<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
EXCHANGE ACT
For the transition period from __________________ to _________________
Commission file number 0-21168
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC.
(Exact name of small business issuer as specified in its charter)
NEW YORK 13-3253392
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
5 East 80th Street, New York, New York 10021
(Address of principal executive offices)
(212) 717-6544
(Issuer's Telephone Number, Including Area Code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
--- ---
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by court. Yes No N/A
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: Common Stock: 8,454,207
Warrants: 1,405,771
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PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 1997 December 31, 1996
------------------ -----------------
(unaudited) (Note 1)
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and equivalents $ 3,936,100 $ 5,352,400
Accounts receivable, less allowance for doubtful accounts of $0 and $10,000 in
1997 and 1996, respectively 92,400 87,400
Inventories 223,300 223,400
Prepaid expenses and other assets 97,700 89,200
------------ ------------
Total Current Assets 4,349,500 5,752,400
COLORMATE(TM) UNITS, LESS ACCUMULATED
DEPRECIATION OF $32,800 (1997) AND $26,000 (1996) 667,200 674,000
PROPERTY AND EQUIPMENT, AT COST LESS ACCUMULATED
DEPRECIATION OF $224,800 (1997) AND $155,300 (1996) 312,800 293,700
OTHER ASSETS 24,400 27,400
------------ ------------
$ 5,353,900 $ 6,747,500
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable - collateralized by equipment $ 6,100 $ 10,000
Notes payable to related party 299,600 326,000
Accounts payable and accrued expenses:
Attorneys and Accountants 306,600 269,700
Consultants 46,600 65,600
Trade 164,000 109,700
Security deposits -- 10,500
------------ ------------
Total Current Liabilities 822,900 791,500
------------ ------------
COMMITMENTS AND CONTINGENCIES
REDEEMABLE CLASS A PREFERRED STOCK,
PAR VALUE $.01 PER SHARE:
Authorized - 1,400,000 Shares
Issued and outstanding - 1,380,000 Shares
At par and redemption value 13,800 13,800
------------ ------------
STOCKHOLDERS' EQUITY (DEFICIENCY):
Common Stock, par value $.001 per share:
Authorized - 50,000,000 shares
Issued and outstanding - 7,798,469 (1997)
and 7,168,730 (1996) 7,800 7,200
Capital in excess of par value 17,307,100 15,370,300
Accumulated deficit (12,797,700) (9,435,300)
------------ ------------
Total Stockholders' Equity 4,517,200 5,942,200
------------ ------------
$ 5,353,900 $ 6,747,500
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
1
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CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES:
Lease, license and service contracts $ 9,000 $ 1,500 $ 10,500 $ 66,100
Interest income 42,900 82,700 148,600 151,700
Other 200 700 1,000 100
----------- ----------- ----------- -----------
52,100 84,900 160,100 217,900
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Food and Drug Administration ("FDA")
medical application expenses 213,000 408,700 1,022,100 821,000
Patent application costs (including
$96,100 of FDA related costs and
$80,800 of research and development
costs for the three months ended
September 30, 1997 and $317,200 of
FDA related costs and $141,800 of
research and development costs for the
nine months ended September 30, 1997) 176,900 109,000 459,000 192,000
Research and development costs 183,800 58,200 301,200 168,600
General and administrative:
Compensation of officers and
employees 182,600 160,600 530,900 540,600
Compensation of consultants 43,200 78,100 138,200 177,800
Legal fees 47,300 41,700 203,100 238,300
Accounting fees 9,500 6,800 31,100 46,800
Rent and storage 49,800 48,200 152,400 151,000
Legal settlement -- 132,000 -- 132,000
Insurance 51,600 50,100 164,000 146,500
Travel and entertainment 13,600 2,000 17,600 26,100
Repairs and maintenance 31,500 27,300 89,800 84,000
Depreciation and amortization 26,600 24,800 79,400 156,800
Payroll taxes 16,800 14,900 70,400 65,200
Stock administration fees 13,900 6,500 38,600 49,100
Printing, press and promotion 30,300 2,100 45,000 15,300
Corporate taxes 13,300 4,700 24,900 15,500
Other 41,200 30,600 134,500 133,700
Interest 6,600 42,300 20,300 59,000
----------- ----------- ----------- -----------
1,151,500 1,248,600 3,522,500 3,219,300
----------- ----------- ----------- -----------
NET LOSS (1,099,400) (1,163,700) $(3,362,400) $(3,001,400)
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES AND
EQUIVALENTS OUTSTANDING 7,579,487 5,432,824 7,478,938 5,777,479
=========== =========== ----------- ===========
NET LOSS PER SHARE $ (0.15) $ (0.21) $ (0.45) $ (0.52)
=========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
2
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CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
(UNAUDITED)
<TABLE>
<CAPTION>
Common Stock
---------------------------------
Number of Capital in Excess Accumulated
Shares Outstanding Par Value of Par Value Deficit
------------------ --------- ------------ -------
<S> <C> <C> <C> <C>
Balances, December 31, 1996 7,168,730 $ 7,200 $ 15,370,300 $ (9,435,300)
Nine Months Ended September 30, 1997:
Net Loss -- -- -- (3,362,400)
Exercise of warrants at $2.50 per share 360,096 332 899,900 --
Exercise of warrants at $5.00 per share 79,710 79 398,500 --
Exercise of options at $2.6875 per share 37,500 37 100,800 --
Exercise of options at $2.50 per share 46,600 46 116,500 --
Exercise of options at $3.375 per share 50,000 50 168,700 --
Exercise of options at $4.375 per share 10,000 10 43,700 --
Exercise of options at $4.4375 per share 45,833 46 203,300 --
Gain on account of "short swing" profits
under Section 16 of the Securities
Exchange Act of 1934 -- -- 5,400 --
------------ ------------ ------------ ------------
Balances, September 30, 1997 7,798,469 $ 7,800 $ 17,307,100 $(12,797,700)
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
3
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CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1997 1996
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(3,362,400) $(3,001,400)
Adjustments to Reconcile Net Loss to Net
Cash Flows From Operating Activities:
Depreciation and Amortization 79,400 158,600
Gains on Sale of Equipment -- (1,500)
Changes in Operating Assets and Liabilities:
Accounts Receivable (5,000) 83,600
Inventories 100 (32,000)
Prepaid Expenses and Other Assets (8,500) (6,800)
Other Assets 3,000 (31,000)
Accounts Payable and Accrued Expenses 72,200 284,800
Security Deposits (10,500) --
----------- -----------
Net Cash Flows From Operating Activities (3,231,700) (2,545,700)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of Property and Equipment (88,600) (144,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds From Issuance of Common Stock Net of Related
Costs -- 7,387,800
Proceeds from Exercise of Options 633,100 --
Proceeds from Exercise of Warrants 1,295,800 --
Short Swing Profits 5,400 --
Payments of Notes Payable to Related Party (26,400) (9,200)
Notes Payable - Collateralized by Equipment (3,900) (3,200)
----------- -----------
Net Cash Flows from Financing Activities 1,904,000 7,375,400
----------- -----------
NET CHANGE IN CASH AND EQUIVALENTS (1,416,300) 4,685,700
CASH AND EQUIVALENTS, BEGINNING OF
PERIOD 5,352,400 1,827,400
----------- -----------
CASH AND EQUIVALENTS, END OF PERIOD $ 3,936,100 $ 6,513,100
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest Paid $ 17,100 $ 59,000
=========== ===========
Income Taxes Paid $ -- $ --
=========== ===========
SUPPLEMENTAL NON-CASH FLOW INFORMATION
Deferred Offering Costs Offset to Additional Paid-in
Capital $ -- $ 554,903
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
4
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CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -- Basis of Presentation:
Nature of Report -- The consolidated balance sheet at the end of the
preceding fiscal year has been derived from the audited consolidated
balance sheet contained in the Company's Form 10-KSB for the fiscal
year ended December 31, 1996 and is presented for comparative
purposes. All other financial statements are unaudited. In the opinion
of management, all adjustments, which include only normal recurring
adjustments necessary to present fairly the financial position,
results of operations and changes in cash flows, for all periods
presented have been made. The results of operations for interim
periods are not necessarily indicative of the operating results for
the full year.
