, in
substantially all of the assets of the Company, including its intellectual
property. The rights of the Bridge Investors in the collateral, and the
procedures governing the Bridge Investors' rights to act with respect to the
collateral, are governed by a security agreement. Upon repayment of the Bridge
Notes following the closing of this Offering or otherwise at maturity or
prepayment, the collateral will be released in full.
The Company intends to repay the Bridge Notes out of a portion of the net
proceeds of this Offering. See "Use of Proceeds." As a result, after the
closing of this Offering no Bridge Notes will remain outstanding. The Company
has the option to prepay the Bridge Notes at any time upon notice to the
holders.
The Company has agreed to file a registration statement no later than nine
months after the effectiveness of this Offering registering the resale of the
Bridge Shares, and the Bridge Investors have certain additional piggyback
registration rights. See "Description of Capital Stock--Registration Rights."
The Bridge Warrants issued in the Bridge Financing have been valued at
issuance for financial statement purposes at their estimated relative fair
market value, and this amount will represent a discount from the principal
amount of the Bridge Notes. The amount of the discount is being amortized to
interest expense over the contractual maturity of the Bridge Notes.
In connection with the Bridge Financing and all Additional Closings
thereunder, the Company paid placement fees and legal fees to third parties of
a total of $72,500.
The transactions described above in which Bridge Notes and Bridge Warrants
were issued are referred to in this Prospectus as the "Bridge Financing."
21
<PAGE>
DILUTION
The net negative tangible book value of the Company as of March 31, 1997 was
approximately $(1,552,000) or $(1.05) per share of Common Stock. Net tangible
book value per share is determined by dividing the amount of total tangible
assets of the Company less total liabilities by the number of shares of Common
Stock outstanding at that date. After giving effect to the sale of the 500,000
Shares offered by the Company hereby in the Minimum Offering (after deducting
the estimated Placement Agent's commissions and offering expenses of the
Minimum Offering), the adjusted net tangible book value of the Company as of
March 31, 1997 would have been approximately $773,000 or $0.39 per share. This
represents an immediate increase in net tangible book value of $1.44 per share
to existing stockholders and an immediate dilution of $5.61 per share to new
investors purchasing Shares at the initial public offering price. After giving
effect to the sale of the 1,125,000 Shares offered by the Company hereby in
the Maximum Offering (after deducting the estimated Placement Agent's
commissions and offering expenses of the Maximum Offering), the adjusted net
tangible book value of the Company as of March 31, 1997 would have been
approximately $4,081,000 or $1.57 per share. This represents an immediate
increase in net tangible book value of $2.62 per share to existing
stockholders and an immediate dilution of $4.43 per share to new investors
purchasing Shares at the initial public offering price. The following table
illustrates the per share dilution.
<TABLE>
<CAPTION>
MINIMUM
OFFERING
--------
<S> <C> <C>
Assumed initial public offering price per share............... $6.00
-----
Net tangible book value per share at March 31, 1997......... $(1.05)
------
Increase in net tangible book value per share attributable
to new investors........................................... 1.44
------
Pro forma net tangible book value per share after this
Offering..................................................... 0.39
-----
Net tangible book value dilution per share to new investors... $5.61
=====
</TABLE>
<TABLE>
<CAPTION>
MAXIMUM
OFFERING
--------
<S> <C> <C>
Assumed initial public offering price per share............... $6.00
-----
Net tangible book value per share at March 31, 1997......... $(1.05)
------
Increase in net tangible book value per share attributable
to new investors........................................... 2.62
------
Pro forma net tangible book value per share after this
Offering..................................................... 1.57
-----
Net tangible book value dilution per share to new investors... $4.43
=====
</TABLE>
The following table summarizes, on a pro forma basis as of March 31, 1997,
the number of shares of Common Stock purchased from the Company, the total
consideration paid and the average price per share paid by the existing
stockholders and by the new investors purchasing Shares in this Offering
(before deduction of estimated Placement Agent's commissions and offering
expenses), based upon an initial public offering price of $6.00 per Share:
<TABLE>
<CAPTION>
TOTAL
SHARES PURCHASED CONSIDERATION
----------------- ------------------ AVERAGE
NUMBER PERCENT AMOUNT PERCENT PRICE PER SHARE
--------- ------- ---------- ------- ---------------
<S> <C> <C> <C> <C> <C>
Existing stockholders...... 1,478,299 74.7% $1,986,186 39.8% $1.34
New investors.............. 500,000 25.3 3,000,000 60.2 6.00
--------- ----- ---------- -----
Totals................... 1,978,299 100.0% $4,986,186 100.0%
========= ===== ========== =====
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
TOTAL
SHARES PURCHASED CONSIDERATION
----------------- ------------------ AVERAGE
NUMBER PERCENT AMOUNT PERCENT PRICE PER SHARE
--------- ------- ---------- ------- ---------------
<S> <C> <C> <C> <C> <C>
Existing stockholders...... 1,478,299 56.8% $1,986,186 22.7% $1.34
New investors.............. 1,125,000 43.2 6,750,000 77.3 6.00
--------- ----- ---------- -----
Totals................... 2,603,299 100.0% $8,736,186 100.0%
========= ===== ========== =====
</TABLE>
The foregoing tables assume no exercise of outstanding stock options and
warrants. As a consequence, the foregoing tables do not include (i) 345,036
shares of Common Stock issuable upon exercise of stock options and warrants
outstanding as of March 31, 1997, at a weighted average exercise price of
$2.14 per share; (ii) 150,000 shares of Common Stock issuable upon exercise of
options to be granted concurrently with the effective date of this Offering,
at an exercise price equal to 110% of the initial public offering price of the
Shares offered hereby; (iii) 200,000 additional shares of Common Stock
reserved for future grants under the Company's 1997 Directors Stock Option
Plan and 1997 Equity Incentive Plan; (iv) an estimated approximately
158,333 shares of Common Stock issuable upon exercise of the Bridge Warrants,
at an exercise price of $0.022 per share and (v) 50,000 shares of Common Stock
issuable upon exercise of the Placement Agent's Warrants if only the Minimum
Shares are sold in this Offering and 112,500 shares of Common Stock issuable
from exercise of the Placement Agent's Warrants if the Maximum Shares are sold
in this Offering, at an exercise price equal to 165% of the initial public
offering price of the Shares offered hereby. To the extent that any of these
options or warrants are exercised, there will be further dilution to new
investors. See "Capitalization," "Management--Employee Benefit Plans" and
"Description of Capital Stock."
23
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the
Financial Statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing elsewhere in this Prospectus.
The statement of operations data for the years ended December 31, 1995 and
1996, and the balance sheet data at December 31, 1995 and 1996, are derived
from and qualified by reference to the Financial Statements included elsewhere
in this Prospectus. The selected financial data as of March 31, 1997 and for
the three months ended March 31, 1996 and 1997 are derived from unaudited
financial statements of the Company and include all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
financial position and the results of operations for the period. Operating
results for the three months ended March 31, 1997 are not necessarily
indicative of the results that may be expected for the entire year. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
-------------- --------------
1995 1996 1996 1997
----- ------- ------ ------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues..................................... $ 328 $ 1,255 $ 171 $ 859
Cost of products sold........................ 160 435 83 370
----- ------- ------ ------
Gross profit............................... 168 820 88 489
Operating expenses:
General and administrative................. 293 542 80 99
Selling and marketing...................... 600 1,588 161 782
Product management......................... 66 91 26 26
----- ------- ------ ------
Loss from operations......................... (791) (1,401) (179) (418)
Other income (expenses):
Interest expense........................... (20) (443) (11) (127)
Other income (expense)..................... -- 2 -- (1)
----- ------- ------ ------
Net loss..................................... $(811) $(1,842) $ (190) $ (546)
===== ======= ====== ======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
------------- ---------
1995 1996 1997
---- ------ ---------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash............................................... $ 37 $ 91 $ 83
Current assets..................................... 280 869 856
Current liabilities................................ 558 1,869 2,447
Total assets....................................... 291 1,372 1,503
Notes payable and capital leases................... 200 844 1,031
Accumulated deficit................................ (890) (2,733) (3,279)
Total stockholders' deficit........................ (273) (536) (982)
</TABLE>
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion contains certain forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from the results discussed in such forward-looking statements.
Factors that could cause or contribute to such differences include those
discussed below and elsewhere in this Prospectus, particularly in "Risk
Factors."
GENERAL
The Company was formed in August 1993 for the purpose of developing and
marketing cosmetic skin care products, including its Patches. The Company will
reincorporate in Delaware before the Closing of this Offering.
The Company has never been profitable and, at March 31, 1997, had a working
capital deficit of $1,590,456 and an accumulated deficit of $3,278,954. The
Company began shipping its first product, Antioxidant Skin Care Derms, in
April 1995, and the Company's limited operating history makes the prediction
of future operating results difficult. The Company does not believe that prior
growth rates are necessarily indicative of future operating results. Future
operating results will depend on many factors, including demand for the
Company's products, the level of product and price competition, the Company's
success in expanding the number of stores through which its products are sold
and its other distribution channels, the ability of the Company to develop and
market line extensions of its present products, the ability of the Company to
control costs, general economic conditions and other factors. See "Risk
Factors--Limited Operating History; History of Operating Losses; Going Concern
Opinion; Accumulated Deficit."
Approximately 36% of the Company's revenues from initial shipments in April
1995 to March 31, 1997 have been derived from the sale of products to Saks
Fifth Avenue stores located in the United States. Revenues from sales to Saks
Fifth Avenue stores accounted for approximately 88%, 37% and 15% of the
Company's revenues for the years ended December 31, 1995 and 1996 and the
three months ended March 31, 1997, respectively. The Company expects that the
ratio of revenues from sales to Saks Fifth Avenue stores to its total revenues
will continue to decrease. See "Risk Factors--Product and Customer
Concentration" and "Business--Strategy." Revenues from sales to Self Care
catalog, Matchbox Agency, Neiman Marcus and House of Fraser stores accounted
for approximately 12%, 1%, 0% and 0% of the Company's revenues, respectively,
for the year ended December 31, 1995, 16%, 2%, 11% and 18% of the Company's
revenues, respectively, for the year ended December 31, 1996 and 11%, 36%, 18%
and 0% of the Company's revenues, respectively, for the three months ended
March 31, 1997. Total foreign sales accounted for 0%, 32% and 50% of the
Company's revenues for the years ended December 31, 1995 and 1996 and three
months ended March 31, 1997, respectively. The Company currently expects that
revenues attributable to Antioxidant Skin Care Derms and other Osmotics label
products will account for a significant portion of the Company's revenues in
1997. As a result, the Company's future operating results are dependent upon
market acceptance of these products in both domestic and international retail
outlets. There can be no assurance that the Company's products will achieve
market acceptance or that the Company will be successful in marketing its
products. A decline in demand for, or market acceptance of, Antioxidant Skin
Care Derms, as a result of competition or other factors, would have a material
adverse effect on the Company's business, operating results and financial
condition. However, the Company began marketing products under the Wrinkle
Patch label in October 1995 and began marketing the Spa-Sante label Patch in
March 1996. Sales from these products accounted for approximately 26% and 13%
of the Company's revenues for the year ended December 31, 1996 and the three
months ended March 31, 1997, respectively. Revenues from sales of The Wrinkle
Patch accounted for approximately 12% and 12% of total revenues for the year
ended December 31, 1996 and the three months ended March 31, 1997,
respectively. Revenues from private label sales to third parties for sale
under their own label accounted for approximately 0%, 2% and 41% of the
Company's revenues for the years ended December 31, 1995 and 1996 and the
three months ended March 31, 1997, respectively.
The cosmetics, skin care and personal care business is highly competitive.
Increased competition could result in price reductions, reduced transaction
size, fewer customer orders and reduced gross margins, any of
25
<PAGE>
which could have a material adverse effect on the Company's business,
operating results and financial condition. See "Risk Factors--Competition."
RESULTS OF OPERATIONS
Years ended December 31, 1995 and 1996
Revenues. Total revenues for 1996 were $1,254,800, compared with $328,465
for 1995. A major component of the increase was an increase in the volume of
domestic retail sales of Osmotics label products. These revenues increased
even though the Company engaged in only limited advertising during 1996. The
Company also benefited from greater market awareness of the Company's
products, stimulated in part by non-Company sponsored articles in television
and print media about the Company's products. Another major component of the
increase in revenues was revenues from sales of new products, primarily The
Wrinkle Patch and, to a lesser extent, Spa-Sante label products. Revenues from
international sales also contributed to the increase in 1996 compared to 1995.
The Company did not have any revenues from international sales in 1995.
Cost of Products Sold. Cost of products sold were $435,201 for 1996 compared
to $160,000 for 1995. The increase was due primarily to the increase in volume
of sales. Cost of products sold as a percentage of revenues was 34.7% for 1996
compared to 48.7% for 1995, due to the costs not increasing proportionately
with higher volume of sales. The Company expects that the dollar amount of
costs of products sold will increase with increases in product sales; however,
there can be no assurance that margins with respect to increased sales will
continue at the levels experienced to date. Margins will vary with the mix of
products sold, unit sales prices, and actual material and manufacturing costs
negotiated with vendors.
Production Management. While the Company's products are manufactured by
third parties, the Company is responsible for purchasing and procurement of
inventory, arranging for product storage and coordination of shipments to
customers. Primary components of production management include expenses
relating to wages and salaries of the Company's personnel engaged in operating
activities, payroll related costs, and travel. Production management expenses
were $90,889 for 1996 compared to $66,059 for 1995. The increase was primarily
due to increase in salary and salary-related items.
Selling and Marketing. Selling and marketing expenses were $1,587,765 for
1996 compared to $600,087 for 1995. Major selling and marketing expenses
include, among other things, development expenses relating to the Company's
products, salaries, fringe benefits, public relations, advertising, trade
shows and travel costs. The increase was primarily due to increase in
personnel, accelerated travel requirements, promotional and advertising
efforts, including attendance at trade shows, to introduce the Company's
products, and greater sample costs.
General and Administrative. General and administrative costs were $541,600
for 1996 compared to $292,742 for 1995. The increase was primarily due to
increased expenses in the areas of salaries and salary related costs of
personnel engaged in administrative functions, accounting and general services
and costs such as rent, insurance, telephone, legal, postage, depreciation and
financing expenses.
Interest. Interest expenses increased to $443,480 for 1996 from $20,285 for
1995 primarily because of interest relating to promissory notes executed in
1994 and 1995, and amortization of the discount related to the Bridge Notes.
Three Months Ended March 31, 1996 and 1997
Revenues. Total revenues for the three months ended March 31, 1997, were
$859,355, compared with $171,047 for the same period in 1996. The major
components of the increase were increases in private label sales to third
parties for sales under their own label and increases in the volume of
domestic and international retail sales of Osmotics label products. The
Company benefitted from significant advertising during the three months ended
March 31, 1997. The Company also benefitted from greater market awareness of
the Company's products, stimulated in part by non-Company sponsored articles
in television and print media about the
26
<PAGE>
Company's products. Revenues also increased from sales of new products,
primarily The Wrinkle Patch and, to a lesser extent, Spa Sante label products.
Costs of Products Sold. Cost of products sold were $369,698 for the three
months ended March 31, 1997, compared to $82,722 for the same period in 1996.
The increase was due primarily to the increase in volume of sales. Cost of
products sold as a percentage of revenues was 43.0% for the three months ended
March 31, 1997, compared to 48.0% for the same period in 1996, due to the
costs decreasing with higher volume of sales. The Company expects that the
dollar amount of costs of products sold will increase with increases in
product sales; however, there can be no assurance that margins with respect to
increased sales will continue at the levels experienced to date. Margins will
vary depending on several factors, including the mix of products sold, unit
sales prices, and actual material and manufacturing costs negotiated with
vendors.
Production Management. Production management expenses were $25,954 for the
three months ended March 31, 1997, compared to $26,676 for the same period in
1996.
Selling and Marketing. Selling and marketing expenses were $782,640 for the
three months ended March 31, 1997, compared to $160,887 for the same period in
1996. Major components of selling and marketing expenses include, among other
things, advertising, development expenses relating to the Company's products,
salaries, fringe benefits, public relations, trade shows and travel costs. The
increase was primarily due to increases in personnel, travel, promotional and
advertising efforts, including attendance at trade shows, to introduce the
Company's products, and greater sample costs. Selling and marketing expenses
are expected to increase significantly after this Offering as a result of
increased marketing efforts, both domestic and international, increased
salaries and hiring of personnel, advertising and promotion and new product
introductions and are expected to initially increase as a percentage of the
Company's revenues until sales volume increases, if any, are achieved.
General and Administrative. General and administrative costs were $99,283
for the three months ended March 31, 1997, compared to $79,843 for the same
period in 1996. The increase was primarily due to increased expenses in the
areas of salaries and salary related costs of personnel engaged in
administrative functions, accounting and general services and costs such as
rent, insurance, telephone, legal, postage, depreciation and financing
expenses. The Company's operating expenses are expected to increase
significantly as the result of anticipated increases in marketing efforts in
the United States and internationally, introduction of the Company's products
in a larger number of stores and through a greater number of channels,
increases in personnel costs associated with the anticipated expansion in the
Company's business and new costs related to being a public company (including
directors and officers liability insurance and increased professional fees).
Interest. Interest expense increased to $127,332 for the three months ended
March 31, 1997, from $10,756 for the same period in 1996, primarily because of
interest relating to promissory notes and Bridge Notes executed in 1996 and
1997, and amortization of the discount related to the Bridge Notes.
As a result of the issuance of the Bridge Notes and Bridge Warrants, for
financial statement purposes the estimated fair market value of the Bridge
Warrants will represent a discount from the principal amount of the Bridge
Notes. The amount of the discount has been amortized to interest expense over
the contractual maturity of the Bridge Notes. Consequently, because the Bridge
Notes will be repaid out of a portion of the net proceeds of this Offering,
the Company will expense any remaining unamortized discount in the quarter in
which this Offering is consummated. The amount of such expense, which will be
a one-time charge, is expected to be approximately $94,000 and will cause the
Company's reported net income for such quarter to be significantly lower (or
reported net loss to be significantly higher) than it otherwise would be.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception in August 1993, the Company has financed its activities
through the issuance of debt instruments and equity in private placement
transactions and, to a lesser degree, from sales of products, which
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commenced in April 1995. From inception to March 31, 1997, the Company had
received approximately $3,161,000 from debt and equity transactions, while
sales in the same period were approximately $2,443,000. At March 31, 1997, the
Company had approximately $83,000 in cash.
Cash used in the Company's operations was $1,629,154 for the year ended
December 31, 1996 compared to $735,081 for the year ended December 31, 1995,
and $157,777 for the three months ended March 31, 1997 compared to $211,873
for the three months ended March 31, 1996. The increase in cash used in the
Company's operations in 1996 compared to 1995 was primarily due to expansion
of the Company's organization and increased sales. The decrease in cash used
in the Company's operations for the first quarter of 1997 compared to the
first quarter of 1996 was due primarily to an increase in accounts payable and
accrued liabilities as of the end of the first quarter of 1997 compared to the
first quarter of 1996. The Company did not have any material capital
expenditures for 1995. Capital expenditures for 1996 consisted primarily of
furniture and fixtures and computer equipment, which together totaled
approximately $93,000. The Company did not have any material capital
expenditures for the three months ended March 31, 1996 or for the three months
ended March 31, 1997.
From inception through March 31, 1997, the Company reported losses of
$3,278,954. At March 31, 1997, the Company had a working capital deficit of
$1,590,456. In the absence of this Offering, the Company will need additional
funding to continue its operations through the remainder of 1997.