Footnotes -- Certain footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been omitted in accordance with the
published rules and regulations of the Securities and Exchange
Commission. These consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included
in the Company's Form 10-KSB for the fiscal year ended December 31,
1996.
Estimates and Uncertainties -- The preparation of financial statements
in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results, as determined at a later date, could differ from those
estimates.
At September 30, 1997, most of the inventory of the Company's products
is in excess of current requirements based on the de minimis level of
recent sales. In addition, the Company has not sold its new line of
cosmetics because the manufacturer has experienced difficulties in
color matching certain shades to be scientifically claimable for the
Company's scientifically color coordinated cosmetics line. Pending
availability of the new line, the Company has ceased active marketing
of its prior existing cosmetics line and Swatch Packs. The Company
believes the new cosmetics will be ready to ship in the first quarter
of 1998, although there can be no assurance. Management believes a
$100,000 loss will be incurred on the disposition of inventory and
provided for such loss in 1996.
Note 2 -- Commitments and Contingencies:
Business Risks -- The Company's business encompasses all of the risks
inherent in the establishment of a new business enterprise, including
a limited operating history with significant competition possessing
substantially greater resources. Current and future operations also
depend upon the continued employment of certain key executives, the
ability to commercialize its proprietary technology and products and
the Company's ability to obtain adequate revenues and/or outside
financing.
Possible Impairment -- Depreciation on a straight-line basis over five
years commences upon initial rental of the Colormate(TM) units. The
Company continually evaluates the life and carrying amount of such
equipment in light of current conditions. Given present conditions, it
is reasonably possible that the Company's estimate that it will
recover the carrying amount from future operations may change in the
near term, but the Company currently believes it is more likely than
not that write-down for impairment will not be necessary. For
assessing whether a write-down is necessary, management compares the
greater of the estimated undiscounted net future revenues and an
annual appraisal with the carrying amount of this specialized
equipment.
Operating Difficulties -- Since 1989, the Company has incurred losses
from operations and net cash outflows from operations and has owned
Colormate(TM) units since June 1991 whose ultimate recoverability
depends upon the Company's future marketing success. Having obtained
confirmation of clearance for
5
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commercial marketing by the United States Food and Drug Administration
("FDA") in July 1997 of its technology for the non-invasive monitoring
of bilirubin infant jaundice, the Company expects to license its
patents and proprietary technology, rent its equipment and market its
related services and products to ultimately overcome these
difficulties. In the event the Colormate(TM) units and related
proprietary technology are not successfully leased/licensed and/or the
products (pending completion of the new cosmetics line) are not
successfully marketed in the future, the principal effect may be a
substantial write-down of the book value of such units.
Management expects that the Company will have sufficient liquidity at
least until December 1, 1998, even if no revenues from operations are
generated. If the Company is able to profitably market its
Intellectual Properties, Colormate(TM) units and new cosmetics line
and products, the Company would use any cash flow obtained from
operations, and may seek additional debt or equity financing, to
further support and expand its operations. The Company's Colormate(TM)
units for all applications will be marketed interchangeably as the
only differences between the different models are design, power supply
improvements and software systems. There can be no assurance that the
Company will not require additional funding. If the Company has not
been able to attract additional future financing or generate
significant revenue from operations, at such point in time, it may
have to cease operations.
Colormate(TM) Units for Beauty Aid and Fashion Industries -- In
connection with a license with Avon Products, Inc. ("Avon"), Avon paid
approximately $4,600,000 to purchase color measurement instruments and
related equipment for its use during the term of the license period.
Due to missing and damaged units, Avon and the Company executed mutual
releases at the termination of the lease on June 24, 1991 with the
principal effect that the Company received 1,947 units of which 1,400
were useable and not in need of significant repair. For accounting
purposes, the $700,000 estimated fair value of the nonproprietary
equipment (based upon an independent appraisal of the complete units
with allowances for the lack of a verifiable used equipment market,
varying usage, the need for refurbishment and similar factors) was
recorded as an asset. The 1,700 useable units of nonproprietary
equipment were received in the form of (i) 1,400 complete units valued
at $500 per unit and (ii) 300 complete units in need of significant
repair that were assigned zero value. No valuation of the proprietary
portion of the units or of the additional 247 unusable units returned
by Avon was performed.
Item 2. Management's Discussion and Analysis
The following is intended to update the information contained in the
Company's Form 10-KSB for the year ended December 31, 1996 (the "Form 10-KSB")
and presumes that readers have access to, and will have read, Management's
Discussion and Analysis contained in the Form 10-KSB.
Except for the historical information contained herein, certain of the
matters discussed are forward-looking statements that are subject to material
risks and uncertainties which may cause actual results to differ materially from
those anticipated by the statements made below. Such risks and uncertainties
include, among other things, the availability of any needed financing, the
Company's ability to operate as a going concern, the Company's ability to
implement its long range business plan for various applications for its
technologies, including medical and industrial applications, the obtaining of
and compliance with regulatory approvals applicable to proposed applications of
the Company's technology, the impact of competition, the management of growth,
and other risks and uncertainties that may be detailed from time to time in the
Company's reports filed with the Securities and Exchange Commission, including
those set forth in this Form 10-QSB.
Overview
Since inception, the Company has been principally engaged in the research
and development of certain intellectual property rights, proprietary technology
and instrumentation in the field of color science (collectively, the
"Intellectual Properties"). The Intellectual Properties relate to the
application of scientific color measurement principles to the classification of
human skin and the classification and color-oriented organization of various
color
6
<PAGE>
sensitive consumer products such as cosmetics, hair color, hosiery, fashion,
print and textiles, as well as the development of the Colormate(TM) units and
the Company's cosmetics line and material swatch packs (the "Products"). The
Company from time to time has also been engaged in test marketing the
Intellectual Properties and Colormate(TM) units in the beauty aid and fashion
industries, marketing them in the cosmetics industry, and in cooperation with
Mt. Sinai Hospital, New York, New York, has conducted clinical research studies
for the non-invasive detection and monitoring of bilirubin infant jaundice.
Since December 31, 1990, the Company has been primarily engaged in developing
and testing further applications of the Intellectual Properties and
Colormate(TM) units, such as the clinical research studies for monitoring
bilirubin infant jaundice and feasibility studies for other medical applications
and obtaining additional financing to support marketing of the Company's
Intellectual Properties, Colormate(TM) units, Products and related services.
The Company has furthered implementation of its long-range plans to exploit
certain medical applications for its technology. In this regard, on November 14,
1996, the Company filed its application with the FDA for certain medical
applications of its technologies and in 1996 developed the working prototype of
the Colormate(TM) unit for such medical applications. On July 30, 1997, the
Company received confirmation of marketing clearance pursuant to a "substantial
equivalence" determination order, in the form of a letter dated July 24, 1997
from the FDA's Center for Devices and Radiological Health, authorizing the
Company to commercially distribute its Colormate(TM) device for non-invasive
monitoring of bilirubin infant jaundice in the United States. The "substantial
equivalence" order states that the Company must comply with the medical device
"general controls," e.g., device establishment registration, medical device
listing, good manufacturing practices (quality system regulation) ("GMP"),
labeling, and the statutory prohibitions against adulteration and misbranding.
The order also states that the Colormate(TM) device is a Class II device which
may be subject to additional "special controls." The Company intends to comply
with any applicable "general controls" and "special controls" for purposes of
commercial distribution.
The Company has incurred significant losses from operations since 1990. The
Company has incurred significant FDA related expenses and research and
development and marketing expenses and, prior to consummation of its IPO in
February 1993, negative shareholders' equity. The Company also has not achieved
significant operating revenues since the conclusion in 1991 of marketing its
intellectual properties and Colormate(TM) units in the cosmetic and beauty aid
industries in a national sales program (the "Avon Project") with Avon. Pending
completion of its new line of cosmetics, the Company has ceased active marketing
of its prior existing cosmetics line and Swatch Packs. See Note 1 of Notes to
Financial Statements. The foregoing factors raise substantial doubt as to the
Company's ability to continue as a going concern.
The Company has financed its operations through (i) private placements of
its securities, which generated an aggregate of $1,167,500 (including $620,400
from Darby Simpson Macfarlane) from 1988 through 1992 (excluding the Bridge
Financing, which was repaid with proceeds of the IPO), (ii) collaborative
research and development arrangements with licensees, (iii) cash receipts from
lease and licensing agreements, which generated in the aggregate $8,386,200 from
inception through December 31, 1992, including $6,944,200 in the period from
January 1, 1988 to December 31, 1992 (primarily attributable to the Avon
Project), (iv) loans from private investors and certain shareholders which
aggregated $549,000 in 1991 and 1992 (excluding $775,000 in a bridge financing
effected in September and October 1992 (the "Bridge Financing")), (v) the IPO,
(vi) private placements of securities from October 1994 to June 1995 (which have
generated gross proceeds of $4,500,000 and net proceeds of $3,729,800), and
(vii) the 1996 Debenture Offering which raised net proceeds of approximately
$4,200,000. In addition, during 1996, the Company received an aggregate of
$2,738,925 from exercise of its Warrants and $207,500 from the exercise of stock
options. From January 1, 1997 to September, 1997, the Company received an
aggregate of $1,295,800 from exercise of Placement Agent Warrants and Public
Warrants, and received approximately an additional $5,240,000 from the exercise
of Placement Agent and Public Warrants in October and November 1997.
Generally, limited revenues have been derived from licenses, leases,
service contracts and product sales to several beauty-related businesses,
testing and laboratory fees from potential licensees evaluating the Company's
technology, and from an exclusive licensing and lease contract with IMS
Cosmetics Inc. In 1996, the Company generated approximately 39% of its lease,
license and service contract revenues from IMS. For the nine months ended
September 30, 1997, the Company generated no such revenues from IMS. The Company
receives payments from licensees, distributors or other sources at various times
during the year. Accordingly, these payments have had, and payments that may be
received in the future will have, a significant impact on quarter-to-quarter
comparisons inasmuch as the Company has not developed stable sources of repeat
revenues.
7
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The Company's ability to generate revenues in the future will depend on its
success in marketing its Intellectual Properties, the related Chromaticity Study
capabilities, the Colormate(TM) units and (pending completion of the new
cosmetics line) its Products. In addition, the Company's future ability to
generate revenues from its technologies and its Colormate(TM) units will depend
on, among other things, the Company's ability to establish marketing,
distribution and manufacturing arrangements with third parties. If these efforts
are not successful in the future, the principal effect may be a substantial
write-down of the book value of the Colormate(TM) units and a substantial
impairment of the Company's capital resources and ability to obtain any future
financing, which would result in a substantial diminution in the value of an
investment in the Company. There can be no assurance the Company will be able to
timely place such units, establish such arrangements or identify alternative
markets. See Note 2 of Notes to Financial Statements.
Results of Operations
The Company incurred net losses of $3,362,400 and $3,000,900 for the
nine-month periods ended September 30, 1997 and 1996, respectively, as revenues
received have not been significant relative to the Company's expenses incurred
in implementing its business plan. Loss per share decreased by $0.06 in the 1997
period compared to the 1996 period, and the 1997 period was favorably impacted
by an increase of 1,701,459 weighted average number of shares outstanding
attributable to the exercise of options and Warrants. The dollar increase in
such losses in the 1997 period as compared to the 1996 period is primarily
attributable to the Company continuing implementation of its long-range business
plan to seek commercial applications of its Intellectual Properties and
technologies in the medical field including an increase in costs and expenses
regarding FDA regulatory applications, patent applications and research and
development expenses. Since the Company received confirmation of marketing
clearance by the FDA as described above, the Company believes that any future
expenses incurred in connection with further regulatory marketing clearances and
related patent application costs should be less than the amount incurred in 1996
and the first nine months of 1997, although no assurance can be given of such
result. However, the Company may have to incur additional costs and expenses in
connection with FDA marketing clearances and state regulatory requirements for
the home health care and pediatric office market, as well as foreign market
clearances. In addition, the Company expects to incur increased expenses
relating to products liability insurance, manufacturing expenses, legal and
regulatory compliance, including GMP quality system compliance, as well as
research and development for new potential applications as it implements the
next phase of its efforts to commercialize medical applications of its
technology.
The Company estimates that research and development expenses (excluding
compensation expenses for officers, employees and long-term consultants but
including patent application costs) for fiscal 1997 will approximate $700,000
although there can be no assurance that such expenses will not exceed that
amount. Of such amount, approximately $300,000 will be applied to developing the
mass manufacture housing prototype for the medical application of the Company's
technology in the detection and monitoring of infant jaundice, approximately
$100,000 will be applied to completing the hand held, less expensive version of
the Colormate(TM) units, approximately $100,000 will be applied to fabricate
molds for each of the foregoing prototypes, and approximately $200,000 will be
applied to the Company's ongoing research and development efforts. There can be
no assurance that such amounts will be sufficient to accomplish completion of
such projects.
In the first nine months of 1997, the Company focused its resources on
implementation of its long-range business plan for medical applications of its
technologies and received an insignificant level of revenues from operations.