Consequently, there is substantial doubt as to the ability of the Company to
continue as a going concern. The Company's financial statements have been
prepared assuming that the Company will continue as a going concern and do not
include any adjustments that might result from the outcome of this
uncertainty. If this Offering is delayed or suspended, other financing sources
will be needed. The Company has no credit facility with a bank or other
financial institution and no in-place source of capital. The Company intends
to use a portion of the net proceeds of this Offering to repay the Bridge
Notes and other outstanding indebtedness. See "Use of Proceeds." While the
timing and amount of the Company's capital requirements cannot be predicted
with accuracy, the Company believes that the net proceeds of the Minimum
Offering, together with cash on hand, cash expected to be received upon
payment of outstanding accounts receivable at March 31, 1997, and cash
expected to be generated from operations, will be sufficient to pay existing
liabilities including notes payable and the Bridge Notes, but may be
insufficient to satisfy other anticipated cash requirements for the 12 months
after the date of this Prospectus, and that the Company may need to obtain
additional funds during such 12-month period through public or private debt or
equity financings, collaborative relationships, bank facilities or other
arrangements. If the Maximum Shares are sold in this Offering, the Company
believes that the net proceeds of the Maximum Offering, together with cash on
hand, cash expected to be received upon payment of outstanding accounts
receivable at March 31, 1997, and cash expected to be generated from
operations, will provide adequate funding for the Company's anticipated cash
requirements through at least 12 months after the date of this Prospectus.
However, the Company's future liquidity and capital requirements will depend
upon numerous factors, including the Company's success in increasing sales of
existing products and introducing new products, expanding the channels through
which the Company's products are sold, and operational costs controls. In
general, however, the Company's cash requirements are expected to increase
significantly over the next several years to meet new product development and
implementation programs, and to fund anticipated marketing and sale activities
associated with expended domestic and international opportunities. The Company
may be required to raise additional funds through public or private debt or
equity financing, collaborative relationships, bank facilities or other
arrangements. There can be no assurance that the Company will not require
additional funding sooner than anticipated or that such additional funding, if
needed, will be available on terms attractive to the Company, or at all. Any
additional equity financing may be dilutive to stockholders, and debt
financing, if available, may involve restrictive covenants. See "Use of
Proceeds" and "Risk Factors--Future Additional Capital Requirements; No
Assurance Future Capital Will be Available."
At March 31, 1997, the Company had net operating loss carryforwards "NOLs"
for federal tax purposes of approximately $2,600,000. The Company's ability to
use these NOLs to offset future taxable income may be subject to future
restrictions under applicable provisions of the Internal Revenue Code of 1986,
as amended (the "Code").
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BUSINESS
The Company develops and markets cosmetic skin care products. The Company's
current principal products are based on technology combining Patches with a
special formulation of ascorbic acid (vitamin C), an antioxidant. The
products, which currently include the Osmotics label Antioxidant Skin Care
Derms, the Spa-Sante label Systeme C Patch and The Wrinkle Patch, are intended
to reduce the appearance of fine facial lines and wrinkles. The Patches are
placed on targeted wrinkles on a person's face to saturate the skin with the
antioxidant. Antioxidants contained in certain current skin care lotions,
creams or oils are exposed to the atmosphere and lose their antioxidant
effectiveness, if not absorbed into the skin within a relatively short time
after application, estimated by the Company to be approximately 40 minutes. In
contrast, the Company's vitamin C formulation is protected by the Patch from
the atmosphere and, therefore, can be absorbed over the recommended 10 hour
period of treatment. Further, Patches maintain the purity of the vitamin C
formulation and deliver the formulation to specific problem areas of the skin.
Drug and Cosmetic Industry Magazine honored the Antioxidant Skin Care Derms in
its December 1995 issue in the cosmetic skin care treatment packaging
category. The Company has filed a U.S. patent application relating to certain
aspects of its Patches.
The Company believes that the skin care segment of the cosmetics market is
large and growing. One industry source has estimated that revenues in the
United States skin care products market were approximately $5.12 billion in
1994, representing approximately 24.6% of total revenues in the United States
personal care products market. The same source projected that revenues in the
United States skin care products market would be approximately $6.46 billion
in 1997 and approximately $9.31 billion in 2001, representing a compound
annual growth rate from 1994 to 2001 of 8.9%. The Company believes that a
significant portion of recent past growth in revenues has come from the
proliferation of alpha hydroxy acid ("AHA") products, which are not
antioxidants. The Company believes that a portion of the future growth in
revenues projected by the industry source will come from the sale of skin care
products containing vitamin ingredients, such as the Company's vitamin C
formulation. In the markets in which the Company intends to compete, the
Company believes that the United States market typically comprises a
significant portion of the overall worldwide market.
The Company believes that the reasons for this continued growth of sales in
the skin care products market include fundamental changes now taking place in
demographic (aging population) and environmental factors, which are
stimulating the need for innovative, more effective skin care products. The
U.S. Bureau of Census has estimated that between 1993 and 2020, the number of
individuals age 45 and over in the United States will increase by 59%, while
those under age 45 in the United States will increase by only 7%. Furthermore,
the first of the approximately 76 million "baby boomers" in the United States
who were born between 1946 and 1960 turned 50 in 1996. The Company believes
that the need for new skin care products will increase as the population ages
because concern with the effects of aging on the skin increases with age.
BACKGROUND
Skin wrinkles are caused by, among other things, free radicals. A free
radical is an unstable oxygen molecule seeking, at the molecular level, to
pair up with an electron. Free radicals can be created in the atmosphere by
the exposure of oxygen to sunlight and pollution. Free radicals can also be
created within a person's skin by natural metabolic processes. A free radical
from the atmosphere can penetrate the top layer of a person's skin, called the
lipid layer, and combine with a molecule in the next layer of skin which
supports the lipid layer, called the collagen, thereby damaging the collagen.
The collagen is weakened over time by this process, causing the lipid layer to
lose its support and the skin to become more wrinkled. Antioxidants are
molecules which can combine with and, as a result, neutralize free radicals.
Antioxidants which are absorbed into a person's skin can thereby neutralize
free radicals and reduce the appearance of fine lines and wrinkles in the
skin.
When exposed to the atmosphere, antioxidants can combine with free radicals
in the atmosphere and lose their beneficial effect, or bioavailability, on the
skin. Antioxidants contained in certain current skin care lotions,
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creams or oils are exposed to the atmosphere and as a result lose their
bioavailability, if not absorbed into the skin within a relatively short time
after application, estimated by the Company to be approximately 40 minutes.
SOLUTION
The Company's current principal products, Antioxidant Skin Care Derms, the
Spa-Sante label Patch and The Wrinkle Patch, combine transdermal cosmetic
delivery skin patches ("Patches") with a special formulation of ascorbic acid
(vitamin C), an antioxidant. The Patches are placed on targeted skin wrinkles
to saturate the skin with the antioxidant. The vitamin C formulation, upon
absorption into a person's skin, can neutralize damaging free radicals and,
therefore, reduce the appearance of fine lines and wrinkles in the skin.
Vitamin C is an unstable compound and loses bioavailability if exposed in
solution form to the atmosphere. However, in powder form, vitamin C maintains
bioavailability for up to five years. The Company's Patches store the vitamin
C formulation in powder form, thereby extending its bioavailability. The
vitamin C formulation is suspended in the raw polymer base of the Patches
through a fabrication process that creates a porous matrix effect (a lattice
work of interconnecting bonds) within the resulting Patch material. The
vitamin C formulation mixes with the moisture of a person's skin and is
absorbed into the skin. The vitamin C formulation is protected by the Patch
from the atmosphere and, therefore, can be absorbed over the recommended 10
hour period of treatment. The Company recommends that each Patch be discarded
after a single use and that a Patch be applied to the target area of skin
three times a week.
Skin patches sold by certain companies to deliver nicotine, estrogen or
nitroglycerin can sometimes cause skin irritation from the penetration
enhancers which they contain as well as from both the compounds in their
adhesives and the strength of the adhesives (which can sometimes cause
irritation when the patch is removed from the skin). However, the Company's
Patches cause little skin irritation because they use lighter adhesives and do
not contain penetration enhancers. Additionally, the Company provides an oil
based formulation to aid in the removal of its Patches.
STRATEGY
The Company's objectives are to be the leader in the marketing of skin care
products that deliver antioxidants by means of skin patches, to remain the
leader in that market segment and to expand its product line of other skin
care products and compete in the cosmeceuticals market. The key elements of
the Company's strategy to achieve this objective are as follows:
Initial Product Launch into the Upscale Retail Market. The Company initially
developed a product line, marketed under the Osmotics label, for the upscale
retail market consisting of several products, including the Antioxidant Skin
Care Derms. These products were initially launched into the upscale retail
market in order to derive the credibility and prestige for the Osmotics brand
customarily associated with success in that market. Antioxidant Skin Care
Derms were introduced in April 1995 exclusively at certain Saks Fifth Avenue
stores located in the United States. Saks Fifth Avenue provided support for
the launch of this product. Introduction of the Company's products into the
upscale market has been accompanied by positive media exposure in fashion
magazines and newspapers, such as Elle, Self and Allure, from national and
international beauty editors, who generally write about prestige market
brands.
Broader Channels of Distribution and Sales. The Company's strategy also
includes marketing and selling products through a broader number of retail
channels. The Company markets the Spa-Sante and The Wrinkle Patch labels to
the broader retail market, but through different channels. The Spa-Sante label
Patch is marketed to spas, beauty salons and estheticians and was introduced
at the International Beauty Show in New York City, a large industry trade
show, in March 1996. The Wrinkle Patch was first offered in October 1995 in
Self Care catalog. The Company offers The Wrinkle Patch label products to
several direct sale catalogs, through TV home shopping channels, through an
infomercial, and through the World Wide Web. The Company also has entered in a
number of agreements with third parties for private label sales by the third
party, and intends to pursue other opportunities
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to enter agreements with other third parties for private label sales. The
Company anticipates that it may ultimately sell a larger volume of products
through these channels than through the upscale retail market, and that at
some future date a greater portion of its total revenues may be comprised of
sales of products through these channels compared to sales of products to the
upscale retail market.
Product Line Extensions. The Company believes that, if and as consumer
awareness of its products using Patches increases, consumers may be more
likely to try other related products sold by the Company. The Company
currently markets several products as part of its different product lines. See
"--Products." The Company expects to develop and market additional line
extensions for all its various labels in the future, which might include,
among others, (1) products using Patches to deliver stronger or different
antioxidants than delivered by the Company's present products or a combination
of such antioxidants, (2) products using Patches to deliver antioxidants to
different parts of a person's body, (3) products using different shaped
Patches to accommodate various facial contours, (4) products used to pre-treat
the areas of skin to which Patches are to be applied, which, the Company
believes, will enhance the effect of the antioxidants contained in the Patch
and (5) hair, body and sun products.
The Company believes that consumers of cosmetics products are increasingly
less loyal to a particular brand name and, as a result, are less likely to
purchase multiple types of products within a brand's product line unless those
products satisfy specific needs of the consumers. The Company believes that
this trend may have aided the Company's introduction of its Patches, but there
can be no assurance that this trend will aid the Company's introduction of
products in the future. See "Risk Factors--Brand Loyalty of Consumers of
Cosmetics."
International Distribution. The Company markets its products outside of the
United States. As in the United States, the Company expects that ordinarily it
will launch its products in a country by first selling products to upscale
retailers, and then selling products into alternative retail channels. The
Company launched its Osmotics label products, including Antioxidant Skin Care
Derms, in the United Kingdom in May 1996 through the Dickins & Jones store
located on Regent Street in London, England, a member of the House of Fraser
group, which the Company believes serves the upscale retail market, and at
five other House of Fraser stores, and has since launched products in other
stores located in Europe and South America. The Company expects to launch
products in other international locations during 1997. See "--Sales and
Marketing."
PRODUCTS
Products Using Patches. The Company's current primary products are
Antioxidant Skin Care Derms, Spa-Sante label Patches and The Wrinkle Patch.
These products are Patches containing a special formulation of ascorbic acid
(vitamin C), an antioxidant. Each of these Patches has a unique shape that
covers the fine lines around a person's eyes ("crow's feet"), upper lip, brow
furrows or other targeted areas of the face, and saturates the skin with the
antioxidant. This vitamin C formulation reduces the appearance of fine lines
and wrinkles in a person's skin.
The Spa-Sante label Patches and The Wrinkle Patch contain the same amount of
vitamin C formula and have the same shape, but contain less vitamin C formula
and have a slightly different shape than Antioxidant Skin Care Derms.
Products Sold Under the Osmotics Label. The following products, in addition
to the Antioxidant Skin Care Derms, are sold under the Osmotics label:
. Hydrating Cleanser, which is a facial cleanser for normal, dry and
sensitive skin types and contains humectants to help retain moisture in
the skin.
. Balancing Cleanser, which is a facial cleanser for normal and oily skin
types and contains humectants, vitamin B6 to regulate oil production
and ingredients to reduce irritation.
. Calming Cleansing Milk, which is a mild cleanser for dry, sensitive or
irritated skin types and contains soothing botanicals and ingredients
to reduce redness and irritation.
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. Firming Tonic Facial Mist, which is a product containing natural
botanicals and pure essential oils sprayed on the face to firm, tone
and hydrate dry, mature skin.
. Balancing Tonic Facial Mist, which is a product containing natural
botanicals and pure essential oils sprayed on the face to regulate oil
control, tone, and hydrate normal to oily skin.
. Hydrating Complex SPF 15, which is a skin lotion containing antioxidant
vitamins A, C and E that replenishes moisture with hyaluronic acid and
other moisturizers and contains active sunscreen ingredients.
. Balancing Complex SPF 15, which is a skin lotion containing vitamins A,
B6, C, and E that replenishes moisture without oils and contains active
sunscreen ingredients.
. Intensive Moisture Therapy, which is a skin cream that hydrates and
nourishes dry, damaged or dehydrated skin.
. Antioxidant Eye Therapy, which is an eye gel containing botanicals to
moisturize and diminish puffiness and dark circles under the eye.
. Daily Eye Protection SPF 15, which is a skin cream designed to
moisturize and protect skin around the eyes and contains active
sunscreen ingredients.
. Facial Renewal, which is a product to be applied at night containing
alpha hydroxy acids, derived from sugarcane, buttermilk and citrus
fruit, used to remove dry, dead surface cells.
. Facial Refining Masque, which is an exfoliating masque containing
natural enzymes to gently remove dead skin cells and refine the skin's
texture.
. Antioxidant Body Complex, which is a skin cream for the body with
kalaya oil and antioxidant vitamins that moisturizes, firms, and
strengthens the skin.
. Lip Colors, which are treatment lipsticks available in six shades
containing antioxidant vitamins, moisturizers and active sunscreen
ingredients.
Products Sold Under The Wrinkle Patch Label. The following products, in
addition to The Wrinkle Patch, are sold under that label:
. Tonic Facial Mist, which is a product sprayed on the face to firm, tone
and hydrate dry, mature skin.
. Two in One Cream, which is a skin cream containing Emu oil, alpha
hydroxy acids and antioxidants.
Product Development. The Company has completed the final formulation of, and
is now in the testing and evaluation process for, emollients to be sold under
the Spa-Sante line, which are to be used to pre-treat areas of the skin to
which Patches are to be applied. The Company believes that use of these
emollients will enhance the effect of the antioxidants contained in Patches
subsequently applied to the target area. The Company designs and develops the
concepts for new products internally. After developing the concept for a
possible new product, the Company generally contracts with third party
chemists and consultants to develop the specific formula for the possible new
product. The Company tests that formula internally and then coordinates with
such third parties to finalize the formulation for the potential product.
SALES AND MARKETING
Antioxidant Skin Care Derms. The Company currently sells in the United
States Antioxidant Skin Care Derms and line extensions of that product,
including cleansers, moisturizers, toners, alpha hydroxy acid, and lipsticks
under the Osmotics label to certain Saks Fifth Avenue, Neiman Marcus and
Nordstrom stores.
Outside the United States, the Company launched Osmotics label products,
including Antioxidant Skin Care Derms, in the United Kingdom in 1996 at six
House of Fraser stores located throughout the United Kingdom. In the fall of
1996, the Company launched products in Paris, France at a Galeries Lafayette
store and in Geneva,
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Switzerland at eight Pharmacies Principale stores. In January 1997, the
Company launched products in France at Au Printemps, Samaritaine, Bon Marche,
BHV and Perfumerie Sephora stores. In December 1996, the Company introduced
products in Brazil and Ecuador. In May 1997, the Company launched products in
over 50 pharmacies in Switzerland. The Company expects to launch products in
additional countries in Canada, South America, Europe and Asia during 1997.
The Company has entered into an agreement with a third party whereby the
third party has the exclusive right to market and sell in France products
manufactured by the Company under the Osmotics label. This agreement
terminates in January 2000, and is renewable for successive three-year periods
unless either party elects otherwise. The agreement is subject to earlier
termination if the third party distributor fails to satisfy certain
performance goals.
The Spa-Sante Line. The Spa-Sante label Patch is, and other products to be
sold under the line by the Company are to be, directed at spas, beauty salons
and estheticians. The Company has entered into an agreement with a third party
whereby the third party has the exclusive right to market, sell and distribute
all skin care products manufactured by the Company under the brand name Spa-
Sante to professional beauty establishments, including spas and beauty salons,
located in North America, Central America, Europe, the Middle East and Africa.
The third party distributor will market, sell and distribute the products on
behalf of the Company and retain a percentage of the selling price of the
products sold. Beginning in 1997, the third party has agreed to pay all costs
of sales. This agreement terminates in July 2001, and is renewable at the
third party distributor's election for two successive five-year periods. The
agreement is subject to earlier termination if the third party distributor
fails to satisfy certain performance goals.
The Company has entered into an agreement with a different party, who holds
45,454 shares of Common Stock, whereby the third party has the exclusive right
to market, sell and distribute all products manufactured by the Company in
Japan, China, Korea, Taiwan, Hong Kong, Singapore, Thailand, Vietnam,
Australia, New Zealand, the Philippines, Malaysia, Indonesia and all other
Southeast Asian countries. The third party distributor will purchase for
resale the products from the Company. This agreement terminates in December
2001, and is renewable at the third party distributor's election for two
successive five-year periods. The agreement is subject to earlier termination
if the third party distributor fails to satisfy certain purchase or
performance goals, and the Company is currently reviewing the third party's
performance under the agreement, including whether the third party has
satisfied the required purchase or performance goals.
The Wrinkle Patch. The Wrinkle Patch was first offered in Self Care catalog
and is now offered in several direct sale catalogs, including Barth's, Taylor
Gifts, and Luminesence. The Company offered The Wrinkle Patch on Q2 Shopping
Channel in February 1996, and on QVC in November 1996. The Company expects to
offer The Wrinkle Patch in 1997 to self-select retail stores (stores where
consumers select their own purchases without assistance of an in-store
demonstrator).
A thirty minute infomercial has been produced offering The Wrinkle Patch,
which was shown first on United States regional cable television stations in
September 1996. Sales of The Wrinkle Patch resulting from the airings, before
the date of this Prospectus, of that infomercial were less than the Company
expected. The Company expects to dub this infomercial into various foreign
languages and show it in other countries. Additionally, an Infomercial
Production and Product Management Agreement, dated as of March 5, 1996 (as
amended, the "VideOne Agreement"), between the Company and VideOne Marketing,
Inc. ("VideOne"), provides that VideOne, the third party producer of the
infomercial, has the exclusive right worldwide, subject to certain exceptions,
(i) to manage the direct response marketing and airing of the infomercial and
(ii) to distribute The Wrinkle Patch, including updates and revisions, in
certain direct response media categories. Notwithstanding VideOne's exclusive
rights, the Company may seek an agreement with any other third party in these
direct response media categories consistent with a general marketing plan
developed by the Company and VideOne, but VideOne has a right of first refusal
to enter into an agreement with the Company on the same terms. The agreement
provides that this exclusivity terminates in March 1997, and is automatically
renewable for two successive one-year periods provided certain stated
performance goals are satisfied. The infomercial was financed
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in part by a third party, who is entitled to receive certain royalties from
sales of the product from the infomercial. A dispute exists between the
Company and VideOne concerning the parties' obligations and performance under
the VideOne Agreement. See"--Legal Proceedings."