The Company believes that sales in the 1997 nine-month period were also
adversely affected by ongoing delays in manufacturing certain color shades of
the Company's new line of cosmetic products for its Colormate(TM) system (which
delays were attributable to finalizing color formulations). The Company
anticipates the new cosmetics will be ready to ship in the first quarter of 1998
although there can be no assurance of this. See Note 1 of Notes to Financial
Statements.
The Company anticipates that it will continue to incur substantial and
increasing net losses for the foreseeable future as increased expenses are
incurred in implementing its long-range business plan for medical applications
of its technologies and as revenues from the Company's existing activities in
the cosmetics, beauty aid and fashion areas are anticipated to continue to be
insignificant relative to its anticipated expenses in the foreseeable future.
8
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Liquidity and Capital Resources
Assets decreased by $1,393,600 in the first three quarters of 1997 as
compared to fiscal 1996, primarily attributable to a decrease in cash and cash
equivalents, which is primarily attributable to the expenses incurred pursuant
to the Company's FDA application. The decrease in notes payable to related party
is attributed to the payment of past due royalty payments of $26,400 in
connection with a note to Peach & Pink Computer Corp. that matured in 1996.
As indicated in the Company's Statements of Cash Flows, the Company
continued to experience significant negative net cash flows from operating and
investing activities in the first nine months of 1997. The 1997 increase in cash
outflows from operating activities is primarily attributable to the increase in
the Company's net loss. Cash flows from financing activities during the 1997
period principally represent $633,100 from the exercise of certain of the
Company's outstanding options, $1,295,800 from the exercise of Warrants and
$5,400 of "short swing" profits paid to the Company in accordance with the
Securities Exchange Act of 1934. Cash flows from financing activities in the
1996 period principally represent the receipt of proceeds from the issuance of
Common Stock (net of related costs), the exercise of Warrants and certain of the
Company's outstanding options and "short swing" profits paid to the Company in
accordance with the Securities Exchange Act of 1934.
The Company has applied a substantial portion of the proceeds from the 1995
Private Placement and 1996 Debenture Financing to begin implementation of its
long-range business plan for commercialization of its technologies for medical
applications in diagnosing certain diseases, including the preparation of the
FDA application and the related patent applications. In this regard, the Company
hired FDA and governmental regulatory consultants (in addition to legal counsel)
to assist in obtaining regulatory clearances for commercial use of its
technology for the detection and monitoring of bilirubin infant jaundice. As
described above, the Company received confirmation of clearance by the FDA on
July 30, 1997 pursuant to a "substantial equivalence" determination order, in
the form of a letter dated July 24, 1997 from the FDA's Center for Devices and
Radiological Health, authorizing the Company to commercially distribute its
Colormate(TM) device for non-invasive monitoring of bilirubin infant jaundice in
the United States. The Company anticipates that any initial penetration of the
medical marketplace will be through the use of specialized distributors, rather
than a direct sales force.
In addition, the Company applied proceeds of the 1995 Private Placement and
1996 Debenture Financing to the ongoing development of a mass manufacture
prototype for medical applications and development of a mass manufacture
prototype for a hand held Colormate(TM) device, salaries of new personnel
including a new president, salespersons and support staff marketing expenses,
working capital, additional prototype research and development and to fund
ongoing operations.
Management believes that if its proposed marketing plans for nonmedical
applications of its technology are successful, then it will generate revenues
from fees from the licensing of the Intellectual Properties and leasing of the
Colormate(TM) units, consulting fees, and sales of cosmetics, although there can
be no prediction or assurance as to which or whether any of these potential
revenue sources will be successful. In 1996 and for the first three quarters of
1997, such licensing, leasing and sales yielded an immaterial level of revenue,
primarily because the Company devoted its resources to the commercialization of
its technologies for medical applications and because the Company's new
cosmetics line is not yet available.
Management expects that the Company will have sufficient liquidity at least
until December 1, 1998, even if no revenues from operations are generated. If
the Company is able to profitably market its Intellectual Properties,
Colormate(TM) units, the Company would use any cash flow obtained from
operations, and may seek additional debt or equity financing, to further support
and expand its operations. The Company's Colormate(TM) units will be marketed
interchangeably as the only differences between the different models are design
and power supply improvements and software systems. There can be no assurance
that the Company will not require additional funding. If the Company has not
been able to attract additional future financing or generate significant revenue
from operations at such point in time and/or successfully market its products
and technologies, it may have to cease operations.
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Estimated Existing Market for Testing of Bilirubin Infant Jaundice
In September 1997, the Company completed its analysis of the existing
market for bilirubin tests on newborn infants in the United States, and the
approximate size of that market in the developed countries of Europe, South
America and Canada combined, and Asia.
The World Health Organization has published the current annual birthrate of
approximately 4,000,000 births in the United States, with approximately 10% of
these births being premature infants. The Company estimates that individual
bilirubin blood tests on newborn infants (heelsticks), which are not part of a
general panel blood test, total approximately 15,000,000 tests performed
annually in the United States, based on data made available by the World Health
Organization, the American Academy of Pediatrics, independent market studies
commissioned by the Company and business proposals from potential marketing
partners.
The Company believes that published reimbursement amounts by third party
insurance carriers for heelstick bilirubin blood tests, not part of a panel
test, range between $22-$34 per test in the United States. Assuming a $22 fee,
the Company estimates that approximately $330 million is spent annually on
monitoring bilirubin infant jaundice in the United States.
Internationally, using the World Health Organization birth rates,
independent market studies and research obtained from companies currently
marketing neonatal medical devices in foreign countries, the Company estimates
that the current European market for infant bilirubin tests is approximately the
same size as the United States; South America and Canada combined represent
approximately 25% of the United States market size and the Southern Chinese and
entire Japanese markets combined represent approximately the same size of market
as the United States.
Since receiving FDA marketing clearance in the United States, the Company
is currently undertaking the effort to obtain required international regulatory
clearances for its noninvasive bilirubin monitoring device and technology. The
Company has also begun the process of establishing third party reimbursement for
its noninvasive bilirubin testing which will be an important factor in its
pricing structure in the United States.
Based on the Company's initial business discussions with international
medical device companies interested in global distribution rights for the
Company's noninvasive bilirubin monitoring medical device for newborns,
significant market penetration in the United States and international markets
would require 3-4 years from the start of commercial distribution.
Risk Factors
Accountant's Report; Going Concern Considerations. The report of Wiss &
Company, LLP, independent auditors for the Company, with respect to the year
ended December 31, 1996, includes an explanatory paragraph relating to doubt as
to the ability of the Company to continue as a going concern. The Company has
suffered significant losses from operations since 1990, as well as other factors
impacting the viability of the Company as a going concern. A "going concern"
explanatory paragraph could have a material adverse effect on the Company's
ability to obtain bank financing or to raise capital in the future.
Limited Operating History. Until 1986, the Company was principally engaged
in research and development relating to the Intellectual Properties,
Colormate(TM) units and the Company's Products. From early 1986 through October
1987, the Company was engaged in limited test-marketing of certain of the
Intellectual Properties and Products through its former licensees. From October
1987 until June 1991, the Company was principally engaged in the Avon Project.