Licensing. The Company has agreed to supply on a non-exclusive basis to a
third party skin patches for inclusion in products to be sold by the third
party under its own label in all countries, other than countries located in
the Pacific Rim. The third party has agreed not to market and sell such
products in the upscale market (which is defined in the contract), and the
Company has agreed not to sell skin patches under the Osmotics trademark
except in the upscale market. This agreement terminates in January 2002, and
is renewable for successive five-year periods unless either party elects
otherwise. The Company is pursuing additional opportunities to enter into
agreements with third parties for private label sales by the third parties.
The Company anticipates that as part of such arrangements, the third parties
would pay the costs of any new product development. The Company expects to
receive royalty fees from such licenses. There can be no assurance that the
Company will be able to enter into any such additional licenses on terms
attractive to the Company, and the Company does not anticipate receiving any
royalty revenues from such licenses, if at all, until at least 1998.
Other Agreements. The Company has entered into various agreements with third
parties to market or distribute the Company's products in various territories
including Venezuela, Greece, the Middle East and Brazil, and expects to enter
into agreements with third parties to market or distribute the Company's
products in various other countries, including Switzerland, Belgium, the
Philippines and Chile. The agreements entered into to date have terms ranging
from three to five years, subject to earlier termination if the third parties
fail to satisfy performance goals.
Public Relations. The Company's marketing efforts also include establishing
and maintaining media relations with fashion magazines and other media
outlets. News of the Company's products has been featured internationally as
well as on several United States broadcasts including CNN Headline News. To
date, the Company has received write-ups in over 25 United States publications
and 20 foreign publications, including: Longevity, World Class, New Woman, The
Rose Sheet, Women's Wear Daily, Beauty Fashion, Glamour, Beverly Hills,
Harper's Bazaar, Self, Elle and Rocky Mountain News.
MANUFACTURING
The Company currently obtains ingredients, packaging and final formulations
from several third party suppliers and has not entered into a written
agreement with any such supplier. Although the Company believes that all
ingredients are presently obtainable and has identified additional third
parties that could also supply such ingredients, there can be no assurance
that the Company will continue to be able to obtain such ingredients from
third parties at all or in sufficient quantities and on terms and conditions
acceptable to the Company. The Company relies on a different third party
contract manufacturer, named Franklin Medical, to assemble components into
finished products. The Company has entered into a written agreement respecting
confidentiality, but not supply requirements or otherwise, with this
manufacturer. The Company believes that if this manufacturer were unexpectedly
to stop assembling components into finished products for the Company, there
would be a temporary adverse effect on the Company's ability to produce
products on a timely basis, but that one or more contract manufacturers could
be identified. The Company neither has nor plans to acquire the equipment and
facilities necessary to manufacture its current and future products and is and
will be dependent upon third party contract manufacturers for such production.
There can be no assurance that the Company will continue to be able to obtain
contract manufacturing on commercially acceptable terms for products in the
quantities currently obtainable or that may be required in the future.
Further, there can be no assurance that manufacturing or quality control
problems will not arise at the manufacturing plant of the Company's present
contract manufacturer. In addition, if the FDA were to determine that any of
the Company's cosmetic products, including products that contain active
sunscreen ingredients and that are labeled with a sun protection factor, are
also drugs, those products would have to be manufactured in accordance with
the FDA's current good manufacturing practice ("GMP") requirements for
finished pharmaceuticals. See "Risk Factors--Suppliers; Manufacturing
Limitations."
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COMPETITION
The cosmetics, skin care and personal care business is highly competitive.
Increased competition could result in price reductions, reduced transaction
size, fewer customer orders, and reduced gross margins, any of which could
have a material adverse effect on the Company's business, operating results
and financial condition. The Company believes that the principal competitive
factors affecting the cosmetics market include product uniqueness, product
performance, the effectiveness of sales and marketing efforts and company
reputation. There can be no assurance that the Company will compete
successfully in the future with respect to these or other factors.
The Company believes that no other company is currently marketing products
using skin patch technology to deliver antioxidants to a person's skin for
cosmetic purposes, although certain products using gauze pads to deliver
antioxidants are presently sold by certain of the Company's competitors. The
Company believes that other products currently utilizing transdermal delivery
systems are sold primarily in prescription pharmaceutical markets for other
than cosmetic use. However, the FDA recently approved the marketing of a
consumer product, without the need for a prescription, for transdermal
delivery of nicotine using a patch. There can be no assurance that products
using patch technology to deliver antioxidants to a person's skin for cosmetic
purposes do not exist or are not under development by others.
Certain skin creams, lotions and oils currently sold by cosmetics companies,
including the Cellex-C brand antioxidant serum, compete with the Company's
comparable products. Additionally, Avon Products markets a vitamin C formula
under the brand name Anew, which Avon claims, among other things, minimizes
the appearance of fine lines and wrinkles. Some of the Company's current, and
many of the Company's potential, competitors have significantly greater
financial, marketing, product development, testing and other resources than
the Company and sell their products more widely than the Company. As a result,
they may have the capacity to respond more quickly to changes in customer
requirements or to devote greater resources to the development, testing,
promotion and sale of their products than the Company. It is possible that new
competitors may emerge and rapidly gain significant market share.
Additionally, it is possible current or new competitors might introduce
competitive products which also utilize skin patch technology or other
technology that produces results similar or superior to the Company's Patches
or which are sold at a lower price than the Company's products in similar
distribution channels. There can be no assurance that the Company will be able
to compete successfully against current and future competitors or that
competitive pressures faced by the Company will not have a material adverse
effect on its business, operating results and financial condition. See "Risk
Factors--Competition."
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company currently relies primarily on a combination of trademark laws,
trade secrets, confidentiality procedures and contractual provisions to
protect its technology. The Osmotics word logo and Antioxidant Skin Care Derms
are registered U.S. trademarks of the Company. The Company has U.S. trademark
applications pending for AKA RED, WRINKLE PATCH, THE NIGHTIME MIRACLE and
SYSTEME C. The PTO has rejected the Company's trademark application for Spa-
Sante. The Company has trademark registrations pending in Japan for OSMOTICS,
Spa Sante, The Wrinkle Patch and SYSTEME C, in Korea for OSMOTICS and the
Osmotics label, Spa Sante, The Wrinkle Patch and SYSTEME C, in the European
Community for OSMOTICS and the Osmotics logo and in Eucador for OSMOTICS.
There can be no assurance that any of these marks for which registration
applications are pending will be registered.
The Company filed one United States patent application in 1994 and filed a
continuation in part of that patent application in 1995. The PTO has rejected
all claims in these applications, alleging that the claimed inventions were
obvious. In response, the Company filed a continuation in part application in
1996, accumulating subject matter of both prior patent applications and
addressing, among other things, the use of the Patches as a method to deliver
antioxidants. The PTO issued an initial office action in April 1997 which
rejected all the claims of the 1996 continuation in part application on the
basis that references not previously relied upon in the examination of the two
earlier applications. The Company plans to respond in due course by arguing in
favor of
35
<PAGE>
patentability. The Company also has filed an application under an
international treaty designating various foreign countries for which the
Company preserved certain rights in the event it files patent applications in
any of those countries. The Company also intends to file additional patent
applications in the PTO on various features of its products in the future, if
appropriate. However, there can be no assurance that any patents will issue in
any country with respect to currently pending applications or any future
patent applications.
The validity and breadth of claims in patents involve complex legal and
factual questions and, therefore, may be highly uncertain. No assurance can be
given that any issued patent or patents based on the pending patent
application or any future patent application will exclude competitors or
provide competitive advantages to the Company or that others will not claim
rights in or ownership of the Company's rights which it regards as
proprietary. Furthermore, there can be no assurance that others have not
developed or will not develop similar products, duplicate any of the Company's
products or design around any patents that may be issued in the future to the
Company. Since patent applications in the United States are maintained in
secrecy until patents issue, the Company also cannot be certain that others
did not first file applications for inventions covered by the Company's
pending patent applications, nor can the Company be certain that it will not
infringe any patents that may issue to others on such applications.
Despite the Company's efforts to protect its rights, unauthorized parties
may attempt to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Policing unauthorized use
of the Company's products may prove to be difficult, and, while the Company is
unable to determine the existence or amount of other products which now or in
the future illegally duplicate the Company's products, such other products can
be expected to be a persistent problem. In addition, the laws of many
countries do not protect the Company's rights which it regards as proprietary
to as great an extent as do the laws of the United States. There can be no
assurance that the Company's means of protecting its rights will be adequate
or that the Company's competitors will not independently develop similar
products.
To date, the Company has not been notified that the Company's products
infringe the proprietary rights of third parties, but there can be no
assurance that third parties will not claim infringement by the Company with
respect to current or future products. Any such claims, with or without merit,
could be time-consuming, result in costly litigation, cause product shipment
delays or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on
terms acceptable to the Company or at all, which could have a material adverse
effect upon the Company's business, operating results and financial condition.
See "Risk Factors--Protection of Intellectual Property."
GOVERNMENT REGULATION
The Company and its cosmetic products are subject to regulation by the FDA
and the Federal Trade Commission (the "FTC") in the United States, as well as
by various other federal, state and local authorities. Such regulation relates
primarily to the ingredients, packaging, labeling, advertising and marketing
of the Company's products. Cosmetics do not require premarket notification to,
or premarket approval by, the FDA, but must be properly labeled and
manufactured. Failure to comply with FDA requirements in such matters can
result in severe civil and criminal penalties, including seizure of product,
injunction against production, distribution, sales, and marketing, and
prosecution. The FTC oversees the advertising of cosmetic products, and
prohibits false or misleading advertising. The FTC has a number of remedies
available to it, including preliminary injunctive relief based on its "reason
to believe" that an advertisement is false or misleading. See "Risk Factors--
Governmental Regulation."
The Company believes that its products are cosmetics under the Federal Food,
Drug, and Cosmetic Act (the "FDC Act"), because the Company, as shown by its
labeling, advertising, promotional, and other activities, intends that its
products be applied to the body to cleanse, beautify, promote attractiveness
or temporarily alter appearance. Such products meet the statutory definition
of cosmetic. By contrast, the Company believes that its products are not drugs
as defined in the FDC Act, because the Company, as shown by its labeling,
advertising,
36
<PAGE>
promotional, and other activities, does not intend that they cure, mitigate,
treat or prevent disease, or have other than a temporary effect on the
structure or function of the body.
There can be no assurance, however, that the FDA will not determine that
some or all of the Company's products are new drugs (as well as or instead of
cosmetics) based on ingredients, their concentrations or labeling,
advertising, or promotional material. In particular, the FDA could determine
that the Company's cosmetic products that contain active sunscreen ingredients
and that are labeled with a sun protection factor ("SPF") are also drugs. Most
over-the-counter ("OTC") drugs are marketed in the United States without FDA
prior approval under FDA regulations that permit such OTC marketing if the FDA
has issued a monograph with respect to that drug (including its ingredients
and indication(s) (claims)), and the product and its labeling comply with that
monograph. In a 1993 proposal to establish a monograph for OTC sunscreen drug
products, the FDA tentatively concluded that the use of the term "sunscreen"
on the label of a product causes it to be a drug, and that the use of the term
SPF in the labeling of a product is a basis for the product to be considered a
drug. The FDA also proposed that any final monograph based on the proposal be
made effective twelve months after the date of publication of the final
monograph. If the FDA adopts these tentative conclusions and finalizes the
proposed monograph for OTC sunscreen drug products, the Company's products
that contain active sunscreen ingredients and/or that are labeled with an SPF
will have to (i) comply with the monograph with respect to ingredients (or
remove ingredients not covered by the monograph), indications (claims) and
labeling, among other things, (ii) be covered by individual marketing
approvals from the FDA (as discussed below), (iii) be relabeled to eliminate
any mention of SPF, sunscreen or the like, or (iv) be removed from the market.
The Company believes that any changes to its products, ingredients,
indications or labeling resulting from the FDA's issuance at a future date of
a final monograph, if it applies to the Company's products in question, would
not have a material adverse effect on its business, operating results or
financial condition.
The preclinical and clinical testing, manufacture, labeling, distribution,
sale, advertising, and marketing of new drugs are subject to extensive and
rigorous regulation by the FDA, and before they can be marketed new drugs must
undergo an extensive regulatory approval process. This process, the successful
completion of which cannot be assured in a timely manner or at all, includes
preclinical studies and clinical trials of each compound to establish its
safety and effectiveness and confirmation by the FDA that good laboratory,
clinical and manufacturing practices were maintained during testing and
manufacturing. The process can take many years and requires the expenditure of
substantial resources. There can be no assurance as to when, if ever, any
required FDA approvals would be obtained. There can be no assurance that the
Company's current or future products will not be regulated by the FDA as new
drugs, nor can there be any assurance that any future requirements will not
have a material adverse effect on the Company's business, financial condition
or results of operations or on the market price of the Common Stock.
Following drug discovery, the steps required before a new pharmaceutical
product may be marketed in the United States include (1) preclinical
laboratory and animal tests, (2) the submission to the FDA of an application
for an investigational new drug ("IND"), (3) clinical and other studies to
assess safety and parameters of use, (4) adequate and well-controlled clinical
trials to establish the safety and effectiveness of the drug, (5) the
submission of a new drug application ("NDA") to the FDA and (6) FDA approval
of the NDA prior to any commercial sale or shipment of the drug.
Typically, preclinical studies are conducted in the laboratory and in animal
model systems to gain preliminary information on the drug's pharmacology and
toxicology and to identify any potential safety problems that would preclude
testing in humans. The results of these studies are submitted to the FDA as
part of the IND application. Testing in humans may commence 30 days after
submission of the IND by the FDA unless the FDA objects, although companies
typically wait for affirmative approval from the FDA before commencing such
testing. A three phase clinical trial program is usually required for FDA
approval of a pharmaceutical product. Phase I clinical trials are designed to
determine the metabolism and pharmacologic effects of the drug in humans, the
side effects associated with increasing doses, and possibly, to obtain early
indication of efficacy. Phase II studies are conducted in an expanded
population to evaluate the effectiveness of the drug for a particular
indication and thus involve patients with the condition under study. These
studies are also intended to elicit
37
<PAGE>
additional safety data on the drug, including evidence of the short-term side
effects and other risks associated with the drug. Phase III studies are
generally designed to provide the substantial evidence of safety and
effectiveness of a drug required to obtain FDA approval. The designation of a
clinical trial as being of a particular phase is not necessarily indicative
that such a trial will be sufficient to satisfy the requirements of a
particular phase. For example, no assurance can be given that a Phase III
clinical trial will be sufficient to support an NDA without further clinical
trials. The FDA monitors and inspects the progress of each of the three phases
of clinical testing and may alter, suspend or terminate the trials based on
the data that have been accumulated to that point and its assessment of the
risk/benefit ratio to the patient. The total time required for completing such
clinical testing typically is many years. Upon completion of clinical testing
which the sponsor believe demonstrate that the product is safe and effective
for a specific indication, an NDA may be submitted to the FDA. This
application includes details of the manufacturing and testing processes,
preclinical studies and clinical trials. FDA approval of the NDA is required
before the applicant may market the new product in the United States. The FDA
may refuse to approve an NDA if applicable statutory and/or regulatory
criteria are not satisfied, or may require additional testing or information.
Even after initial FDA approval had been obtained, further studies may be
required to provide additional data on safety or to gain approval for the use
of a product as a treatment in clinical indications other than those for which
the product was initially tested. The FDA may also require post-marketing
testing and surveillance programs to monitor the drug's effects.
Once the sale of a product is approved, the FDA regulates production,
distribution, marketing, advertising and other activities under the FDC Act
and the FDA's implementing regulations. All manufacturing facilities, methods
and controls used for the manufacturing, processing, packing or holding of
drug products must be operated in conformity with FDA's GMP requirements. A
post-marketing testing, surveillance and reporting program may be required to
continuously monitor the product's usage and effects. Product approvals may be
withdrawn, or other actions may be ordered, or sanctions imposed if compliance
with regulatory requirements is not maintained.
In addition to regulations enforced by the FDA, the Company also is subject
to regulation under the Occupational Safety and Health Act, the Environmental
Protection Act, the Toxic Substances Control Act, the Resource Conservation
and Recovery Act and other similar federal, state and local regulations
governing permissible laboratory activities, waste disposal handling of toxic,
dangerous or radioactive materials and other matters. The Company believes
that it is in compliance in all material respects with such regulations.
EMPLOYEES
At March 31, 1997, the Company had 12 full-time employees, including three
persons engaged in direct sales functions at retail store locations. The
remaining nine persons are engaged in various corporate functions. In
addition, at March 31, 1997, there were 17 persons working in retail stores
for whom the Company was responsible for all or a portion of their salary. Of
those 17 persons, 13 were in the United States. The Company plans to hire
additional employees in 1997, including a Controller and additional
administrative, sales and marketing personnel.
The loss of any of the Company's senior management or other key research,
development, sales and marketing personnel, particularly if lost to
competitors, could have a material adverse effect on the Company's business,
operating results and financial condition, including its ability to attract
employees. In particular, the loss of Steven S. Porter, who is the Company's
President, Chief Executive Officer and Chairman of the Board, or Francine E.
Porter, who is the Company's Executive Vice President, Secretary and
Treasurer, would have a material adverse effect on the Company's development
and marketing efforts. None of the Company's employees is represented by a
labor union or is the subject of a collective bargaining agreement with
respect to his or her employment by the Company. The Company has never
experienced a work stoppage and believes that its employee relations are good.
See "Risk Factors--Management of Growth" and "Risk Factors--Dependence on Key
Personnel."
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<PAGE>
FACILITIES
The Company's principal administrative, sales and marketing offices are
located in approximately 4,000 square feet of space in Denver, Colorado. The
lease relating to this office space expires in October 1999. The Company
believes that suitable additional or alternative space will be available in
the future on commercially reasonable terms as needed.
LEGAL PROCEEDINGS
During 1995 and 1996, the Company sold Common Stock to several investors in
private placement transactions. In certain states in which securities were
sold, the Company may not have complied with all applicable requirements in
order to satisfy the exemptions from the registration or qualification
requirements in those states. Pursuant to the provisions of applicable state
laws, the Company delivered to certain stockholders, none of whom is
affiliated with the Company or any of its directors or officers, offers to
repurchase the shares they acquired, and under the laws of such states the
failure to accept such offers made in compliance with such state laws within
certain time periods (generally, 30 days from receipt of such offer)
terminates such purchasers' rescission rights under such state laws. All of
those stockholders have declined in writing the Company's offer to repurchase
their shares. As a result, the Company believes that the stockholders no
longer have rescission rights under such state laws respecting their shares.
From October through December 1996, in Additional Closings of the Bridge
Financing, the Company issued Bridge Notes in the aggregate principal amount
of $250,000 and additional Bridge Warrants to purchase an estimated
approximately 41,667 shares of Common Stock. Such issuances may not have
complied with all applicable requirements to satisfy exemptions from the
registration or qualification requirements under securities laws of the United
States and certain states in which those securities were issued, possibly
entitling the purchasers of those securities to certain remedies, including
rescission rights, and possibly subjecting the Company and its officers and
directors to potential sanctions. The Bridge Notes will, however, be repaid in
full at the closing of this Offering, and to date no purchaser has made a
claim for rescission or other remedies. As a result, the Company believes that
even if such transactions were found to have violated federal or state
securities laws, such violations would not have a material adverse effect on
the Company's business, operating results or financial condition, although
there can be no assurances that this would be the case.
On March 5, 1997, VideOne filed a complaint against the Company and its
President and Chief Executive Officer, Steven S. Porter, in District Court,
Arapahoe County, State of Colorado. The lawsuit alleges various breaches of
the VideOne Agreement. VideOne alleges that the VideOne Agreement provides
that VideOne and the Company would share the costs of and produce an
infomercial for The Wrinkle Patch. VideOne also claims it had the sole and
exclusive worldwide right during the term of the agreement to manage direct
response marketing, namely, television; print media; outbound telemarketing;
package inserts; catalogs; radio; televised shopping; credit card syndication;
direct mail; seminars; and Internet web sites. VideOne claims the Company did
not cooperate with and systematically frustrated VideOne's efforts in
producing the infomercial and in marketing The Wrinkle Patch products.