From October 1990 to date, the Company has not conducted any material revenue
producing operations and there can be no assurance it will be able to do so in
the future. The Company's business is subject to the risks inherent in the
development of new products using new technologies and approaches. There can be
no assurance that unforeseen problems will not develop with these technologies
or applications, that the Company will be able to successfully address
technological challenges it encounters in its research and development program
or that commercially feasible products will ultimately be developed by the
Company.
Operating Losses. The Company has incurred significant losses from
operations for the years ended December 31, 1996 and 1995 ($4,442,300 and
$2,494,300, respectively) and for the nine months ended September
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30, 1997 ($3,362,400). The Company anticipates incurring increased operating
expenses as the Company attempts to expand its marketing and sales activity and
otherwise continues to implement its business plan, including its long-range
business plan for potential medical applications of its technology, including
the monitoring of bilirubin infant jaundice. There can be no assurance the
Company will not continue to incur such losses or will ever generate revenues at
levels sufficient to support profitable operations.
Need for Additional Financing; Cessation of Operations. The Company has
limited resources and has not been able to finance its activities with cash flow
from operations since fiscal 1989. There can be no assurance that the Company
will not continue to incur operating losses, and from exercise of its Warrants,
that remaining proceeds of the 1996 Debenture Offering and from exercise of its
Warrants will be sufficient to fund operations beyond December 1998, that
sufficient sales levels, if any, will be achieved thereafter to fund operations
or that the Company will not incur additional unanticipated expenses. In this
regard, if the Company is unable to successfully market its Intellectual
Properties, Colormate(TM) units and Products, it is extremely doubtful it will
be able to obtain additional future financing and, at such point, may have to
cease operations. The Company's continued operation will depend on its ability
to obtain significant commercial sales of the Products and/or licensing and
leasing fees from its Intellectual Properties and the Colormate(TM) units, the
successful marketing of the Colormate(TM) units in medical applications and the
availability of future financing. There can be no assurance that the Company
will be able to obtain additional financing, such commercial sales or fees, in
which case the Company's operations would be materially adversely affected and
it may be forced to cease operations.
No Assurance of Successful Commercialization of Medical Device for
Monitoring Bilirubin Disease; Early Stage of Other Medical Product Development.
There is no assurance the Company's technology for monitoring bilirubin infant
jaundice, or other medical applications of the Company's technology, will be
capable of being produced in commercial quantities at acceptable costs, be
eligible for third-party reimbursement from governmental or private insurers or
be successfully marketed or achieve market acceptance. If any of the Company's
marketing or development programs are not successfully completed, required
regulatory approvals or clearances are not obtained, or products for which
approvals or clearances are obtained are not commercially successful, the
Company's business, financial condition and results of operations would be
materially adversely affected. Although the Company has received FDA clearance
to commercially market its Colormate(TM) device to monitor bilirubin infant
jaundice, as described above, and has conducted early stage research with
respect to certain other chromogenic diseases identified by the Company, the
Company's clinical and research development programs for any other medical
application of its technology have not effectively commenced, and substantial
additional research and development and clinical trials will be necessary before
commercial prototypes of the Company's products are produced for any such other
medical application. The Company could encounter unforeseen problems in the
development of such other products such as delays in conducting clinical trials,
delays in the supply of key components or delays in overcoming technical
hurdles. There can be no assurance that the Company will be able to successfully
address the problems that may arise during the development and commercialization
process. In addition, there can be no assurance that any of the Company's
products for any such other medical application will be successfully developed,
proven safe and efficacious in clinical trials or meet applicable regulatory
standards and requirements.
Uncertainty of Medical Market Acceptance and Lack of Medical Marketing and
Sales Experience. The Company's Colormate(TM) unit is a new device for the
monitoring and screening of bilirubin infant jaundice, and there can be no
assurance that it will gain market acceptance. To date, except for the clinical
studies and related information regarding the Company's bilirubin infant
jaundice device, the medical community generally has had no exposure to the
Company or its proposed medical applications and methods. Because the medical
community is generally relatively slow to adopt new technologies, procedures or
devices, the Company might be unable to gain access to potential customers in
order to attempt to demonstrate the operation and efficacy of its Intellectual
Properties in the medical field. Even if the Company gains access to potential
customers, no assurance can be given that members of the medical community will
perceive a need for or accept the Company's proposed medical applications and
methods. Physicians and individuals will not recommend or use the Company's
device unless they determine, based on experience, clinical data, relative cost,
and other factors, that these products are an attractive alternative to current
blood-based tests that have a long history of safe and effective use. The
Company may need to conduct additional independent studies in order to achieve
acceptance in the medical community. In addition, purchase decisions for the
device will be greatly influenced by health care administrators who are subject
to increasing pressures to reduce costs. Some purchasers, such as hospitals,
pediatricians and independent medical supply and home health care distributors,
might also be reluctant to purchase products from a company that has not
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demonstrated the ability to satisfy ongoing delivery requirements. In addition,
hospitals, clinics and pediatricians may be unwilling or unable to commit funds
to the purchase of the Company's proposed medical applications due to
institutional budgetary constraints, particularly in a slower economy. Failure
of the Company's device to achieve significant market acceptance would have a
material adverse effect on the Company's business, financial condition and
results of operations.
In addition, the Company's proposed medical applications will compete with
existing devices, technologies and methods in achieving acceptance in the
medical community and in attracting support from independent medical device
distribution organizations which sell medical equipment to the anticipated
target market (i.e., hospitals, pediatricians and home health care services).
While the Company believes its medical applications are superior to the existing
devices, technologies and methods, no assurance can be given that the medical
community will accept and support the Company's medical device.
There can be no assurance that the Company will be able to successfully
market its proposed medical applications and methods to the target customers, or
that the market for such applications and methods will be large enough to
support profitable operations. There can be no assurance that the Intellectual
Properties or Colormate(TM) units will be found to have successful commercial
medical market acceptance.
Once the Company obtains all necessary regulatory approvals and clearances
to market its Colormate(TM) unit in the medical industry, in order to
successfully market and sell its Colormate(TM) unit, the Company must either
develop a marketing and sales force or enter into arrangements with third
parties to market and sell this product. There can be no assurance that the
Company will be able to successfully develop a marketing and sales force or that
it will be able to enter into marketing and sales agreements with third parties
on acceptable terms, if at all. If the Company develops its own marketing and
sales capabilities, it will compete with other companies that have experienced
and well-funded marketing and sales operations. If the Company enters into a
marketing arrangement with a third party for the marketing and sale of its
bilirubin infant jaundice product, any revenues to be received by the Company
from this product will be dependent on this third party and the Company will
likely be required to pay a sales commission or other compensation to this
party.
Lack of Market Penetration in Other Industries. The Company has not yet
achieved commercial market penetration in any industry, and there can be no
assurance the Company will be able to do so in the future. The Company currently
has a limited number of Colormate(TM) units in commercial use. The Company has
not achieved significant levels of cosmetics sales from its Colormate(TM) unit
locations, and expects based on the cosmetics sales levels achieved per location
to date, that it will have to greatly increase the number of Colormate(TM) unit
installations to achieve significant levels of cosmetics sale revenues. The
Company has collected some cosmetic revenues from its salon installations in the
third quarter of 1997. See "Management's Discussion and Analysis." The Company
also believes, based on its operating history since February 1993, that
obtaining such increased cosmetic sales revenue will take significantly longer
to achieve than was originally anticipated. At December 31, 1996, most of the
inventory of the Company's products was in excess of requirements based on the
recent level of sales. After giving effect to the $100,000 write off in 1996
actual inventory, management believes no further significant loss will be
incurred on the disposition of inventory. No estimate can be made of a range of
amounts of loss that are reasonably possible should the Company's expectations
not be met. There can be no assurance that no such loss will be incurred upon
the disposition of inventory. However, the Company currently provides hair color
analysis in certain salons, expects to complete its inventory of a new line of
chromatically balanced and color coordinated cosmetics in the first quarter of
1998, and although there can be no assurance, expects to commence marketing of
its new line of custom blended foundations in 1998. Although there can be no
assurance, the Company believes these factors may enhance revenues from its
beauty-related operations. In order to implement its marketing plans in the
United States and abroad, including in industries in which the Company does not
have prior experience, the Company will have to develop additional marketing
skills and spend proceeds from additional financing and from the exercise of its
Warrants on sales and marketing activities, including hiring finders and new
personnel including consultants, and entering into arrangements with
distribution companies having a national presence. There can be no assurance the
Company's marketing plan will be successful.
Prior Marketing Attempts. Other than the Avon Project, its more recent
arrangements with IMS and its beauty salon placements, the Company's own
attempts to license and/or lease its Intellectual Properties and the
Colormate(TM) units and to market its Products independently and/or through
licensees never proceeded beyond the
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test marketing stage. There can be no assurance the Company will in the future
achieve commercial leasing of its Colormate(TM) units and commercial licensing
of the Intellectual Properties or the sale of the Products. In addition, other
than its installation of Colormate(TM) units in beauty salons and beauty related
businesses, the Company's revenue generating activities have been primarily
conducted in conjunction with its former licensees (i.e., Clairol, Hanes and
Avon), that provided substantial economic, administrative, marketing and
advertising support. There can be no assurance that without the support of a
marketing partner with financial resources, an advertising budget, market
presence and consumer recognition, the Company will be able to achieve
successful operations. Further, there can be no assurance the Company will ever
develop a commercial market for the licensing or leasing of its Colormate(TM)
units and Intellectual Properties, for the sale of the Products or for any
medical applications of its technologies.
Competition. To the extent the Company implements its business plan to
commercialize medical applications for its Intellectual Properties, it will be
entering a field characterized by rapidly changing technology, intense
competition and extensive research and development. The Company will be
competing with established companies which have greater financial, technical,
manufacturing, marketing, research and development and management resources
(including companies such as Minolta Camera Co. Ltd., Healthdyne Technologies,
Inc. and SpectRx Inc., among others), which have actively pursued development of
noninvasive monitoring of bilirubin infant jaundice. In addition, there will be
other companies with which the Company will compete regarding other medical
applications which the Company may pursue. Furthermore, the monitoring methods
currently in use for bilirubin and tuberculosis, the principle diseases for
which the Company intends to develop commercial applications for its
technologies, have already achieved acceptance by and are in widespread use in
the medical community, unlike the Company's proposed methods. There can be no
assurance that the Company's proposed methods will be accepted by the medical
community.
Further, technological developments by others could result in the Company's
proposed medical applications and devices becoming obsolete even before the
expenses of bringing the proposed applications to market, if ever, are recouped.
There can be no assurance that the Company will be able to upgrade its medical
applications and devices to compete with such competitors or with persons who
may in the future develop products or detection methods competitive with the
Company's proposed medical applications and devices.
Independent medical supply distributors who may be retained by the Company
will distribute other products which may compete with those of the Company or
which would provide greater revenues to such distributors than would be provided
by the Company. In addition, many medical supply companies with which the
Company's proposed medical applications and devices will compete, and which have
significantly greater financial research, technical, manufacturing, and
distribution resources and broader product lines than the Company, have their
own in-house marketing and distribution capabilities and have established
relationships with potential customers for the Company's proposed medical
applications, such as pediatricians and hospitals. Some competitors have greater
name recognition and lengthier operating histories in the health care industry.
No assurance can be given that the Company will successfully and effectively
market its medical products against these and other competitors.
Furthermore, there can be no assurance that the Company's competitors will
not succeed in developing, either before or after the development and
commercialization of the Company's Colormate(TM) units, devices and technologies
that permit more efficient, less expensive non-invasive bilirubin infant
jaundice monitoring. It is also possible that one of more pharmaceutical or
other health care companies will develop therapeutic drugs, treatments or other
products that will substantially reduce the prevalence of bilirubin infant
jaundice or otherwise render the Company's Colormate(TM) unit obsolete in the
medical industry. Such competition could have a material adverse effect on the
Company's business, financial condition and results of operation.
The cosmetics industry and fashion industry are particularly sensitive to
changing consumer preferences and demands, which are difficult to predict and
beyond the Company's control. Competition in the cosmetics industry is diverse
and fragmented, but is nevertheless dominated by a number of large, established,
well-known corporations having, among other things, significantly greater
financial, marketing and human resources than the Company. Virtually all of such
companies have in the past marketed, and continue to market, their products
based on their own color analysis system and advertised claims of "color
compatibility" with the personal color and/or wardrobe of the consumer. These
competitors also have established presence in the market and their own cosmetic
manufacturing facilities, unlike the Company. There can be no assurance that
consumers will prefer products based on the
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Company's scientifically based color determinations, rather than the products
sold by the Company's competitors based on subjective techniques.
The Company has not previously licensed its Intellectual Properties for use
in any industry other than the beauty aid, hosiery and cosmetics industries. In
addition, management of the Company has not had any experience in marketing the
Intellectual Properties, Colormate(TM) units or Products in any other field. To
the extent the Company commences marketing activities in other industries,
specifically in the medical industry, the Company will compete with established
companies and technologies in such industries, which companies may have, among
other things, significantly greater financial, marketing and human resources
than the Company, as well as an established presence in their own industries. In
fact, the Company would be competing in these industries with suppliers of
components for the Colormate(TM) units.
Protection of Intellectual Property. The Company's U.S. Patents Nos.