VideOne's complaint asserts claims for breach of contract; breach of covenant
of good faith and fair dealing; fraud; negligent misrepresentation;
intentional interference with contractual relations; and interference with
prospective business advantage. VideOne seeks monetary damages, attorneys'
fees, pre- and post-judgment interest, costs and other expenses of litigation.
VideOne alleges its compensatory damages are no less than $1,000,000. VideOne
also seeks exemplary damages.
The Company and Mr. Porter submitted their answer and counterclaim on March
31, 1997. The Company denies the substantive allegations contained in
VideOne's complaint. As affirmative defenses, the Company alleges that it was
fraudulently induced to enter into the VideOne Agreement; that VideOne's
claims are barred by failure of consideration; that VideOne's claims are
barred by its material breaches of the VideOne Agreement; that VideOne's
claims are barred by its failure to give timely and adequate notice of alleged
breaches; that VideOne's claims are barred because the VideOne Agreement fails
in its essential purpose; that VideOne's claims are barred because the terms
and provisions of the VideOne Agreement are too vague and indefinite to be
39
<PAGE>
enforced; that VideOne's claims are barred by waiver, estoppel and laches;
that VideOne's claims sounding in tort are barred in whole or part by
VideOne's own fault pursuant to state law; that VideOne's claims sounding in
tort are barred in whole or part by the fault attributable to responsible
nonparties pursuant to state law; and that VideOne's claims based upon the
Company's alleged representations are barred by the merger clause of the
VideOne Agreement.
The Company also filed counterclaims against VideOne and Richard M.
Bartenburg, Jr., a director and its Chief Executive Officer and President, and
David Cohen, its Chairman of the Board of Directors and Executive Producer.
The Company's counterclaims allege that the Company was fraudulently induced
to enter into the VideOne Agreement; that VideOne breached the warranties
contained in the VideOne Agreement; that VideOne breached the VideOne
Agreement; that VideOne and the individuals violated the Colorado Deceptive
Trade Practices Act; that VideOne and the individuals intentionally interfered
with the Company's prospective business advantage; that VideOne and the
individuals intentionally interfered with the Company's contractual relations;
and that VideOne abused process. The Company seeks money damages, interest,
costs, injunctive relief and declaratory relief.
The lawsuit is in its preliminary stages. Discovery has not yet commenced.
The Company intends to vigorously defend the claims made against it by VideOne
and to vigorously prosecute its claims against VideOne.
Although the Company believes that the matters raised in the VideOne
complaint will be resolved without material liability to the Company, there
can be no assurance that this will be the case and, if VideOne were finally to
prevail in its claims against the Company, such outcome could have a material
adverse effect on the Company's business, operating results and financial
condition.
The Company is subject to various claims and business disputes in the
ordinary course of business; however, the Company is unaware of any present
claims or disputes which would have a material adverse effect on the Company's
business, operating results or financial condition.
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<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company, and their ages and
positions, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
Steven S. Porter President, Chief Executive Officer and Chairman
47 of the Board
Francine E. Porter Executive Vice President, Secretary, Treasurer
37 and Director
Thomas G. Wiley 69 Chief Financial Officer and Director
Suzanne J. Porter 49 Vice President, Operations
S. Herbert Ostern 66 Vice President, International Sales
Marvin J. Rosenblum(1) 54 Director
Richard G. Hartigan(1) Senior Vice President, Corporate Development and
60 Director
</TABLE>
- --------
(1) Member of Compensation Committee.
Each director holds office until the next annual meeting of stockholders and
until his or her successor is elected and qualified or until his or her
earlier resignation or removal. Each officer serves at the discretion of the
Board of Directors (the "Board").
Steven S. Porter is a co-founder of the Company and has served as its
President and Chief Executive Officer and Chairman of the Board since its
inception in August 1993. In January 1986, Mr. Porter and two other persons
founded GDP Technologies, Inc. ("GDP"), and from that time until August 1993,
Mr. Porter served as Executive Vice President of that company. GDP is
currently an inactive corporation, and Mr. Porter has devoted, and after this
Offering is expected to devote, substantially all of his business time and
efforts to the business of the Company.
Francine E. Porter, the wife of Steven S. Porter, is a co-founder of the
Company and has served as its Executive Vice President and a director since
its inception in August 1993. From March 1993 to August 1993, Mrs. Porter
served as a make-up artist for Bobbi Brown Professional Cosmetics. From April
1990 to March 1993, Mrs. Porter was self-employed on a part-time basis,
providing services as a make-up artist to a number of businesses in the
cosmetics industry.
Thomas G. Wiley has served as the Chief Financial Officer and a director of
the Company since January 1994. From October 1989 until January 1994, Mr.
Wiley was retired. From September 1988 through October 1989, Mr. Wiley served
as the President of TexPort Inc., a computer-related enterprise. From November
1984 to September 1988, Mr. Wiley was retired. From August 1980 to November
1984, Mr. Wiley served as the President of Computer Elections Systems, the
largest manufacturer of computerized voting equipment in the United States.
From March 1973 until October 1984, Mr. Wiley served as Executive Vice
President of Hale Technology, a venture capital firm. From July 1964 to
December 1972, Mr. Wiley served as Vice President, Finance of Electronic
Memories and Magnetics, an NYSE listed company engaged primarily in
manufacturing components and subsystems for computers.
Suzanne J. Porter, sister of Steven S. Porter, has served as the Vice
President, Operations of the Company since November 1993. From May 1989 to
October 1993, Ms. Porter served as Vice President, Operations for GDP. From
June 1974 to April 1989, Ms. Porter served in several positions for Business
Records Corporation and its predecessor, including as Vice President, Services
and Support.
S. Herbert Ostern has served as the Vice President, International Sales of
the Company since January 1994. Since June 1991, Mr. Ostern has provided
independent consulting services to a number of cosmetics companies. From April
1969 to June 1991, Mr. Ostern served as Senior Vice President and the Regional
Director for Estee Lauder International.
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<PAGE>
Marvin J. Rosenblum has served as a director of the Company since January
1995. Since 1973 he has been an attorney in private practice in Chicago,
Illinois, concentrating in financial transactions, and licensing and
technology transfer arrangements in Europe and Asia.
Richard G. Hartigan, Jr. has served as Senior Vice President, Corporate
Development and a director of the Company since February 1997. Since January
1995, Mr. Hartigan has served as the managing director of the Hartigan Group,
which provides marketing advice to cosmetics companies. From October 1990 to
January 1995, Mr. Hartigan served as President and Chief Executive Officer of
Lancaster Group, a cosmetics company. From September 1965 to September 1990,
Mr. Hartigan was employed by Estee Lauder, a cosmetics company, in several
positions, the last of which was Executive Vice President.
SCIENTIFIC ADVISORY PANEL
The Company has engaged certain industry experts for the purpose of
consultation and advice regarding various aspects of its business plan,
product design and development and other matters relating to the Company. The
nature, scope and frequency of the consultations between the Company and each
adviser varies depending on the Company's current activities, the need for
scientific advice and the individual scientific adviser. Although the Company
expects to receive guidance from its advisers, each of the advisers has
substantial commitments to third parties and is able to devote only a small
amount of time to the affairs of the Company. The Company's Scientific
Advisory Board includes:
<TABLE>
<CAPTION>
NAME OCCUPATION/TITLE
---- ----------------
<C> <S>
Bernard Idson, Ph.D. Professor of Pharmacy, Pharmaceutical and
Cosmetic Consultant, Drug Dynamic Institute,
University of Texas
Joe M. McCord, Ph.D. Professor of Medicine, Head, Division of
Biochemistry and Molecular Biology, Webb-Waring
Institute for Biomedical Research, University of
Colorado
Guy F. Webster, M.D., Ph.D. Associate Professor of Dermatology, Director of
the Center for Cutaneous Pharmacology, Thomas
Jefferson University Medical College
(Philadelphia, Pennsylvania)
</TABLE>
DIRECTOR COMPENSATION
Directors of the Company do not receive cash compensation for their services
as directors but are reimbursed for their reasonable expenses in attending
meetings of the Board. Directors are eligible to participate in the Incentive
Plan, and outside directors are eligible to participate in the Directors Plan.
See "--Employee Benefit Plans."
In March 1996, each person who at the time was a director received a non-
qualified stock option to purchase 15,909 shares of Common Stock at an
exercise price of $4.40 per share. Each option is exercisable as to 6,818
shares upon grant and as to approximately 454 of the remaining shares each
month thereafter commencing April 1, 1996. These options expire on March 24,
2001.
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<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth all compensation awarded to, earned by, or
paid for services rendered to the Company by, in all capacities during 1996,
(i) the Company's chief executive officer and (ii) the Company's other
executive officers whose salary and bonus (including consulting fees) exceeded
$100,000 during 1996 (of which there were none) (each a "Named Executive
Officer").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL LONG-TERM
COMPENSATION COMPENSATION AWARDS
------------------ --------------------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#) COMPENSATION($)
--------------------------- ---- --------- -------- ---------- ---------------
<S> <C> <C> <C> <C> <C>
Steven S. Porter............ 1996 $67,500 $ -- 15,909 --
President, Chief Executive
Officer
and Chairman of the Board
</TABLE>
Option Grants in Last Fiscal Year. The following table sets forth each grant
of stock options made during the fiscal year ended December 31, 1996 to each
of the Named Executive Officers:
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------
NUMBER OF PERCENT OF
SECURITIES TOTAL OPTIONS
UNDERLYING GRANTED DURING
OPTIONS FISCAL EXERCISE PRICE EXPIRATION
NAME GRANTED(#)(1) 1996(%)(2) ($/SH)(3) DATE
- ---- ------------- -------------- -------------- ----------
<S> <C> <C> <C> <C>
Steven S. Porter......... 15,909 15.4% $4.40 03/24/01
</TABLE>
- --------
(1) The option is exercisable with respect to 6,818 of the shares upon grant
and approximately 454 of the remaining shares monthly thereafter
commencing April 1, 1996.
(2) Based on an aggregate of 103,060 options granted by the Company in the
year ended December 31, 1996 to employees of and consultants to the
Company, including the Named Executive Officer.
(3) The exercise price per share of the option was equal to the fair market
value of the Common Stock on the date of grant as determined by the Board.
Option Exercises in Last Fiscal Year and Fiscal Year End Option Values. The
following table sets forth the information with respect to the number and
value of securities underlying unexercised options held by the Named Executive
Officers at December 31, 1996.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END
OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS/SARS AT DECEMBER IN-THE-MONEY OPTIONS AT
SHARES VALUE 31, 1996(#)(1) DECEMBER 31, 1996($)(2)
ACQUIRED ON REALIZED ------------------------- -------------------------
NAME EXERCISE(#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Steven S. Porter........ -- -- 10,909 5,000 17,454 8,000
</TABLE>
- --------
(1) Does not include 100,000 shares of Common Stock issuable upon exercise of
an option to be granted concurrently with the effective date of this
Offering, at an exercise price equal to 110% of the initial public
offering price of the Shares offered hereby.
(2) Based on an initial public offering price of $6.00 per share, minus the
per share exercise price, multiplied by the number of shares underlying
the option.
No Named Executive Officer exercised any options in fiscal 1996, and no
Named Executive Officer acquired shares upon the exercise of stock options
during 1996.
43
<PAGE>
EMPLOYMENT AGREEMENTS
The Company is party to employment agreements with Steven Porter and
Francine Porter. The agreements become effective upon the closing of this
Offering. The agreements provide that the officer will devote all of his or
her business time and energy to the affairs of the Company. The agreements
have a term of three years and provide for annual salaries to Steven Porter
and Francine Porter of $100,000 and $75,000, respectively. The agreements
provide for grants of new stock options to Steven Porter and Francine Porter
to purchase 100,000 and 50,000 shares, respectively, at an exercise price
equal to 110% of the initial public offering price of the Shares. The options
will become immediately exercisable upon grant with respect to 25,000 shares
as to Mr. Porter and 12,500 shares as to Mrs. Porter, and the options will
vest as to the remaining 75,000 shares and 37,500 shares, respectively, over
three years, one-third at the end of each year. Either the Company or the
officer may terminate the agreement at any time upon notice to the other
party. The agreements provide that upon a termination of employment without
cause, the officer is entitled to severance compensation of the lesser of 18
months or the remaining term of the agreement (but in no event less than 6
months) of his or her salary, which would be paid at the same time as salary
payments would otherwise have been paid. The Company also has a number of
agreements with other officers describing certain terms of their employment.
See "Certain Transactions."
EMPLOYEE BENEFIT PLANS
1997 Equity Incentive Plan. In February 1997, the Board adopted the 1997
Equity Incentive Plan (the "Incentive Plan") and reserved a total of 300,000
shares of Common Stock for issuance thereunder. The Company's stockholders are
expected to approve the Incentive Plan before the effective date of this
Offering, and upon such approval the Incentive Plan will become effective upon
the effective date of this Offering. Of the shares reserved for issuance under
the Incentive Plan, options to purchase a total of 150,000 shares of Common
Stock will be granted to Steven Porter and Francine Porter upon the
effectiveness of this Offering. Shares that (i) are subject to an option under
the Incentive Plan but cease to be subject to such option for any reason other
than exercise of such option, (ii) are awarded under the Incentive Plan but
are forfeited or are repurchased by the Company at the original issue price or
(iii) are subject to an award that otherwise terminates without shares being
issued will, in each case, be redesignated as available for grant or issuance
under the Incentive Plan.
The Incentive Plan provides for the grant of stock options and stock bonuses
and the issuance of restricted stock by the Company to its employees,
officers, directors, consultants, independent contractors and advisers. No
person will be eligible to receive more than 250,000 shares in any calendar
year pursuant to grants under the Incentive Plan. The Incentive Plan is
currently administered by the Compensation Committee of the Board (the
administrator referred to as the "Committee"), consisting of Messrs. Hartigan
and Rosenblum. The Incentive Plan permits the Committee to grant options that
are either incentive stock options, as defined in Section 422 of the Code, or
nonqualified stock options, on terms (including the exercise price, which may
not be less than 85% of the fair market value of the Common Stock, and the
vesting schedule) determined by the Committee, subject to certain statutory
and other limitations in the Incentive Plan. In addition to, or in tandem
with, awards of stock options, the Committee may grant participants restricted
stock awards to purchase Common Stock for not less than 85% of its fair market
value at the time of grant. The other terms of such restricted stock awards
may be determined by the Committee. The Committee may also grant stock bonus
awards of the Company's Common Stock either in addition to, or in tandem with,
other awards under the Incentive Plan, under such terms, conditions and
restrictions as the Compensation Committee may determine. Under the Incentive
Plan, stock bonuses may be awarded for the satisfaction of performance goals
established in advance. In the event of a merger, consolidation or similar
corporate transaction, any or all outstanding awards under the Incentive Plan
may be assumed, converted, replaced or substituted by the successor
corporation (if any), which assumption, conversion, replacement or
substitution will be binding on all participants in the Incentive Plan. In the
event such successor corporation (if any) does not assume or substitute
awards, the vesting of such awards will accelerate and such awards will be
exercisable in full at such times and on such conditions as the Committee
determines. The Incentive Plan will terminate in February 2007, unless
terminated earlier in accordance with its provisions.
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<PAGE>
Directors Plan. In February 1997, the Board adopted the 1997 Directors Stock
Option Plan (the "Directors Plan") and reserved a total of 50,000 shares of
Common Stock for issuance thereunder. The Company's stockholders are expected
to approve the Directors Plan before the effectiveness of this Offering, and
upon such approval the Directors Plan will become effective upon the
effectiveness of this Offering. Members of the Board who are not employees of
the Company, or any parent, subsidiary or affiliate of the Company, are
eligible to participate in the Directors Plan. Each eligible director who
first becomes a member of the Board on or after the date that the Directors
Plan becomes effective will automatically be granted an option to acquire
15,000 shares on the date such director first becomes a director. At each
annual meeting of stockholders of the Company, each eligible director will
automatically be granted an additional option to purchase 1,000 shares if such
director has served continually as a member of the Board since the date of the
last annual meeting of stockholders. All options issued under the Directors
Plan will vest as to 1/48 of the shares subject to the option per month after
the date of grant, provided the optionee continues as a member of the Board or
as a consultant of the Company. The exercise price of all options granted
under the Directors Plan will be the fair market value of the Common Stock on
the date of grant. In the event of a dissolution, a merger in which the
Company is not the surviving corporation, a sale of substantially all the
assets of the Company or certain other transactions, the successor corporation
may assume the outstanding options issued under the Directors Plan or may
substitute equivalent options or substantially similar consideration. In the
event such successor corporation refuses to assume or substitute those
options, the vesting of such options will accelerate and such options will be
exercisable in full at such times and on such conditions as the Committee
determines.
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF
LIABILITY
The Company intends to enter into indemnity agreements with each of its
current directors and executive officers to give such directors and officers
additional contractual assurances regarding the scope of the indemnification
set forth in the Company's Bylaws and to provide additional procedural
protections. At present, there is no pending litigation or proceeding
involving a director, officer or employee of the Company regarding which
indemnification is sought, nor is the Company aware of any threatened
litigation that may result in claims for indemnification.
As permitted by Section 145 of the Delaware General Corporation Law (the
"DGCL"), the Bylaws of the Company provide that (i) the Company is required to
indemnify its directors and officers to the maximum extent permitted by the
DGCL, (ii) the Company may, in its discretion, indemnify other persons as set
forth in the DGCL, (iii) to the maximum extent permitted by the DGCL, the
Company is required to advance expenses, as incurred, to its directors and
officers in connection with a legal proceeding (subject to certain
exceptions), (iv) the rights conferred in the Bylaws are not exclusive and (v)
the Company is authorized to enter into indemnification agreements with its
directors, officers, employees and agents.
As permitted by the DGCL, the Company's Certificate of Incorporation
includes a provision that eliminates the personal liability of directors for
monetary damages for breach of fiduciary duty as a director except for
liability (i) for any breach of the director's duty of loyalty to the Company
or its stockholders, (ii) for acts or omissions not in good faith or that
involve intentional misconduct or a knowing violation of law, (iii) under
Section 174 of the DGCL or (iv) for any transaction from which the director
derived an improper personal benefit.
After this Offering, the Company intends to seek to obtain directors and
officers liability insurance.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to the foregoing provisions, or otherwise, the Company has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable.
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<PAGE>
CERTAIN TRANSACTIONS
Since January 1, 1994, there has not been, nor is there currently proposed,
any transaction or series of similar transactions to which the Company was or
is to be a party in which the amount involved exceeds $60,000 and in which any
director, executive officer, holder of more than 5% of the Common Stock or any
member of the immediate family of any such person, had or will have a direct
or indirect material interest other than compensation agreements, see
"Management," and as described below.
The Company was founded by Steven S. and Francine E. Porter and incorporated
in August 1993. Mr. and Mrs. Porter received a total of 454,545 shares of
Common Stock in consideration of past services to the Company. Mr. and Mrs.
Porter subsequently transferred 2,362 of these shares to two third parties. In
August 1993, Scott Thring received 13,636 shares of Common Stock for services
rendered to the Company, and an option to purchase 13,636 shares of Common
Stock at an exercise price of $.22 per share, all of which are now
exercisable. In November 1993, the Company entered into a letter agreement
with Suzanne J. Porter, the sister of Steven Porter, to obtain her services as
Vice President, Operations, pursuant to which the Company issued to her
113,636 shares of Common Stock for services rendered to the Company. In
December 1993, the Company entered into a letter agreement with David Ross to
obtain his services as Vice President, Sales and Marketing, and Mr. Ross
received a total of 113,636 shares of Common Stock for services rendered to
the Company. In January 1994, the Company entered into a letter agreement with
S. Herbert Ostern to obtain his services as Vice President of International
Sales, pursuant to which the Company issued to him 22,727 shares of Common
Stock for services rendered to the Company, granted him an option to purchase
22,727 shares of Common Stock at an exercise price of $.22 per share,
exercisable as to 50% of the shares after one year of his continuous
employment and as to the remaining shares after two years of his continuous
employment, and agreed to pay him a commission of .5% of certain of the
Company's international net sales to be paid quarterly in arrears as long as
he remains an employee. Also in January 1994, the Company entered into a
letter agreement with Thomas G. Wiley to obtain his services as Chief
Financial Officer, pursuant to which the Company issued to him 22,727 shares
of Common Stock for services rendered to the Company and granted him an option
to purchase 22,727 shares of Common Stock at an exercise price of $.22 per
share, exercisable as to 50% of the shares after one year of his continuous
employment and as to the remaining shares after two years of his continuous
employment. In the aggregate, the Company issued 740,907 shares of Common
Stock to Mr. and Mrs. Porter, Ms. Suzanne Porter, Mr. Ross, Mr. Thring, Mr.
Wiley, and Mr. Ostern through April 1994. At the time of issuance of these
shares, the Company was being organized and operating activities had not
commenced. Consequently, for financial reporting purposes these shares were
deemed to be founders stock of nominal value at the date of issuance.
On April 17, 1995, Steven and Francine Porter, who are directors and
executive officers of the Company, assigned to the Company for nominal
consideration all right, title and interest they had in their invention
described in a patent application titled "Skin Care Composition And Methods,"
and any United States and foreign patents, and any applications which might
then or thereafter be filed for the described invention.
The Company paid to Edward Lewis, who was a director of the Company until
February 1997, a total of $23,510 between April 1996 and June 1996, and in
April 1996 issued to Mr. Lewis 15,673 shares of Common Stock for services
rendered to the Company.
Between June 1995 and June 1996, the Company issued to Hillary Management,
S.A., 136,440 shares of Common Stock at purchase prices between $1.10 per
share and $4.40 per share. Certain members of Edward Lewis' family have a
beneficial interest in 21,629 of these shares.
The Company borrowed certain amounts from several investors between November
1994 and July 1995 (the "1995 Note Financing"), giving to each such investor a
promissory note and an option to purchase a stated number of shares of Common
Stock. In connection with the 1995 Note Financing, Thomas G. Wiley, a director
and Chief Financial Officer of the Company, loaned the Company $20,000,
evidenced by a promissory note dated July 7, 1995. The note is due at the
earlier of September 30, 1996 or completion of this Offering. To secure
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<PAGE>
payment, Steven Porter pledged 40,000 shares of his stock in GDP. In addition,
on July 7, 1995, the Company granted Mr. Wiley an option to purchase 9,090
shares of Common Stock at an exercise price of $1.10 per share exercisable
until the earlier of July 7, 2000, or the effective date of this Offering. The
exercise price may be paid by, among other means, cancellation of outstanding
indebtedness of the Company owed to Mr. Wiley.
In January 1995, Marvin Rosenblum, a director of the Company, entered into
an agreement with the Company, pursuant to which (i) Mr. Rosenblum agreed to
provide financial consulting services and assist the Company in evaluating its
general business and planning, (ii) the Company sold to Mr. Rosenblum 68,181
shares of Common Stock at $0.73 per share, (iii) the Company granted to Mr.
Rosenblum an option, exercisable through April 30, 1995, to purchase 68,181
shares of Common Stock at an exercise price of $1.10 per share and (iv) Steven
and Francine Porter granted Mr. Rosenblum an option to purchase 68,181 shares
of Common Stock which they owned, at an exercise price of $1.10 per share,
with a term ending February 1, 2000. In April 1995, Mr. Rosenblum partially
exercised the 68,181 share option by purchasing 45,454 shares of Common Stock,
and transferred those shares to a third party. The remainder of that option
expired unexercised. In July 1995, the Company granted a five-year option to
Mr. Rosenblum to purchase 22,727 shares of Common Stock at an exercise price
of $1.10 per share. In connection with these transactions, the Company granted
Mr. Rosenblum piggyback registration rights and a right of first refusal to
purchase his pro rata share of certain future issuances of Common Stock, and
the Company and the Porters granted Mr. Rosenblum certain "tag along" rights
to sell a portion of his shares if any beneficial holder of 5% or more of the
Common Stock sold his shares. These rights of first refusal and tag along
rights terminate upon the registration of any class of the Company's
securities under the Exchange Act.
In November 1994, certain stockholders of the Company, including Steven and
Francine Porter, Suzanne Porter, Thomas Wiley and Scott Thring, executed an
agreement which, except in cases of transfers to certain family members of
such stockholders, granted a right of first refusal to the Company, and a
right of second refusal to the stockholders in the event any existing
stockholder desired to transfer his or her shares of Common Stock to any third
party. Under these rights, first the Company, and if the Company elected not
to exercise such right then the stockholders, could purchase the stock from
the selling stockholder at the same price and on the same terms as those
offered by the third party purchaser. This transfer restriction continued up
to six months after the closing of any initial public offering of Common
Stock, or such longer period, not to exceed one year from the date of the
initial public offering, as requested by the underwriters. In addition, the
agreement required that any person who acquired shares from such stockholders
after the date of its execution agree, as a condition of ownership, to the
restrictions described above. In June 1996, this agreement was terminated by
mutual agreement among the parties.
In August 1994, the Company issued to Dermal Technologies, Inc. 90,909
shares of Common Stock in exchange for (i) the assignment to the Company of
all Dermal Technologies' right, title and interest in certain transdermal
delivery technology and (ii) the introduction to Dermal Technologies' major
component suppliers. Additionally, for the services of Dermal Technologies'
principals in obtaining an agreement between the Company and a third party to
commercialize certain of the Company's products, the Company granted Dermal
Technologies royalty rights, based on sales of certain of its products, which
terminate on the close of this Offering. Such royalty payments have not been
significant.
Also in 1994, the Company entered into letter agreements with Bernard Idson,
Ph.D., Guy F. Webster, M.D., Ph.D., and Joseph M. McCord, Ph.D. to retain
their services as members of the Company's Scientific Advisory Board. Pursuant
to these agreements, the Company granted each adviser an option to purchase
4,545 shares of Common Stock at an exercise price of $.22 per share and agreed
to pay each consultant a retainer of $1,000 per month. Through December 31,
1996, $2,000 of these payments have been made, and approximately $61,000 of
the net proceeds of this Offering will be used to pay the remainder of these
payments. See "Use of Proceeds."
In connection with the Bridge Financing, if the Bridge Notes are not repaid
by specified dates, then Steven Porter, Francine Porter, Suzanne Porter,
Marvin Rosenblum, Thomas Wiley, Hillary Management, S.A., and
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Dermal Technologies, Inc. have agreed to vote their shares of Common Stock in
favor of the directors designated by a representative of the Bridge Investors,
and the Company has agreed in certain circumstances to cause additional shares
to become subject to the voting agreement so that the representative of the
Bridge Investors can elect a majority of the directors of the Company. See
"Capitalization--Recent Financing Transactions."
No officer or director of the Company is an officer, director or shareholder
of either Dermal Technologies, Inc. or Hillary Management, S.A. Further,
although certain officers and directors of the Company are shareholders of GDP
Technologies, Inc., the Company has not entered into any contractual or other
relationship with that company, and does not expect to do so in the future.
The Company believes that, except for the issuance by the Company of the
shares deemed to be founders stock for financial reporting purposes as
described above, all of the transactions set forth above were made on terms no
less favorable to the Company than could have been obtained from unaffiliated
third parties. All future transactions between the Company and its officers,
directors and principal stockholders and their affiliates will be approved by
a majority of the Board, including a majority of the independent and
disinterested directors of the Board, and will be on terms no less favorable
to the Company than could be obtained from unaffiliated third parties.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to the Company
regarding beneficial ownership of the Common Stock as of March 31, 1997, and
as adjusted to reflect the sale of the shares of Common Stock offered hereby,
by (i) each person known by the Company to be the beneficial owner of more
than 5% of the Common Stock, (ii) each of the Company's directors, (iii) each
Named Executive Officer and (iv) all executive officers and directors as a
group.
<TABLE>
<CAPTION>
SHARES SHARES
SHARES BENEFICIALLY BENEFICIALLY
BENEFICIALLY OWNED AFTER OWNED AFTER
OWNED PRIOR TO THE MINIMUM THE MAXIMUM
OFFERING(1) OFFERING(1) OFFERING(1)
DIRECTORS, NAMED EXECUTIVE --------------- --------------- ---------------
OFFICERS AND 5% STOCKHOLDERS NUMBER PERCENT NUMBER PERCENT NUMBER PERCENT
---------------------------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Steven S. Porter(2)............ 490,362 32.3% 490,362 24.3% 490,362 18.6%
Francine E. Porter(3).......... 477,862 31.8 477,862 23.8 477,862 18.2
Marvin J. Rosenblum(4)......... 172,270 11.3 172,270 8.6 172,270 6.5
Hillary Management, S.A.(5).... 136,440 9.2 136,440 6.9 136,440 5.2
David Ross(6).................. 107,909 7.3 107,909 5.5 107,909 4.2
Finesse Development Corp.(6)... 105,545 7.1 105,545 5.3 105,545 4.1
Suzanne J. Porter.............. 113,636 7.7 113,636 5.7 113,636 4.4
Dermal Technologies, Inc....... 90,909 6.1 90,909 4.6 90,909 3.5
Thomas G. Wiley(7)............. 67,725 4.4 67,725 3.3 67,725 2.6
Richard G. Hartigan............ -- -- -- -- -- --
All executive officers and
directors
as a group (7 persons)(8)..... 846,947 51.5 846,947 39.5 846,947 30.6
</TABLE>
- --------
(1) Unless otherwise indicated below, the persons and entities named in the
table have sole voting and sole investment power with respect to all
shares beneficially owned, subject to community property laws where
applicable.
(2) Includes 452,181 shares held jointly with Francine Porter and 38,181
shares subject to options exercisable before May 30, 1997.
(3) Includes 452,181 shares held jointly with Steven Porter and 25,681 shares
subject to options exercisable before May 30, 1997.
(4) Includes 68,181 shares owned by Steven and Francine Porter that are
subject to an option exercisable by Mr. Rosenblum before May 30, 1997, and
35,908 shares subject to an option exercisable before May 30, 1997.
(5) Includes 21,629 shares in which certain members of a former director's
family have a beneficial interest.
(6) Includes 105,545 shares subject to an option to purchase such shares,
subject to a number of terms and conditions, held by Finesse Development
Corp. ("Finesse") pursuant to an agreement between David Ross and Finesse
entered into in May 1997.
(7) Includes 44,998 shares subject to options exercisable before May 30, 1997.
(8) Includes 167,495 shares subject to options exercisable before May 30,
1997.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the closing of this Offering, the authorized capital stock of the
Company will consist of 15,000,000 shares of $.001 par value Common Stock and
10,000,000 shares of $.001 par value Preferred Stock. As of May 15, 1997,
there were outstanding 1,478,299 shares of Common Stock held of record by
approximately 63 stockholders, options and warrants (excluding Bridge
Warrants) to purchase 345,036 shares of Common Stock, additional options to
purchase 150,000 shares of Common Stock that will be outstanding upon the
effectiveness of this Offering and Bridge Warrants to acquire an estimated
158,333 Bridge Shares.
COMMON STOCK
Subject to preferences that may be applicable to any Preferred Stock
outstanding at the time, the holders of outstanding shares of Common Stock are
entitled to receive dividends out of assets legally available therefor at such
times and in such amounts as the Board may from time to time determine. Each
stockholder is entitled to one vote for each share of Common Stock held on all
matters submitted to a vote of stockholders. Cumulative voting for the
election of directors is not provided for in the Company's Certificate of
Incorporation, which means that the holders of a majority of the shares voted
can elect all of the directors then standing for election. The Common Stock is
not entitled to preemptive rights and is not subject to conversion or
redemption. Upon liquidation, dissolution or winding-up of the Company, the
assets legally available for distribution to stockholders are distributable
ratably among the holders of the Common Stock and any participating Preferred
Stock outstanding at that time after payment of liquidation preferences, if
any, on any outstanding Preferred Stock and payment of other claims of
creditors. Each outstanding share of Common Stock is, and all shares of Common
Stock to be outstanding upon completion of this Offering will be, fully paid
and nonassessable.
PREFERRED STOCK
The Board is authorized, subject to any limitations prescribed by Delaware
law, to provide for the issuance of shares of Preferred Stock in one or more
series, to establish from time to time the number of shares to be included in
each such series, to fix the rights, preferences and privileges of the shares
of each wholly unissued series and any qualifications, limitations or
restrictions thereon, and to increase or decrease the number of shares of any
such series (but not below the number of shares of such series then
outstanding), without any further vote or action by the stockholders. The
Board may authorize the issuance of Preferred Stock with voting or conversion
rights that could adversely affect the voting power or other rights of the
holders of Common Stock. Thus, the issuance of Preferred Stock may have the
effect of delaying, deferring or preventing a change in control of the
Company. The Company has no current plans to issue any shares of Preferred
Stock.
OTHER SECURITIES
Placement Agent's Warrants
In connection with this Offering, the Company has authorized the issuance to
the Placement Agent of up to 112,500 Placement Agent's Warrants and has
reserved 112,500 shares of Common Stock for issuance upon exercise of the
Placement Agent's Warrants. Each Placement Agent's Warrant will entitle the
holder to purchase one share of Common Stock at a price of $9.90 per share,
which is 165% of the initial public offering price of the Shares in this
Offering. The Placement Agent's Warrants will, subject to certain conditions,
be exercisable any time from the first until the fifth anniversary of the date
of this Prospectus. The Placement Agent will be issued one Placement Agent's
Warrant for every 10 shares of Common Stock sold in this Offering. See "Plan
of Distribution."
The Placement Agent's Warrants also contain provisions to protect the holder
against dilution by adjustment of the exercise price in certain events, such
as stock dividends and distributions, stock splits and recapitalizations. The
Company is not required to issue fractional shares upon the exercise of a
Placement Agent's Warrant, and
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the holder thereof will not possess any rights as a stockholder of the Company
until such holder exercises the Placement Agent's Warrants.
The foregoing discussion of certain terms and provisions of the Placement
Agent's Warrants is qualified in its entirety by reference to the detailed
provisions of the Placement Agent's Warrant Agreement, the form of which has
been filed as an exhibit to the Registration Statement of which this
Prospectus is a part.
For the life of the Placement Agent's Warrants, the holders thereof have the
opportunity to profit from a rise in the market price of the Common Stock
without assuming the risk of ownership of the shares of Common Stock issuable
upon the exercise of the warrants, with the resulting dilution in the interest
of the Company's stockholders by reason of exercise of the warrants at a time
when the exercise price is less than the market price for the Common Stock.
Further, the terms on which the Company could obtain additional capital during
the life of the warrants may be adversely affected. The warrant holders may be
expected to exercise the Placement Agent's Warrants at a time when the Company
would, in all likelihood, be able to obtain any needed capital by a new
offering of its securities on more favorable terms than those provided for by
the Placement Agent's Warrants.
REGISTRATION RIGHTS
Pursuant to a subscription agreement and certain purchase options, the
Company has granted Marvin J. Rosenblum, subject to certain exceptions, the
right to request inclusion of 68,181 shares of Common Stock and 90,909 shares
purchasable upon exercise of stock options previously granted by the Company
or Steven and Francine Porter, if the Company elects to register any of its
Common Stock under the Securities Act either for its own account or for the
account of any other stockholder. The Company is required to bear all
registration expenses, other than underwriting discounts and selling
commissions, incurred in connection with such registrations. The registration
rights relating to the 90,909 shares subject to the options described above
may be transferred to a permitted assignee or transferee of the options.
The Company granted to the investors in the 1995 Note Financing Transaction
the right to include the shares issuable to them upon exercise of the options
granted in the 1995 Note Financing Transaction, totalling approximately 95,763
shares of Common Stock, in any underwritten public offering which occurred
during the exercise period of their options (subject to the underwriter's
right to exclude such shares from a registration). The Company is required to
bear all registration expenses, other than underwriting discounts and selling
commissions, incurred in connection with the registration of the investors'
shares on one such registration.
In connection with the Bridge Financing, the Company agreed to file a
registration statement no later than nine months after the effectiveness of
this Offering to register the resale of the Bridge Shares. The Company has
agreed to keep such a registration statement effective until such shares have
been sold or until such shares can be sold without restriction pursuant to
Rule 144. If such registration statement does not remain effective, then the
Bridge Investors have certain additional demand registration rights. In
addition, the Bridge Investors have piggyback registration rights to require
the Company to include the Bridge Shares in registration statements filed by
the Company registering Common Stock under the Securities Act, either for its
own account or for the account of any other stockholder.
The holders of approximately 121,120 shares of Common Stock purchased in a
private placement transaction concluded in June 1996 have piggyback
registration rights entitling them to have their shares included in future
registrations by the Company, subject to certain restrictions. The Company is
required to bear all registration expenses, other than underwriting discounts
and selling commissions, incurred in connection with the registration of the
shares.
The holders of the Placement Agent's Warrants have the right to require the
Company to file a registration statement, commencing one year after the
effectiveness of this Offering, to register the sale of the shares of Common
Stock issuable upon exercise of the Representative's Warrants. The Company is
required to bear all
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<PAGE>
registration expenses, other than underwriting discounts and selling
commissions, incurred in connection with the registration of the shares
underlying Representative's Warrants.
The Company has granted to David Ross piggyback registration rights
entitling him to have the shares of Common Stock held by him, totalling
approximately 105,545 shares, included in future registrations by the Company,
subject to certain restrictions. Such registration rights expire with respect
to any such shares that may be distributed to the public pursuant to Rule 144
within the succeeding six months without regard to the volume restrictions of
Rule 144.
These registration rights could result in substantial future expense to the
Company and could adversely affect the Company's ability to complete future
equity or debt financings. Furthermore, the registration and sale of Common
Stock of the Company held by or issuable to the holders of registration
rights, or even the potential of such sales, could have an adverse affect on
the market price of the securities offered hereby.
TRANSFER AGENT AND REGISTRAR AND ESCROW AGENT
The Transfer Agent and Registrar for the Company's Common Stock, and the
Escrow Agent in connection with this Offering is Continental Stock Transfer &
Trust Company.
LISTING
The Company expects that the Common Stock will be quoted on the OTC
Electronic Bulletin Board under the symbol "OSMO."
SHARES ELIGIBLE FOR FUTURE SALE
Before this Offering, there has been no market for the Common Stock. Future
sales of substantial amounts of Common Stock in the public market could
adversely affect market prices prevailing from time to time.
Assuming no exercise of options or warrants after May 15, 1997, the Company
will have issued and outstanding following completion of the Minimum Offering
and the Maximum Offering 1,978,299 and 2,603,299 shares of Common Stock,
respectively. The shares of Common Stock sold in this Offering will be freely
tradeable without restriction under the Securities Act, unless purchased by
"affiliates" of the Company as that term is defined in Rule 144 under the
Securities Act. The remaining 1,478,299 shares of Common Stock held by
existing stockholders were issued and sold by the Company in reliance on
exemptions from the registration requirements of the Securities Act. These
shares may be sold in the public market only if registered or pursuant to an
exemption from registration such as Rules 144, 144(k) or 701 under the
Securities Act. Holders of approximately 1,218,133 shares have executed lock-
up agreements providing that they will not directly or indirectly sell,
contract to sell, grant any option to purchase or otherwise transfer or
dispose of any securities of the Company (subject to certain exceptions) until
one year from the closing of this Offering without the prior written consent
of the Placement Agent. Additionally, a stockholder holding 105,545 shares of
Common Stock has agreed to these restrictions for a period of one year from
the effective date of the Registration Statement relating to this Offering,
except that 37,500 of his shares will not be so restricted. Another
stockholder beneficially owning 136,440 shares of Common Stock has agreed to
these restrictions for a period of one year from the Closing of this Offering,
except that up to 30,000 of such shares will not be so restricted. Further,
another stockholder holding 11,363 shares of Common Stock has agreed to these
restrictions for a period of 120 days following the Closing of this Offering.