4,909,632 and 5,311,293 expire in 2007; the Company's U.S. Patent No. 5,313,267
expires in 2011; the Company's U.S. Patent No. 5,671,735 expires in 2014; after
the respective expiration date of each, the proprietary technology and
instrumentation disclosed in each Patent will be available for use by others
without compensation to the Company, unless protected by the claims of other
U.S. patents that may be issued to the Company in the future. The Company has
developed intellectual property rights in color analysis in a number of fields
including medical, biological, dental, cosmetic and materials testing. The
intellectual property rights include trade secrets, know how and thirteen
pending United States patent applications. These rights also include various
foreign patent applications corresponding, at least in part, to the U.S. Patents
and the U.S. patent applications. There can be no assurance that patents will
issue based on these patent applications or that any patent claims will provide
sufficient protection to exclude others from the Company's proprietary
technology and instrumentation. There can be no assurance that the Company will
not be involved in litigation to protect its trade secrets and know how or that
the Company will prevail in such litigation. There can be no assurance that
challenges will not be instituted against the validity or enforceability of any
patents owned by or issued in the future to the Company, or that such challenges
will not be successful. There can be no assurance that patent infringement
claims will not be asserted against the Company and found to have merit, that
the Company will not be enjoined from using its proprietary technology and
instrumentation and from manufacturing and selling certain of its Products, or
would not be forced to obtain a license and pay future royalty fees as well as
past damages to the party claiming infringement in amounts not presently
determinable. There can be no assurance that any such license will be available
to the Company. Conversely, to the extent third parties infringe upon the
Company's patented Intellectual Properties, the Company may have to litigate
against such third parties in order to prevent further infringement. There can
be no assurance the Company will have the resources to prosecute any such
litigation, or that any such litigation would be resolved in favor of the
Company. In the event it is unable to bring such litigations or obtain a
favorable outcome, the Company's operations could be materially adversely
affected in that the Company's failure to enforce its Patents could result in
increased competition. If the Patents are declared invalid, the Company would
lose patent protection for certain of its Intellectual Properties, which could
have a material adverse effect on its operations.
There can be no assurance that the Company's Intellectual Properties will
provide it with a competitive advantage in that it may be possible for a
competitor independently to develop similar non-infringing technologies,
independently duplicate the Company's unpatented technology through reverse
engineering, design around the patented aspects of the Company's technology, or
otherwise independently develop scientifically accurate processes, instruments
or color charts to measure skin tone color categories and conduct comparative
color analysis without infringing the Company's Patents.
The Company's U.S. Patents apply only to the United States. The Company has
filed patent applications in a number of foreign jurisdictions which correspond,
at least in part, to the Company's U.S. Patents. The Company has been granted a
European Patent No. 0446512, a Singapore registration of that European patent,
Australian and Mexican patents corresponding, at least in part, to its
U.S. Patent No. 4,909,632 and Taiwanese and Colombian patents corresponding,
at least in part, to its U.S. Patent No. 5,313,267. The Company has not yet
been granted any other foreign patents for its Intellectual Properties and
there can be no assurance it will be granted any such patents.
Consequently, wherever the Company does not have foreign patents, third parties
currently could exploit outside the United States, the technology disclosed in
the U.S. Patents, thereby increasing competition in such foreign markets. In
addition, persons gaining access to the Company's unpatented proprietary
information and technology and who are not bound by confidentiality agreements
with the Company would have the ability to exploit
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the Company's unpatented proprietary information and technology both inside and
outside the United States, thereby increasing competition.
There can be no assurance that one or more of the patents held by the
Company will not be successfully challenged or circumvented or that the Company
will otherwise be able to rely on such patents. In addition, there can be no
assurance that competitors, many of whom have substantial resources and have
made substantial investments in competing technologies, will not seek to apply
for and obtain patents that prevent, limit or interfere with the Company's
ability to make, use and sell its products either in the United States or in
foreign markets. If any of the Company's patents are successfully challenged or
circumvented or the Company's right or ability to manufacture its products were
to be proscribed or limited, the Company's ability to continue to manufacture
and market its products could be adversely affected, which would likely have a
material adverse effect upon the Company's business, financial condition and
results of operations.
The Company has not applied for patent protection for many aspects of the
Intellectual Properties (i.e., its proprietary trade secrets and other
confidential information). The Company typically imposes on its consultants, key
employees and advisers confidentiality obligations in connection with their
employment, consulting or advisory relationship with the Company. There can be
no assurance that such confidentiality obligations will be observed or that the
Company will have adequate remedies if those obligations are breached. To the
extent that consultants, key employees or other advisors apply technological
information taken from the Company in violation of confidentiality obligations,
disputes may arise as to the proprietary rights to such information which may
not be resolved in favor of the Company. There can be no assurance that others
will not independently develop technology that is substantially equivalent or
superior to that included in the Company's Intellectual Properties which are not
protected by patents.
There can be no assurance that the Company's copyright protection for the
software used in the Colormate(TM) systems will provide it with a competitive
advantage in that it may be possible for a competitor independently to develop
similar software, design around the Company's copyrighted software or otherwise
independently develop software with the capacity accurately to measure skin tone
categories and conduct comparative color analysis.
The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights. In addition, the
United States Patent and Trademark Office ("USPTO") may institute re-examination
or interference proceedings. There can be no assurance that the Company will not
become subject to patent infringement claims brought by third parties, or
re-examination of previously issued patents by the USPTO or interference
proceedings instituted by the USPTO to determine the priority of inventions. The
defense and prosecution of intellectual property suits, USPTO interference
proceedings and related legal and administrative proceedings are both costly and
time consuming. Litigation may be necessary to enforce patents issued to the
Company, to protect trade secrets or know how owned by the Company or to
determine the enforceability, scope and validity of the proprietary rights of
others. Any litigation or interference proceedings brought against, initiated by
or otherwise involving the Company may require the Company to incur substantial
legal and other fees and expenses and may require some of the Company's
employees to devote all or a substantial portion of their time to the
prosecution or defense of such litigation or proceedings. An adverse
determination in litigation or interference proceedings to which the Company may
become a party, including any litigation that may arise against the Company,
could subject the Company to significant liabilities to third parties, require
the Company to seek licenses from third parties or prevent the Company from
selling its products in certain markets, or at all. Although patent and
intellectual property disputes regarding medical devices are often settled
through licensing or similar arrangements, there can be no assurance that the
Company would be able to reach a satisfactory settlement of such a dispute that
would allow it to license necessary patents or other intellectual property. Even
if such a settlement were reached, the settlement process may be expensive and
time consuming, and the terms of the settlement may require the Company to pay
substantial royalties. An adverse determination in a judicial or administrative
proceeding or the failure to obtain a necessary license could prevent the
Company from manufacturing and selling its products, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.
Need for Arrangements with Third Parties. The Company's business strategy
for the commercialization of its medical products depends upon the Company's
ability to selectively enter into and maintain arrangements with leading
marketing and distribution companies in the medical field. There can be no
assurance that the Company will be able to do so. The obligation of any
potential third party to fund or undertake the marketing, distribution and/or
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sale of the product covered by any arrangements with the Company may be
dependent upon the satisfaction of certain goals or "milestones" by certain
specified dates, some of which are outside the Company's control. To the extent
that the obligations of any third party to fund or undertake the foregoing
activities are not contingent upon the satisfaction of certain goals or
milestones, a third party may retain a significant degree of discretion
regarding the timing of these activities and the amount and quality of
financial, personnel and other resources that they devote to these activities.
Furthermore, there can be no assurance that disputes will not arise between the
Company and any third party regarding their respective rights and obligations
under the arrangements. Finally, there can be no assurance that a third party
will not be unable, due to financial, regulatory or other reasons, to satisfy
its obligations under its collaborative arrangement with the Company or will not
intentionally or unintentionally breach its obligations under the arrangement.