The Placement Agent has represented that it will not release any Bridge Shares
before expiration of the lock-up period.
As a result of the foregoing lock-up agreements and securities law
restrictions, assuming no exercise of options or warrants after May 15, 1997,
37,500 shares of Common Stock, and up to an additional 30,000 shares of Common
Stock, other than the Shares offered hereby will be eligible for resale
without restriction immediately
52
<PAGE>
after the Closing of this Offering pursuant to Rule 144 or Rule 144(k), 6,818
shares of Common Stock will be eligible for resale commencing 90 days after
the date of this Prospectus pursuant to Rule 144, 11,363 shares of Common
Stock will be eligible for resale commencing 120 days after the date of this
Prospectus pursuant to Rule 144, and approximately 1,392,618 additional shares
of Common Stock will be eligible for resale, pursuant to either Rule 701, Rule
144, or Rule 144(k) beginning one year from the date of this Prospectus with
respect to 68,045 of such shares and one year from the Closing of this
Offering with respect to the remaining shares.
In general, under Rule 144, beginning 90 days after the date of this
Prospectus, a person (or persons whose shares are aggregated) who has
beneficially owned restricted shares for at least one year (including the
holding period of any prior owner except an affiliate) is entitled to sell,
within any three-month period, a number of shares that does not exceed the
greater of (i) one percent of the number of shares of Common Stock then
outstanding (which, assuming no exercise of options or warrants after May 15,
1997, will equal approximately 2,603,299 total outstanding shares immediately
after this Offering if the Maximum Shares are sold) or (ii) the average weekly
trading volume of the Common Stock during the four calendar weeks preceding
the filing of a Form 144 with respect to such sale. Sales under Rule 144 are
also subject to certain manner of sale provisions and notice requirements and
to the availability of current public information about the Company. Under
Rule 144(k), a person who is not deemed to have been an affiliate of the
Company at any time during the 90 days preceding a sale, and who has
beneficially owned the shares to be sold for at least two years (including the
holding period of any prior owner except an affiliate), is entitled to sell
such shares without complying with the manner of sale, public information,
volume limitation or notice provisions of Rule 144.
Rule 701 permits resales of shares in reliance upon Rule 144 but without
compliance with the holding period requirements of Rule 144. Any employee,
officer or director of or consultant to the Company who purchased his or her
shares pursuant to a written compensatory plan or contract may be entitled to
rely on the resale provisions of Rule 701. Rule 701 further provides that non-
affiliates may sell such shares in reliance on Rule 144 without having to
comply with the holding period, public information, volume limitation or
notice provisions of Rule 144. Each holder of Rule 701 shares is required to
wait until 90 days after the date of this Prospectus before selling such
shares.
Shortly after this Offering, the Company intends to file a registration
statement under the Securities Act covering shares of Common Stock subject to
certain outstanding options or reserved for issuance under the Incentive Plan
or Directors Plan. Based upon the number of outstanding options and reserved
shares as of March 31, 1997, such registration statement would cover
approximately 622,000 shares. Accordingly, shares registered under such
registration statement will, subject to Rule 144 volume limitations applicable
to affiliates of the Company, be available for sale in the open market
immediately following the expiration of lock-up provisions. See "Risk
Factors--Shares Eligible for Future Sale."
Additional shares of Common Stock issuable upon the exercise of certain
outstanding options and warrants will become eligible for public sale as a
result of registration rights agreements with the Company or the Company
otherwise agreeing to register such shares. See "Description of Capital
Stock--Registration Rights."
53
<PAGE>
PLAN OF DISTRIBUTION
The Minimum Offering is being offered on a "best efforts, all or none"
basis. The proceeds from the sale of the Common Stock will be held in an
escrow account for the benefit of the subscribers by the Escrow Agent until
the Minimum Shares have been sold or earlier termination of this Offering. In
the event that subscriptions for the Minimum Shares have not been received by
the Termination Date, this Offering will terminate and all funds will be
returned promptly by the Escrow Agent without any deductions therefrom or
interest thereon. In any event, this Offering will expire on the earlier to
occur of (i) 60 days after the date of this Prospectus, (ii) termination of
this Offering by the Company at any time 30 days following the effective date
of the registration statement of which this Prospectus forms a part or at any
time upon 2 days notice to National after the Closing of the Minimum Offering
and (iii) the sale of the Maximum Shares, unless the Company and the Placement
Agent agree to extend this Offering for an additional 30-day period.
The Company has agreed to indemnify the Placement Agent against certain
liabilities, including liabilities under the Securities Act. The Company has
agreed to pay to the Placement Agent a non-accountable expense allowance equal
to 1.8% of the gross proceeds derived from the sale of the Shares
underwritten, of which $50,000 has been advanced.
The Company has agreed to sell to the Placement Agent for $.0001 each the
Placement Agent's Warrants to purchase from the Company up to 112,500 Shares
at an exercise price of $9.90 per share. The Placement Agent's Warrants are
exercisable for a period of four years commencing one year from the date of
this Prospectus and are restricted from sale, transfer, assignment or
hypothecation for a period of 12 months from the date of this Prospectus,
except to officers of the Placement Agent. The Placement Agent's Warrants
provide for adjustment in the exercise price of the Placement Agent's Warrants
in the event of certain mergers, acquisitions, stock dividends and capital
changes. The Placement Agent's Warrants grant to the holders thereof certain
rights with respect to the registration under the Securities Act of the
securities issuable upon exercise of the Placement Agent's Warrants.
The offering prices set forth on the cover page of this Prospectus should
not be considered indications of the actual values of the Common Stock. Such
prices are subject to change as a result of market conditions and other
factors and no assurance can be given that the Common Stock can be resold at
its public offering price.
The Company's officers and directors and other stockholders and option
holders holding approximately 1,218,133 shares of Common Stock have agreed
that for a period of 12 months following the closing of this Offering, they
will not offer, sell, contract to sell, grant any option for the sale or
otherwise dispose of any securities of the Company (other than intra-family
transfers or transfers to trust for estate planning purposes and other than
non-public transfers where the transferee agrees to be bound by the lock-up
agreement provisions), without the Placement Agent's consent. Additionally, a
stockholder holding 105,545 shares of Common Stock has agreed to those
restrictions for a period of 12 months following the effective date of the
Registration Statement relating to this Offering, except that 37,500 of his
shares will not be so restricted. Another stockholder beneficially owning
136,440 shares of Common Stock has agreed to these restrictions for a period
of one year from the Closing of this Offering, except that up to 30,000 of
such shares will not be so restricted. Further, another stockholder holding
11,363 shares of Common Stock has agreed to these restrictions for a period of
120 days following the Closing of this Offering. These restrictions do not
apply to the issuance of shares of Common Stock upon the exercise of options
and warrants outstanding prior to the sale of the Shares offered hereby. The
Placement Agent has represented that it will not release any Bridge Shares
before expiration of the lock-up period.
The Company has agreed that if the Minimum Shares are sold in this Offering,
for a period of two years from the Closing of the Minimum Offering, the
Placement Agent will have the right to designate an observer who shall be
entitled to attend all meetings of the Board. The Placement Agent has not yet
identified to the Company the person who is to be designated as an observer.
The Company has agreed to reimburse designees of the
54
<PAGE>
Placement Agent for their out-of-pocket expenses incurred in connection with
their attendance of meetings of the Board.
The foregoing is a summary of the principal terms of the agreements
described above and does not purport to be complete. Reference is made to
copies of each such agreement which are filed as exhibits to the Registration
Statement, of which this Prospectus forms a part. See "Available Information."
Certain persons participating in this Offering may engage in transactions,
including stabilizing bids, syndicate covering transactions or the imposition
of penalty bids, which may involve the purchase of Common Stock. Such
transactions may stabilize or maintain the market price of the Common Stock at
a level above that which might otherwise prevail in the open market and, if
commenced, may be discontinued at any time.
Determination of Offering Price
Prior to this Offering, there has been no public market for the Common
Stock. Accordingly, the initial public offering price was determined by
negotiations between the Company and the Placement Agent. Among the factors
considered in determining the initial public offering price were the history
and the prospects of the Company and the industry in which it operates, the
past and present operating results of the Company and the trends of such
results, the previous experience of the Company's executive officers and the
general condition of the securities markets at the time of this Offering.
LEGAL MATTERS
The validity of the issuance of the Shares offered hereby will be passed
upon for the Company by Fenwick & West LLP, Palo Alto, California, and certain
legal matters relating only to patent matters will be passed upon for the
Company by Davis, Graham & Stubbs LLP, Denver, Colorado. Certain legal matters
in connection with this Offering will be passed upon for the Placement Agent
by Camhy Karlinsky & Stein LLP, New York, New York.
EXPERTS
The balance sheets as of December 31, 1995 and 1996, and the statements of
operations, stockholders' (deficit) equity, and cash flows for the years then
ended, have been audited by Arthur Andersen LLP, independent public
accountants, as set forth in their report thereon appearing elsewhere herein
and in the Registration Statement of which this Prospectus forms a part, and
are included in reliance upon such report given upon the authority of such
firm as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"), Denver, Colorado, a Registration Statement under the Securities
Act with respect to the shares of Common Stock. This Prospectus does not
contain all of the information set forth in the Registration Statement and its
exhibits. For further information with respect to the Company and the Common
Stock offered hereby, reference is made to the Registration Statement and
exhibits. Statements contained in this Prospectus regarding the contents of
any contract or any other document to which reference is made are not
necessarily complete, and in each instance reference is made to the copy of
such contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference. A copy of the Registration Statement, including the exhibits
thereto, may be inspected without charge at the Commission's principal office
in Washington, D.C., and copies of all or any part thereof may be obtained
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, upon payment of certain prescribed rates.
55
<PAGE>
OSMOTICS CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Arthur Andersen LLP, Independent Public Accountants.............. F-2
Balance Sheets............................................................. F-3
Statements of Operations................................................... F-4
Statements of Stockholders' (Deficit) Equity............................... F-5
Statements of Cash Flows................................................... F-6
Notes to Financial Statements.............................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Osmotics Corporation:
We have audited the accompanying balance sheets of OSMOTICS CORPORATION (a
Colorado corporation) as of December 31, 1995 and 1996, and the related
statements of operations, stockholders' (deficit) equity and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Osmotics Corporation as of
December 31, 1995 and 1996, and the results of its operations and its cash
flows for the 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 1 to the
financial statements, the Company has suffered recurring losses from
operations and has a net capital deficiency that raises substantial doubt
about its ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
Arthur Andersen LLP
Denver, Colorado,
January 31, 1997
F-2
<PAGE>
OSMOTICS CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- MARCH 31,
1995 1996 1997
--------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash.................................... $ 37,352 $ 90,930 $ 83,080
Trade accounts receivable, net of allow-
ance for doubtful accounts of $0,
$15,000 and $15,000, respectively...... 50,343 478,306 531,305
Inventory, net of reserve for
obsolesence of $0, $15,000 and $15,000,
respectively........................... 183,694 234,113 216,875
Prepaid expenses........................ 8,293 65,247 25,088
--------- ----------- -----------
Total current assets.................. 279,682 868,596 856,348
--------- ----------- -----------
PROPERTY AND EQUIPMENT, at cost:
Furniture, fixtures and equipment....... 12,217 105,490 106,364
Less: Accumulated depreciation.......... (6,593) (22,580) (29,279)
--------- ----------- -----------
Property and equipment, net............. 5,624 82,910 77,085
--------- ----------- -----------
OTHER ASSETS, net of accumulated
amortization of $150, $6,112 and $150,
respectively............................. 5,467 15,940 16,898
--------- ----------- -----------
DEFERRED INITIAL PUBLIC OFFERING COSTS.... -- 404,347 553,037
--------- ----------- -----------
Total assets............................ $ 290,773 $ 1,371,793 $ 1,503,368
========= =========== ===========
LIABILITIES AND
STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Accounts payable........................ $ 213,573 $ 281,370 $ 532,309
Accrued initial public offering costs... -- 365,811 474,475
Accrued compensation and other accrued
liabilities............................ 150,437 275,648 340,510
Deferred revenue and product warranties. -- 141,130 106,921
Bridge financing, net of unamortized
discount of $0, $90,000 and $94,166,
respectively........................... -- 660,000 855,834
Current portion of notes payable........ 193,948 128,500 128,500
Current portion of capital leases pay-
able................................... -- 16,470 8,255
--------- ----------- -----------
Total current liabilities............... 557,958 1,868,929 2,446,804
--------- ----------- -----------
LONG-TERM LIABILITIES:
Notes payable, net of current portion... 5,653 -- --
Capital leases payable.................. -- 38,601 38,601
--------- ----------- -----------
Total long-term liabilities............. 5,653 38,601 38,601
--------- ----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' (DEFICIT) EQUITY:
Common stock, no par value, 6,000,000
shares authorized, 1,153,770, 1,478,299
and 1,478,299 shares issued and
outstanding at December 31, 1995 and
1996, and March 31, 1997, respectively. 609,414 1,815,839 1,815,839
Warrants................................ 7,935 381,078 481,078
Accumulated deficit..................... (890,187) (2,732,654) (3,278,954)
--------- ----------- -----------
Total stockholders' (deficit) equity.... (272,838) (535,737) (982,037)
--------- ----------- -----------
Total liabilities and stockholders'
(deficit) equity....................... $ 290,773 $ 1,371,793 $ 1,503,368
========= =========== ===========
</TABLE>
The accompanying notes to financial statements are an integral part of these
balance sheets.
F-3
<PAGE>
OSMOTICS CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE THREE
FOR THE YEAR ENDED MONTHS ENDED MARCH
DECEMBER 31, 31,
---------------------- --------------------
1995 1996 1996 1997
--------- ----------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES......................... $ 328,465 $ 1,254,800 $ 171,047 $ 859,355
COST OF PRODUCTS SOLD............ 160,000 435,201 82,722 369,698
--------- ----------- --------- ---------
GROSS PROFIT..................... 168,465 819,599 88,325 489,657
OPERATING EXPENSES:
General and administrative..... 292,742 541,600 79,843 99,283
Selling and marketing.......... 600,087 1,587,765 160,887 782,640
Production management.......... 66,059 90,889 26,676 25,954
--------- ----------- --------- ---------
LOSS FROM OPERATIONS............. (790,423) (1,400,655) (179,081) (418,220)
OTHER INCOME (EXPENSE):
Interest expense............... (20,285) (443,480) (10,756) (127,332)
Other income (expense), net.... -- 1,668 -- (748)
--------- ----------- --------- ---------
NET LOSS......................... $(810,708) $(1,842,467) $(189,837) $(546,300)
========= =========== ========= =========
PER SHARE DATA (Note 2):
Pro forma net loss per common
and common equivalent share... $ (0.68) $ (1.27) $ (0.15) $ (0.36)
========= =========== ========= =========
Shares used in computing pro
forma net loss per common and
common equivalent share....... 1,186,733 1,446,012 1,299,098 1,515,303
========= =========== ========= =========
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
F-4
<PAGE>
OSMOTICS CORPORATION
STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
<TABLE>
<CAPTION>
COMMON STOCK WARRANTS
-------------------- ------------------ ACCUMULATED
SHARES AMOUNT SHARES AMOUNT DEFICIT
--------- ---------- ------- -------- -----------
<S> <C> <C> <C> <C> <C>
BALANCES, December 31,
1994................... 836,362 $ 25,000 34,403 $ 3,187 $ (79,479)
Common stock issued for
cash at $.74 per share
in January 1995........ 68,181 50,000 -- -- --
Common stock issued for
services in February,
April and June 1995, at
$1.10 per share........ 11,363 12,501 -- -- --
Stock options exercised
in April 1995 at $1.10
per share.............. 45,454 50,000 -- -- --
Common stock issued for
cash at $1.10 per share
in June and July 1995.. 45,454 50,000 -- -- --
Warrants issued to
lenders for purchase of
common stock at $1.10
per share.............. -- -- 61,360 4,748 --
Private placement of
common stock for cash
at $3.19 per share, net
of offering costs of
$46,879................ 146,956 421,913 -- -- --
Net loss................ -- -- -- -- (810,708)
--------- ---------- ------- -------- -----------
BALANCES, December 31,
1995................... 1,153,770 609,414 95,763 7,935 (890,187)
Private placement of
common stock for cash
at $3.19 per share, net
of offering costs of
$26,631................ 92,569 268,665 -- -- --
Common stock issued for
services--
In April 1996, at $3.19
per share............. 15,673 50,000 -- -- --
In June 1996, at $4.40
per share............. 2,045 9,000 -- -- --
In July 1996, at $4.40
per share............. 409 1,800 -- -- --
Private placement of
common stock for cash
at $4.40 per share, net
of offering costs of
$48,800................ 121,106 484,200 -- -- --
Warrants issued in
connection with Bridge
Financing.............. -- -- 125,000 * 375,000 --
Exercise of warrants
issued to lenders at
$1.10 per share in July
1996................... 22,727 26,857 (22,727) (1,857) --
Private placement of
common stock for cash
at $5.94 per share, net
of offering costs of
$49,897................ 70,000 365,903 -- -- --
Net loss................ -- -- -- -- (1,842,467)
--------- ---------- ------- -------- -----------
BALANCES, December 31,
1996................... 1,478,299 1,815,839 198,036 381,078 (2,732,654)
Warrants issued in
connection with Bridge
Financing.............. -- -- 33,333 100,000 --
Net loss................ -- -- -- -- (546,300)
--------- ---------- ------- -------- -----------
BALANCES, March 31, 1997
(unaudited)............ 1,478,299 $1,815,839 231,369 $481,078 $(3,278,954)
========= ========== ======= ======== ===========
</TABLE>
- --------
* The estimated number of shares of common stock issuable upon exercise of
these warrants will be determined by the Company's initial public offering
price per share of common stock, which is assumed to be $6.00 per share
(see Notes 1 and 11).
The accompanying notes to financial statements are an integral part of these
statements.
F-5
<PAGE>
OSMOTICS CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE THREE
FOR THE YEAR ENDED MONTHS ENDED MARCH
DECEMBER 31, 31,
---------------------- --------------------
1995 1996 1996 1997
--------- ----------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss...................... $(810,708) $(1,842,467) $(189,837) $(546,300)
Adjustments--
Depreciation and amortiza-
tion....................... 16,360 79,332 9,254 6,699
Amortization of debt dis-
count (Note 4)............. -- 285,000 -- 95,834
Common stock issued for
services................... 12,501 10,800 -- --
Provision for bad debt...... -- 15,000 -- --
Inventory reserve........... -- 15,000 -- --
Changes in--
Accounts receivable....... (50,343) (442,963) (66,847) (52,999)
Inventory................. (183,694) (65,419) 45,700 17,238
Prepaid expenses and other
assets................... (8,070) (56,956) (321) 40,159
Accounts payable and ac-
crued liabilities........ 288,873 232,389 (9,822) 315,801
Deferred revenue and prod-
uct warranties........... -- 141,130 -- (34,209)
--------- ----------- --------- ---------
Net cash flows from op-
erating activities..... (735,081) (1,629,154) (211,873) (157,777)
--------- ----------- --------- ---------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchases of property and
equipment.................... (12,217) (12,535) (3,434) (874)
Other assets.................. (750) (8,373) -- (958)
--------- ----------- --------- ---------
Net cash flows from in-
vesting activities....... (12,967) (20,908) (3,434) (1,832)
--------- ----------- --------- ---------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from issuance of com-
mon stock.................... 618,792 1,269,096 226,296 --
Proceeds from issuance of
notes payable and warrants... 135,000 21,000 -- --
Proceeds from Bridge Financ-
ing.......................... -- 750,000 -- 200,000
Payments on notes payable..... -- (96,448) -- --
Stock issuance costs.......... -- (111,805) (8,100) --
Deferred initial public offer-
ing costs.................... -- (38,536) -- (40,026)
Debt issuance costs........... -- (64,000) -- --
Payments on capital leases.... -- (25,667) -- (8,215)
--------- ----------- --------- ---------
Net cash flows from fi-
nancing activities..... 753,792 1,703,640 218,196 151,759
--------- ----------- --------- ---------
NET INCREASE(DECREASE) IN CASH.. 5,744 53,578 2,889 (7,850)
CASH, beginning of period....... 31,608 37,352 37,352 90,930
--------- ----------- --------- ---------
CASH, end of period............. $ 37,352 $ 90,930 $ 40,241 83,080
========= =========== ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid for interest........ $ -- $ 22,467 $ -- $ --
========= =========== ========= =========
SUPPLEMENTAL DISCLOSURES OF
NONCASH INVESTING AND FINANCING
ACTIVITIES:
Property purchased under capi-
tal leases................... $ -- $ 80,738 $ -- $ --
Discount of notes payable
equal to warrants issued to
lenders...................... 4,748 375,000 -- 100,000
Common stock issued for--
Stock offering costs........ 36,479 13,521 13,080 --
Accrued liabilities for--
Stock offering costs........ 10,400 -- -- --
Deferred initial public of-
fering costs............... -- 365,811 -- 108,664
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
F-6
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(1) ORGANIZATION AND BUSINESS RISKS
Osmotics Corporation (the "Company") develops and markets cosmetics skin
care products, including products using the Company's transdermal delivery
method. Its products are currently produced, based on Company specifications,
by independent contract manufacturers.
The Company was initially incorporated in the state of Colorado on August
18, 1993 as Porter Skinsystems, Ltd., and was subsequently renamed Osmotics
Corp. on November 1, 1993. On April 19, 1996, the Company was renamed Osmotics
Corporation. The Company intends to reincorporate in the state of Delaware
prior to the initial closing of its initial public offering (Note 11). The
Company's corporate office is located in Denver, Colorado and its customers
are primarily located in the United States, England and France.
The Company began shipping its first product in April 1995 and has a limited
operating history. It has incurred losses and negative cash flow from
operations since its inception. The success of future operating results will
depend on many factors, including market acceptance and demand for the
Company's products, the intensity of future product and price competition
experienced, effective expansion of its sales force and distribution channels,
its ability to control costs and manage growth, and general economic
conditions. There can be no assurance that the Company will ever generate
significant revenues or achieve or sustain profitability. The Company's
revenues to date have been principally derived from four customers (Note 9),
the loss of which would have a material adverse effect on the Company's
results of operations and financial condition. During the period of time
required to achieve profitable operations, the Company will require additional
financing which may not be available.
The Company's capital requirements to date have been provided through
private placements of common stock (Note 3), notes payable and the Bridge
Financing (Note 4). At March 31, 1997, the Company's current liabilities
exceeded its current assets by approximately $1.6 million. The Company needs
additional funding to continue its operations through the remainder of 1997.
Consequently, there is substantial doubt as to the ability of the Company to
continue as a going concern. The accompanying financial statements have been
prepared assuming that the Company will continue as a going concern and do not
include any adjustments that might result from the outcome of this
uncertainty. The Company plans to register and sell shares of its common stock
in an initial public offering (the "Offering") (Note 11). If the Offering is
delayed or suspended, other financing sources will be needed. The Company
currently has no commitments for such alternative financing and has no
assurance it would be available.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Inventory
Inventories are stated at the lower of cost (first-in, first-out basis) or
market. Cost includes the purchase price of components and amounts due to
contract manufacturers based on items produced for the Company. Inventories
consist principally of raw materials and purchased components. Finished
products are generally shipped upon completion of production.
Property and Equipment
Property and equipment are stated at cost and depreciation is provided using
the straight-line method over the estimated useful lives of the respective
assets, generally two to five years. Depreciation expense for the years ended
December 31, 1995 and 1996 was $6,593 and $20,063, respectively. Maintenance
and repairs are expensed as incurred and improvements are capitalized.
F-7
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Earnings Per Share
Earnings per share is computed using the weighted average number of common
and common equivalent shares outstanding for each period. Common equivalent
shares include stock options and warrants to purchase the Company's common
stock. Pursuant to Securities and Exchange Commission Accounting Staff
Bulletin No. 83, common and common equivalent shares issued during the twelve
months immediately preceding the Company's initial public offering filing date
have been included in the calculation of common and common equivalent shares,
regardless of whether their inclusion is dilutive, using the treasury stock
method and the anticipated public offering price as if they were outstanding
for all periods. Common stock equivalents, excluding those issued within
twelve months immediately preceding the Company's initial public offering
filing date, are excluded for loss periods because their inclusion would be
anti-dilutive (i.e., it would reduce the reported loss per share).
Interim Results (Unaudited)
The accompanying balance sheet as of March 31, 1997, the statements of
operations and of cash flows for the three months ended March 31, 1996 and
1997, and the statement of stockholders' (deficit) equity for the three months
ended March 31, 1997 are unaudited. In the opinion of management, the
statements have been prepared on the same basis as the audited financial
statements and include all adjustments, consisting only of normal recurring
adjustments, necessary for the fair statement of the results of the interim
periods. Operating results for the three months ended March 31, 1997 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1997.
Revenue Recognition
Revenues are recognized upon shipment of products to customers. The Company
may accept product returns in its discretion, but retailers are not granted
the right to return unsold products. Generally, returns accepted by the
Company represent products returned to retailers by consumers and the Company
provides an allowance for such estimated returns which is included in deferred
revenue and product warranties. Certain customers have full rights to return
unsold products. These shipments are treated as consignments and related
revenue is deferred until the products are sold by the consignees to
consumers. As of December 31, 1996, deferred revenue and product warranties is
comprised of $80,000 related to sales treated as consignments and $61,130 of
allowance for estimated product warranty and returns.
Credit Risk/Foreign Currency Risk/Off-Balance-Sheet Risk
The Company performs ongoing credit evaluations of its customers' financial
condition and generally does not require collateral. The Company's principal
customers (Note 9) accounted for 87% and 68% of the Company's accounts
receivable as of December 31, 1995 and 1996, respectively.
Transactions denominated in currencies other than U. S. dollars are recorded
based on exchange rates at the time such transactions arise. Subsequent
changes in exchange rates result in transaction gains and losses which are
reflected in income as unrealized (based on period end translation) or
realized (upon settlement of the transactions). Certain sales during 1996 were
denominated in foreign currencies; however, no significant foreign exchange
gains or losses were incurred.
The Company has no significant financial instruments with off-balance-sheet
risk of accounting loss such as foreign exchange contracts, options contracts
or other foreign hedging arrangements.
F-8
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Fair Value of Financial Instruments
The Company's financial instruments consist of cash, short-term trade
receivables and payables and notes and capital leases payable. The carrying
values of cash and short-term trade receivables and payables approximate fair
value. The fair value of notes and capital leases payable is estimated based
on current rates available for similarly secured debt with similar maturities,
and at December 31, 1996, approximates the carrying value.
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,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Income Taxes
The current provision for income taxes represents actual or estimated
amounts payable or refundable on tax returns filed or to be filed for each
year. Deferred income tax assets and liabilities are recorded for the expected
future income tax consequences, based on enacted tax laws, of temporary
differences between the financial reporting and tax bases of assets and
liabilities and carryforwards. The overall change in deferred tax assets and
liabilities for the period measures the deferred tax expense for the period.
Effects of changes in tax laws on deferred tax assets and liabilities are
reflected as adjustments to tax expense in the period of enactment. Deferred
tax assets are recognized for the expected future tax effects of all
deductible temporary differences, loss carryforwards and tax credit
carryforwards. Deferred tax assets are then reduced, if deemed necessary, by a
valuation allowance for the amount of any tax benefits which, more likely than
not based on current circumstances, are not expected to be realized (see Note
8).
Effects of Recently Issued Accounting Pronouncements
In March 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
(SFAS No. 128), which supersedes Accounting Principles Board Opinion No. 15,
"Earnings Per Share" ("APB No. 15"). SFAS No. 128 simplifies the requirements
for reporting earnings per share ("EPS") by requiring companies only to report
"basic" and "diluted" EPS. SFAS No. 128 is effective for both interim and
annual periods ending after December 15, 1997 but requires retroactive
restatement upon adoption. The Company will adopt SFAS No. 128 in the fourth
quarter of 1997. The Company does not believe such adoption will have a
material effect on either its previously reported earnings per share.
In March 1997, the FASB issued Statement of Financial Accounting Standards
No. 129, "Disclosure of Information about Capital Structure" (SFAS No. 129),
which continues the existing requirements of APB No. 15 but expands the number
of companies subject to portions of its requirements. Specifically, SFAS No.
129 requires that entities previously exempt from the requirements of APB No.
15 disclose the pertinent rights and privileges of all securities other than
ordinary common stock. SFAS No. 129 is effective for periods ending after
December 15, 1997. The Company was not exempt from APB No. 15; accordingly,
the adoption of SFAS No. 129 will not have any effect on the Company.
Stock Options
At various dates since inception, the Company's Board of Directors has
granted "nonqualified" stock options, as defined by the Internal Revenue Code
and related regulations, to purchase shares of the Company's common stock to
officers, employees, directors and consultants.
F-9
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In February 1997, the Board of Directors adopted the 1997 Equity Incentive
Plan (the "Incentive Plan"). The Incentive Plan, which is expected to be
approved by the stockholders, is administered by a committee of the Board of
Directors (the "Committee") and becomes effective only upon the effective date
of a registration statement for an initial public offering.
The Incentive Plan provides that the Committee may award up to 300,000
shares of the Company's common stock in the form of nonqualified or incentive
stock options or stock bonuses and the issuance of restricted stock by the
Company to its employees, directors, consultants, independent contractors and
advisers. Nonqualified stock options or restricted stock awards to purchase
the Company's common stock may be awarded at a price not less than 85% of the
fair market value of the stock at the date of the award. Incentive stock
options must be awarded at a price not less than 100% of the fair market value
of the stock at the date of the award, or 110% of the fair market value for
awards to more than 10% stockholders. Options granted under the Incentive Plan
may have a term of up to 10 years. The Incentive Plan will terminate in
February 2007, unless terminated earlier in accordance with its provisions.
In February 1997, the Board of Directors adopted the 1997 Directors Stock
Option Plan (the "Directors Plan") and reserved a total of 50,000 shares of
Common Stock for issuance thereunder. The Directors Plan is expected to be
approved by the stockholders and becomes effective only upon the effective
date of a registration statement for an initial public offering. Members of
the Board of Directors who are not employees of the Company, or any parent,
subsidiary or affiliate of the Company, are eligible to participate in the
Directors Plan. Each eligible director who first becomes a member of the Board
of Directors on or after the date that the Directors Plan becomes effective
will automatically be granted an option to acquire 15,000 shares on the date
such director first becomes a director. At each annual meeting of stockholders
of the Company, each eligible director will automatically be granted an
additional option to purchase 1,000 shares if such director has served
continually as a member of the Board since the date of the last annual meeting
of stockholders. All options issued under the Directors Plan will vest as to
one-forty-eighth of the shares subject to the option per month after the date
of grant, provided the optionee continues as a member of the Board of
Directors or as a consultant of the Company. The exercise price of all options
granted under the Directors Plan will be the fair market value of the common
stock on the date of grant.
(3) STOCKHOLDERS' (DEFICIT) EQUITY
The Board of Directors intends to approve the reincorporation of the Company
in the state of Delaware, which is expected to be consummated before the
initial closing of the Offering. The reincorporation will result in a change
in the authorized capital stock of the Company to 15,000,000 shares of $0.001
par value common stock and 10,000,000 shares of $0.001 par value preferred
stock. The reincorporation will be effected through a merger with an effective
exchange ratio of 2.2 shares of common stock of the Colorado corporation for
one share of common stock of the Delaware corporation. All share and per share
amounts included in the accompanying financial statements and notes for all
periods presented have been retroactively adjusted to reflect the stock
exchange.
Effective August 30, 1994, the Company issued 90,909 shares of common stock
to Dermal Technologies in consideration for certain services provided to the
Company and the Company recorded $20,000 of expense relating to these
services. Under the terms of a related agreement, Dermal Technologies is
entitled to receive a 1% royalty on all sales of Antioxidant Skin Care Derms.
The term of the royalty agreement terminates on the effective date of an
initial public offering.
F-10
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Pursuant to a private placement memorandum dated August 1, 1995, the Company
issued 146,956 and 92,569 shares of common stock in exchange for cash of
$468,792 and $295,296 during 1995 and 1996, respectively.
Pursuant to a March 30, 1996 private placement memorandum, the Company
authorized the issuance of up to 227,272 shares of common stock at $4.40 per
share. As of December 31, 1996, the Company had received cash proceeds of
$533,000 in connection with the issuances of 121,106 shares of common stock.
In November and December 1996, the Company sold a total of 70,000 shares of
common stock in a private placement transaction, in reliance on Regulation S
of the Securities Act, to investors at $5.94 per share. Proceeds to the
Company, net of placement fees were $365,903.
Effective February 1, 1996, the Company entered into a six month agreement
with a consultant to provide consulting services to the Company in exchange
for a monthly fee comprised of shares of common stock valued at $1,800 and
$1,800 in cash each month over the term of the agreement. The Company recorded
the shares of common stock based on their market value at the date of issuance
to the consultant. As of December 31, 1996, the Company has issued 2,454
shares of the Company's common stock for $4.40 per share related to this
transaction, and the Company recognized the related $21,600 of consulting fees
in general and administrative expense in the accompanying 1996 statement of
operations.
Statement of Financial Accounting Standards No. 123 ("SFAS 123")
SFAS 123, "Accounting for Stock-Based Compensation," defines a fair value
based method of accounting for employee stock options or similar equity
instruments. However, SFAS 123 allows the continued measurement of
compensation cost for such plans using the intrinsic value based method
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"), provided that pro forma disclosures are made of net income or loss
and net income or loss per share, assuming the fair value based method of SFAS
123 had been applied. The Company has elected to account for its stock-based
compensation plans under APB 25; accordingly, for purposes of the pro forma
disclosures presented below, the Company has computed the fair values of all
options granted during 1995 and 1996, using the Black-Scholes pricing model
and the following weighted average assumptions:
<TABLE>
<CAPTION>
1995 1996
--------- ---------
<S> <C> <C>
Risk-free interest rate............................. 6.6% 5.5%
Expected dividend yield............................. 0% 0%
Expected lives outstanding 3.0 years 2.0 years
Expected volatility................................. 19.46% 19.46%
</TABLE>
To estimate lives of options for this valuation, it was assumed options will
be exercised upon becoming fully vested and the Company has completed an
initial public offering of its common stock. All options are initially assumed
to vest. Cumulative compensation cost recognized in pro forma net income or
loss with respect to options that are forfeited prior to vesting is adjusted
as a reduction of pro forma compensation expense in the period of forfeiture.
Because the Company's common stock is not yet publicly traded, the expected
market volatility was based on an approximation of the volatility of the
NASDAQ index for 1996. Actual volatility of the Company's common stock may
vary. Fair value computations are highly sensitive to the volatility factor
assumed; the greater the volatility, the higher the computed fair value of
options granted.
F-11
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The total fair value of options granted was computed to be approximately
$45,053 and $79,356 for the years ended December 31, 1995 and 1996,
respectively. These amounts are amortized ratably over the vesting periods of
the options or recognized at date of grant if no vesting period is required.
Pro forma stock-based compensation, net of the effect of forfeitures, was
$36,284 and $78,346 for 1995 and 1996, respectively.
If the Company had accounted for its stock-based compensation plans in
accordance with SFAS 123, the Company's net loss and pro forma net loss per
common share would have been reported as follows:
<TABLE>
<CAPTION>
1995 1996
-------- ----------
<S> <C> <C> <C>
Net loss: As reported $810,708 $1,842,467
Pro forma $846,992 $1,920,813
EPS: As reported $(0.68) $(1.27)
Pro forma $(0.71) $(1.33)
</TABLE>
Weighted average shares used to calculate pro forma net loss per share were
determined as described in Note 2, except in applying the treasury stock
method to outstanding options, net proceeds assumed received upon exercise
were increased by the amount of compensation cost attributable to future
service periods and not yet recognized as pro forma expense.
Because the Statement 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
A summary of stock options as of December 31, 1995 and 1996 and changes
during the years then ended is presented below:
<TABLE>
<CAPTION>
1995 1996
----------------- -----------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
------- -------- ------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning of year...... 118,181 $ .55 169,894 $1.08
Granted............................. 120,409 $1.72 103,060 $4.64
Canceled............................ (23,242) $1.10 (954) $3.19
Exercised........................... (45,454) $1.10 -- --
------- -------
Outstanding at end of year............ 169,894 $1.08 272,000 $2.42
======= =======
Weighted average fair value of options
granted.............................. $ .374 $ .77
======= =======
</TABLE>
The following table summarizes information about the options outstanding at
December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
RANGE OF EXERCISE PRICES AT 12/31/96 LIFE PRICE AT 12/31/96 PRICE
------------------------ ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$.22.................... 72,727 7.1 years $ .22 72,727 $ .22
$1.10................... 68,181 8.0 years $1.10 68,182 $1.10
$3.19-$5.94............. 131,092 9.8 years $4.66 77,515 $2.55
------- -------
$.22-$5.94.............. 272,000 8.3 years $2.42 218,424 $1.91
======= =======
</TABLE>
F-12
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
A summary of stock options as of December 31, 1995 and 1996 and changes
during the years then ended is presented below:
<TABLE>
<CAPTION>
1995 1996
----------------- -----------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
------- -------- ------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning of year...... 118,181 $ .55 169,894 $1.08
Granted............................. 120,409 $1.72 103,060 $4.64
Canceled............................ (23,242) $1.10 (954) $3.19
Exercised........................... (45,454) $1.10 -- --
------- -------
Outstanding at end of year............ 169,894 $1.08 272,000 $2.42
======= =======
Weighted average fair value of options
granted.............................. $ .374 $ .77
======= =======
</TABLE>
The following table summarizes information about the options outstanding at
December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
RANGE OF EXERCISE PRICES AT 12/31/96 LIFE PRICE AT 12/31/96 PRICE
------------------------ ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$.22.................... 72,727 7.1 years $ .22 72,727 $ .22
$1.10................... 68,181 8.0 years $1.10 68,182 $1.10
$3.19-$5.94............. 131,092 9.8 years $4.66 77,515 $2.55
------- -------
$.22-$5.94.............. 272,000 8.3 years $2.42 218,424 $1.91
======= =======
</TABLE>
Summary of Potentially Dilutive Securities Outstanding
In addition to the options described above, the Company has issued certain
warrants for the purchase of common stock described elsewhere herein. A
summary of these potentially dilutive securities outstanding as of December
31, 1996 (and subsequently, as indicated) follows:
<TABLE>
<CAPTION>
NUMBER EXERCISE
OF SHARES PRICE
--------- ----------
<S> <C> <C>
Outstanding stock options per above................... 272,000 $.22-$5.40
Warrants issued to lenders (Note 4)................... 73,036 $ 1.10
Bridge Warrants (Note 4).............................. 125,000 $ .022
Additional issuances subsequent to December 31, 1996:
Bridge Warrants issued in January 1997 (Note 4)..... 33,333 $ .022
Options to be granted in connection with employment
agreements effective upon closing of the Offering
(Note 11).......................................... 150,000 $ 6.60 *
</TABLE>
- --------
* The estimated number of shares of common stock issuable upon exercise of
these warrants will be determined by the Company's initial public offering
price per share of common stock, which is assumed to be $6.00 per share.
** 110% of assumed initial public offering price of $6.00 per share.
F-13
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(4) BRIDGE FINANCING AND NOTES PAYABLE
During 1996, the Company entered into certain agreements ("Bridge
Financing") with individual investors (the "Bridge Investors") to obtain
bridge loans ("Bridge Notes") in the principal amount of $750,000. The Company
received $500,000 of proceeds from the Bridge Financings in July 1996 and had
additional closings totaling $250,000 in October through December 1996 (Note
7) for an aggregate principal balance of $750,000 as of December 31, 1996. The
Company issued additional Bridge Notes in the aggregate principal amount of
$200,000 in January 1997, increasing the aggregate principal balance of the
Bridge Notes to $950,000 as of January 31, 1997. Each Bridge Note bears
interest at 12% per annum until six months following its issuance, and 15% per
annum thereafter, until maturity. Principal and interest under each Bridge
Note is due in four equal quarterly installments beginning nine months
following its issuance, unless an initial public offering becomes effective
before that date, at which time principal will be due five days after
receiving funds from the initial public offering. The agent for the Bridge
Investors, on behalf of the Bridge Investors, has agreed, until the earlier of
July 31, 1997 or one business day following the Closing of the Minimum
Offering, not to declare any amounts owing under the Bridge Notes to be due
and payable. The Bridge Notes are secured by a security interest, granted to a
representative of the Bridge Investors, in substantially all of the assets of
the Company, including its intellectual property. In connection with the
Bridge Notes, the Company granted warrants (the "Bridge Warrants") to purchase
shares of the Company's common stock. The Bridge Warrants entitle the holder
to acquire for total consideration of $.022 per Bridge Warrant a number of
shares of common stock equal to the principal amount of the holder's Bridge
Notes ($750,000 and $950,000 as of December 31, 1996 and January 31, 1997,
respectively, in the aggregate) divided by the initial public offering price
of one share of common stock. If an offering is not consummated before one
year following the date a Bridge Warrant is issued, then such Bridge Warrant
will entitle the holder to acquire a number of shares of common stock equal to
the principal amount of the holder's Bridge Note divided by $4.40 per share.
The warrants relating to the original Bridge Financing of $500,000 are
exercisable immediately following such time as the number of shares for which
they are exercisable may be determined with certainty. The warrants relating
to the additional Bridge Financings in July 1996 through January 1997 of
$450,000, are not exercisable until one year following the effective date of
the Offering. In addition, under the terms of the Bridge Financing, the
Company has paid a placement fee and legal costs of $72,500, which has been
recorded as deferred debt issuance costs and is being amortized to interest
expense over the life of the notes.
The Company has accounted for the Bridge financing as a borrowing and a sale
of equity securities (i.e., the warrants). The $750,000 and $950,000 as of
December 31, 1996 and January 31, 1997, respectively, gross proceeds were
allocated between the debt and the warrants based on their relative fair
values at the date of issuance. Because of the nominal exercise price of the
warrants, the fair value of the warrants was estimated to approximate the fair
value of the underlying common stock (i.e., $750,000 in the aggregate). The
fair value of the debt is its principal amount of $750,000. Consequently, the
debt was recorded at an initial discounted amount of $375,000 and $475,000 as
of December 31, 1996 and January 31, 1997, respectively, and the discount is
being amortized to interest expense ($285,000 and $96,000 for the year ended
December 31, 1996 and the three months ended March 31, 1997) over the term of
the borrowing. As the Bridge Notes will be repaid out of a portion of the net
proceeds of the Offering, the Company will expense any remaining unamortized
discount in the quarter in which the Offering is consummated.
If the Company does not repay each Bridge Note within six months following
its issuance, then that Bridge Note allows for extended payment terms. If an
event of default occurs with respect to the payment by the Company of any of
these installments, then holders of approximately 884,074 shares of common
stock have agreed to vote their shares in favor of the directors designated by
a representative of the Bridge Investors, and the Company has agreed in
certain circumstances to cause additional shares to become subject to the
voting agreement so that the representative of the Bridge Investors can elect
a majority of the directors of the Company.
F-14
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
During 1994 and 1995, the Company borrowed $203,949 from individual
investors (the "Notes"). In connection with the issuance of the Notes, the
investors received warrants to purchase 95,763 shares of the Company's common
stock exercisable at $1.10 per share. The warrants expire at the earlier of
five years from the date of the Notes or the effective date of an initial
public offering. The warrants were valued at their estimated fair value of
$7,935 and this amount is reflected in stockholders' equity and as a discount
of the notes payable. The discount is being amortized as interest expense
($3,505 and $4,348 for the years ended December 31, 1995 and 1996,
respectively) over the term of the Notes. The Notes are due at various dates
through January 1997, or upon a public offering of the Company's common stock.
The Notes bear interest at 10% per annum and are collateralized by a pledge of
certain equity securities owned by the Company's president. During 1996, two
lenders exercised such warrants to purchase 22,727 shares of common stock and
the Company repaid three of the Notes totaling $96,448.
In November 1996, the Company entered into an unsecured promissory note with
a shareholder of the Company to borrow up to $30,000 to fund additional
infomercial costs (Note 6). As of December 31, 1996, the Company had drawn
approximately $21,000 on this note. The note bears interest at 10% per annum
and it matures at the earliest of (i) November 1, 1997, (ii) five business
days following the closing of a qualified initial public offering, (iii) five
business days following the closing of a funding whereby the Company receives
gross proceeds of $2,000,000, or (iv) on the dissolution or winding up of the
Company.
(5) CAPITAL LEASES
During 1996, the Company financed certain office furniture and equipment
through capital leases totaling $80,738.
The following is a schedule of future minimum lease payments under capital
leases, together with the present value of net minimum lease payments, as of
December 31, 1996:
<TABLE>
<S> <C>
1997............................................................ $ 21,374
1998............................................................ 21,031
1999............................................................ 14,032
2000............................................................ 8,382
2001............................................................ --
Thereafter...................................................... --
Less: interest.................................................. (9,748)
--------
Present value of future minimum lease payments.................. 55,071
Less: current portion........................................... (16,470)
--------
Capital lease obligations, long-term............................ $ 38,601
========
</TABLE>
(6) LICENSE AND DISTRIBUTION AGREEMENTS
Infomercial
In March 1996, the Company and VideOne Marketing, Inc. ("VideOne") entered
into an Infomercial Production and Product Management Agreement (the "VideOne
Agreement") to produce a Wrinkle Patch infomercial. Additionally, the VideOne
Agreement provides that VideOne has the exclusive right worldwide, subject to
certain exceptions, (i) to manage the direct response marketing and airing of
the infomercial and (ii) to distribute The Wrinkle Patch, including updates
and revisions, in certain direct response media categories.
In connection with an agreement with a shareholder of the Company, the
shareholder will pay VideOne for the set-up and production costs totaling
$98,898 in consideration for certain future royalties based solely on future
sales of Company products by VideOne.
F-15
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Distribution Agreements
In March 1996, the Company entered into a distribution agreement with an
individual shareholder, whereby this individual has exclusive rights to
market, sell and distribute all products manufactured by the Company in a
defined territory. At the time of entering such agreement, this individual
held 45,454 shares of the Company's common stock, which this individual
continues to hold. The distribution agreement expires on December 31, 2001,
with an option to extend for two additional five-year periods. The
distribution agreement is subject to earlier termination if this individual
fails to meet certain performance standards set forth in the agreement.
In May 1996, the Company entered into a distribution agreement with a third
party whereby the third party has the exclusive right to market, sell and
distribute all skin care products manufactured by the Company under the brand
name Spa-Sante to professional beauty establishments, including spas and
beauty salons, located in North America, Central America, Europe, the Middle
East and Africa. The third party distributor will market, sell and distribute
the products on behalf of the Company and retain a percentage of the selling
price of the products sold. Beginning in 1997, the third party has agreed to
pay all costs of sales. This agreement terminates in July 2001, and is
renewable at the third party distributor's election for two successive five-
year periods. The agreement is subject to earlier termination if the third
party distributor fails to satisfy certain performance goals.
In January 1997, the Company entered into a distribution agreement with a
third party whereby the third party has the exclusive right to market and sell
in France cosmetic products manufactured by the Company. The agreement
terminates in January 2000, and is renewable for additional periods of three
years each. The agreement is subject to earlier termination if the third party
fails to meet certain performance standards set forth in the agreement.
Licensing
The Company has agreed to supply on a non-exclusive basis to a third party
skin patches for inclusion in products to be sold by the third party under its
own label in all countries, other than countries located in the Pacific Rim.
The third party has agreed not to market and sell such products in the upscale
market (which is defined in the contract), and the Company has agreed not to
sell skin patches under the Osmotics trademark except in the up-scale market.
This agreement terminates in January 2002, and is renewable for successive
five-year periods unless either party elects otherwise.
(7) COMMITMENTS AND CONTINGENCIES
During 1995 and 1996, the Company sold common stock to several investors in
private placement transactions. In certain states in which securities were
sold, the Company may not have complied with all applicable requirements in
order to satisfy the exemptions from the registration or qualification
requirements in those states. Pursuant to the provisions of applicable state
laws, the Company delivered to certain stockholders, none of whom is
affiliated with the Company or any of its directors or officers, offers to
repurchase the shares they acquired, and under the laws of such states the
failure to accept such offers made in compliance with such state laws within
certain time periods (generally, 30 days from receipt of such offer)
terminates such purchasers' rescission rights under such state laws. All of
those stockholders have declined in writing the Company's offer to repurchase
their shares. As a result, the Company believes that the stockholders no
longer have rescission rights under such state laws respecting their shares.
From October through December 1996, in additional closings of the Bridge
Financing, the Company issued Bridge Notes in the aggregate principal amount
of $250,000 and additional Bridge Warrants to purchase an estimated
approximately 41,667 shares of Common Stock. Such issuances may not have
complied with all applicable requirements to satisfy exemptions from the
registration or qualification requirements under securities
F-16
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
laws of the United States and certain states in which those securities were
issued, possibly entitling the purchasers of those securities to certain
remedies, including rescission rights, and possibly subjecting the Company and
its officers and directors to potential sanctions. The Bridge Notes will,
however, be repaid in full at the closing of this Offering, and to date no
purchaser has made a claim for rescission or other remedies. As a result, the
Company believes that even if such transactions were found to have violated
federal or state securities laws, such violations would not have a material
adverse effect on the Company's business, operating results or financial
condition, although there can be no assurances that this would be the case.
On March 5, 1997, VideOne Marketing, Inc. ("VideOne"), filed a complaint
against the Company and its President and Chief Executive Officer, Steven S.
Porter, in District Court, Arapahoe County, State of Colorado. The lawsuit
alleges various breaches of the VideOne Agreement between VideOne and the
Company. VideOne alleges that the VideOne Agreement provides that VideOne and
the Company would share the costs of and produce an infomercial for The
Wrinkle Patch. VideOne also claims it had the sole and exclusive worldwide
right during the term of the agreement to manage direct response marketing,
namely, television; print media; outbound telemarketing; package inserts;
catalogs; radio; televised shopping; credit card syndication; direct mail;
seminars; and Internet web sites. VideOne claims the Company did not cooperate
with and systematically frustrated VideOne's efforts in producing the
infomercial and in marketing The Wrinkle Patch products. VideOne's complaint
asserts claims for breach of contract; breach of covenant of good faith and
fair dealing; fraud; negligent misrepresentation; intentional interference
with contractual relations; and interference with prospective business
advantage. VideOne seeks monetary damages, attorneys' fees, pre- and post-
judgment interest, costs and other expenses of litigation. VideOne alleges its
compensatory damages are no less than $1,000,000. VideOne also seeks exemplary
damages.
The Company and Mr. Porter submitted their answer and counterclaim on March
31, 1997. The Company denies the substantive allegations contained in
VideOne's complaint. As affirmative defenses, the Company alleges that it was
fraudulently induced to enter into the VideOne Agreement; that VideOne's
claims are barred by failure of consideration; that VideOne's claims are
barred by its material breaches of the VideOne Agreement; that VideOne's
claims are barred by its failure to give timely and adequate notice of alleged
breaches; that VideOne's claims are barred because the VideOne Agreement fails
in its essential purpose; that VideOne's claims are barred because the terms
and provisions of the VideOne Agreement are too vague and indefinite to be
enforced; that VideOne's claims are barred by waiver, estoppel and laches;
that VideOne's claims sounding in tort are barred in whole or part by
VideOne's own fault pursuant to state law; that VideOne's claims sounding in
tort are barred in whole or part by the fault attributable to responsible
nonparties pursuant to state law; and that VideOne's claims based upon the
Company's alleged representations are barred by the merger clause of the
VideOne Agreement.
The Company also filed counterclaims against VideOne and Richard M.
Bartenburg, Jr., a director and its Chief Executive Officer and President, and
David Cohen, its Chairman of the Board of Directors and Executive Producer.
The Company's counterclaims allege that the Company was fraudulently induced
to enter into the VideOne Agreement; that VideOne breached the warranties
contained in the VideOne Agreement; that VideOne breached the VideOne
Agreement; that VideOne and the individuals violated the Colorado Deceptive
Trade Practices Act; that VideOne and the individuals intentionally interfered
with the Company's prospective business advantage; that VideOne and the
individuals intentionally interfered with the Company's contractual relations;
and that VideOne abused process. The Company seeks money damages, interest,
costs, injunctive relief and declaratory relief.
The lawsuit is in its preliminary stages. Discovery has not yet commenced.
The Company intends to vigorously defend the claims made against it by VideOne
and to vigorously prosecute its claims against VideOne.
Although the Company believes that the matters raised in the letter will be
resolved without material liability to the Company, there can be no assurance
that this will be the case and, if VideOne were finally to
F-17
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
prevail in its claims against the Company, such outcome could have a material
adverse effect on the Company's business, operating results and financial
condition.
In April 1996, the Company entered into a lease for office space under a
noncancelable lease agreement which expires in 1999. The Company had
previously leased offices on a month-to-month basis. The Company also leases
certain office equipment under lease agreements which terminate in 1999.
Future minimum commitments under noncancelable leases in effect as of December
31, 1996 are as follows:
<TABLE>
<S> <C>
Year ended December 31,
1997........................................................... $ 45,428
1998........................................................... 45,428
1999........................................................... 37,856
--------
$128,712
========
</TABLE>
Rent expense for the years ended December 31, 1995 and 1996, was
approximately $22,000 and $44,000, respectively.
The Company and its cosmetic products are subject to regulation by the Food
and Drug Administration ("FDA") and the Federal Trade Commission ("FTC"), as
well as various other federal, state and local authorities. Such regulation
relates primarily to the ingredients, packaging, labeling, advertising and
marketing of the Company's products. Failure to comply with FDA requirements
in such matters can result in severe civil and criminal penalties, including
seizure of product, injunction against production, distribution, sales, and
prosecution. Cosmetics, in contrast to new drugs, do not require premarket
notification to, or approval by, the FDA, but must be properly labeled and
manufactured. The Company believes its products meet the statutory definition
of cosmetics and are not currently drugs. The FTC oversees the advertising of
cosmetic products, and prohibits false or misleading advertising. Management
believes it has taken appropriate steps to monitor and assure compliance with
material aspects of the above regulations. However, an assertion by the FDA,
FTC or similar authority of noncompliance by the Company could have a material
adverse effect on the Company's results of operations and financial condition.
The Company is subject to various claims and business disputes in the
ordinary course of business. Management does not anticipate that the ultimate
outcome of these issues will have a material impact on the Company's financial
position or results of operations.
(8) INCOME TAXES
From its inception, the Company has generated losses for both financial
reporting and tax purposes. The federal net operating loss carryforward is
approximately $2,200,000 as of December 31, 1996. The deferred tax asset
related to this benefit of approximately $814,000 has been fully offset by a
valuation allowance, due to the Company's history of operating losses.
The Company's net operating loss carryforwards expire at various dates
through the year 2011. The Tax Reform Act of 1986 contains provisions which
may limit the net operating loss carryforwards available for use in any given
year if certain events occur, including changes in ownership interests.
F-18
<PAGE>
OSMOTICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(9) SIGNIFICANT CUSTOMERS
Below is a listing of major customers, each of which comprised more than 10%
of revenue:
<TABLE>
<CAPTION>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
DECEMBER 31, DECEMBER 31,
1995 1996
---------------- ----------------
AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Customer 1.............................. $288,639 88% $467,606 37%
Customer 2.............................. $ 38,855 12% $204,181 16%
Customer 3.............................. $ -- --% $229,374 18%
Customer 4.............................. $ -- --% $134,925 11%
</TABLE>
The Company's sales within the United States were $328,465 and $850,374 for
the years ended December 31, 1995 and 1996, respectively. The Company's sales
to retailers in London, England and Paris, France were $0 and $404,426 for the
years ended December 31, 1995 and 1996, respectively.
(10) ACCRUED COMPENSATION AND OTHER ACCRUED LIABILITIES
The components of accrued compensation and other accrued liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------- MARCH 31,
1995 1996 1997
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Accrued consulting fees..................... $ 85,000 $121,000 $130,000
Accrued commissions and royalties........... 38,295 11,376 11,777
Accrued interest............................ 17,146 66,409 95,409
Accrued payroll related items............... 9,996 56,863 55,742
Accrued advertising......................... -- -- 27,582
Accrued audit fees.......................... -- 20,000 20,000
-------- -------- --------
$150,437 $275,648 $340,510
======== ======== ========
</TABLE>
(11) SUBSEQUENT EVENTS
In January 1997, the Board of Directors authorized management of the Company
to resume the process initiated in July 1996, of preparing a Registration
Statement with the Securities and Exchange Commission for the Company's
initial public offering. Once effective, the Registration Statement may permit
the Company to sell shares of its common stock to the public. As of December
31, 1996 and March 31, 1997, the balance sheets include approximately $404,000
and $553,037, respectively, of deferred costs directly related to the
Offering. The Company will also sell to the placement agent, upon closing of
the Offering, warrants to purchase shares of common stock at an exercise price
equal to 165% of the initial public offering per share.
Upon the initial closing of the Offering, the Company will enter into
employment agreements with Steven and Francine Porter that are to become
effective on the closing date of this Offering. The agreements provide for
salaries to Steven and Francine Porter of $100,000 and $75,000, respectively.
Each agreement has a three year term. The agreements also provide for grants
of stock options of 100,000 and 50,000 shares to Steven and Francine Porter,
respectively, at an exercise price equal to 110% of the initial public
offering price. On the effective date of the Offering, 25% of the options
become exercisable and the balance of the shares vest at 25% at the end of
each year thereafter. The agreements provide that upon termination of
employment by the Company without cause, the respective officer is entitled to
severance compensation for the lesser of 18 months or the remaining term of
the employment agreement of his or her salary, payable at the same time as the
salary payments would otherwise have been paid.
F-19
<PAGE>
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NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS CONTAINED IN THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER OR
PLACEMENT AGENT. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY
PERSON OR ANYONE IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE
MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE
HEREOF.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 8
Use of Proceeds........................................................... 17
Dividend Policy........................................................... 18
Capitalization............................................................ 19
Dilution.................................................................. 22
Selected Financial Data................................................... 24
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 25
Business.................................................................. 29
Management................................................................ 41
Certain Transactions...................................................... 46
Principal Stockholders.................................................... 49
Description of Capital Stock.............................................. 50
Shares Eligible for Future Sale........................................... 52
Plan of Distribution...................................................... 54
Legal Matters............................................................. 55
Experts................................................................... 55
Additional Information.................................................... 55
Index to Financial Statements............................................. F-1
</TABLE>
---------------
UNTIL SEPTEMBER 3, 1997 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK OFFERED HEREBY, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
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MINIMUM OFFERING OF 500,000 AND MAXIMUM OFFERING OF 1,125,000 SHARES OF COMMON
STOCK
[LOGO OF NATIONAL SECURITIES CORPORATION]
-----------------
PROSPECTUS
-----------------
NATIONAL SECURITIES
CORPORATION
JUNE 5, 1997
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