There can be no assurance that any third party will not, for competitive
reasons, support, directly or indirectly, a company or product that competes
with the Company's business. Furthermore, any dispute between the Company and a
third party might require the Company to initiate or defend expensive litigation
or arbitration proceedings.
Any significant dispute with or breach, inability to perform, or
termination of any arrangement with such third party would likely require the
Company to seek and reach an agreement with another third party or to assume, to
the extent possible and at its own expense, all the responsibilities being
undertaken by the first such third party. There can be no assurance that the
Company would be able to reach an agreement with a replacement third party. If
the Company were not able to find a replacement third party, there can be no
assurance that the Company would be able to perform or fund the activities for
which the first such third party would be responsible. Even if the Company were
able to perform and fund these activities, the Company's capital requirements
would increase substantially. In addition, the further development and
marketing, distribution and sale of the product covered by such arrangement
would be significantly delayed.
Any of the foregoing circumstances could have material adverse effect upon
the Company's business, financial condition and results of operations.
To the extent the Company develops and markets production units for medical
applications, the Company initially will use the nonproprietary and proprietary
components of the existing Colormate(TM) units in its inventory to manufacture a
limited number of such devices for commercial use and early stage marketing and
sales efforts. Thereafter, the Company will need to source such components from
suppliers for additional manufacturing needs, if any. All manufacturers' units
must comply with GMP regulations.
The Company does not itself manufacture the Colormate(TM) units or the
Products, and in the past has been wholly dependent on third party original
equipment manufacturers of parts, assemblers, cosmetics suppliers and textile
suppliers. To the extent the Company completes development of the mass
manufacture prototypes for the hand-held Colormate(TM) devices or for medical
applications, the Company will have to establish relationships with such third
party suppliers, manufacturers and assemblers, for the production of such
devices. The Company does not have any current arrangements with such suppliers,
parts manufacturers or assemblers for the building of any additional
Colormate(TM) units or the mass production of such prototype devices (or of the
hand held device or modified devices for medical application), and there can be
no assurance the Company will be able to enter into future arrangements with
these or other parts manufacturers or assemblers on terms satisfactory to the
Company. The manufacturer's warranties covering certain parts incorporated in
the Colormate(TM) units are renewable but, if not renewed for any reason, the
costs of any repairs of such parts, or of any uncovered parts, would be borne by
the Company.
The Company's costs of parts for the Colormate(TM) units are based on
original mass manufacturing costs in connection with the Avon Project. There can
be no assurance that the Company can arrange for manufacture of additional
comparable quantities at costs of parts comparable to those manufactured in the
Avon Project. Costs of parts in manufacturing smaller quantities of
Colormate(TM) units could involve significantly greater costs to the extent the
Company does not use existing components from its existing inventory of
Colormate(TM) units.
In connection with any future manufacturing of the Colormate(TM) units
including the medical device, the Company could be required to make significant
advance payments, obtain letters of credit, cause potential customers
16
<PAGE>
or licensees to advance funds under their agreements entered into with the
Company or otherwise secure its payment obligations to manufacturers. There can
be no assurance the Company will be able to enter into such agreements on
acceptable terms, be able to secure its payment obligations itself or by having
customers and/or licensees advance funds, or otherwise be able to manufacture
the Colormate(TM) units or obtain further manufacture of the Colormate(TM) units
or its Products.
Uncertainty of Third-Party Reimbursement. In the United States and
elsewhere, sales of medical products are dependent, in part, on the ability of
consumers of these products to obtain reimbursement for all or a portion of
their cost from third-party payors, such as government and private insurance
plans. Third-party payors are increasingly challenging the prices charged for
medical products and services. If the Company succeeds in bringing its bilirubin
monitoring product or other products to market, there can no assurance that such
products will be considered cost effective and that reimbursement to the
consumer will be available or sufficient to allow the Company to sell its
medical device products on a competitive basis.
Future Developments; Further Development and Marketing Activities Required.
Prior to licensing the Company's Intellectual Properties in any industry other
than the cosmetic, beauty aids and fashion industries, the Company will be
required to develop additional marketing skills relevant to such industries and
conduct significant further marketing activity, and in certain of these
industries, overcome regulatory hurdles, professional skepticism and develop
specific practical applications therefor, which to date has not been achieved.
Accomplishing the foregoing will require the Company to incur significant
additional expenses. The Company is subject to the risks of failure inherent in
the commercialization of products based on innovative technologies, many of
which are beyond the Company's control, such as unanticipated development,
manufacturing and regulatory delays and expenses. The Company expects that
additional financing will be required to commercialize medical applications of
its technologies.
Government Regulations. The Company's advertising, sales practices and
cosmetics products (including the labeling and packaging thereof) are and will
be subject to applicable federal, state and local regulation (including
regulation by the FDA, the Federal Trade Commission, the Federal Communications
Commission, under the Fair Packaging and Labeling Act and/or any comparable
state authority, agency or statute) and will be subject to regulation by
comparable foreign authorities if the Company markets its cosmetic products
abroad. The Company will also be subject to regulation by various governmental
agencies that regulate direct selling activities.
Since the Company has received FDA clearance on its Colormate(TM) device
pursuant to a "substantial equivalence" determination order, in the form of a
letter dated July 24, 1997 from the FDA's Center for Devices and Radiological
Health, authorizing the Company to commercially distribute its Colormate(TM)
device for non-invasive monitoring of bilirubin infant jaundice in the United
States, the Company must comply with the rules and regulations promulgated by
the FDA. The "substantial equivalence" order states that the Company must comply
with the medical device "general controls," e.g., device establishment
registration, medical device listing, good manufacturing practices (quality
system regulation), labeling, and the statutory prohibitions against
adulteration and misbranding. The order also states that the Colormate(TM)
device is a Class II device which may be subject to additional "special
controls." The Company intends to comply with any applicable "general controls"
and "special controls" for purposes of commercial distribution. In this regard,
there may be additional marketing clearance required by the FDA for the
marketing of the Company's Colormate(TM) unit in pediatrician's offices and home
health care markets. There may also be additional FDA marketing clearances
required for the Company's hand-held Colormate(TM) system when final prototype
development is completed.
In order for the Company to market its products in Europe and certain other
foreign jurisdictions, the Company and its distributors and agents must obtain
required regulatory registrations or approvals and otherwise comply with
extensive regulations regarding safety, efficacy and quality in those
jurisdictions. Specifically, certain foreign regulatory bodies have adopted
various regulations governing product standards, packaging requirements,
labeling requirements, import restrictions, tariff regulations, duties and tax
requirements. These regulations vary from country to country. In order to
commence sales in Europe, the Company will be required to obtain ISO 9001
certifications and after mid-1998, the Company will be prohibited from selling
its products in Europe until such time as the Company receives CE mark
certification, which is an international symbol of quality and compliance with
applicable European medical device directives. There can be no assurance that
the Company will be successful in obtaining ISO 9001 or CE mark certification.
Failure to receive ISO 9001 or CE mark certification or other foreign regulatory
approvals could have a material adverse effect on the Company's business,
financial condition and results
17
<PAGE>
of operations. There can be no assurance that the Company will obtain any other
required regulatory registrations or approval in such countries or that it will
not be required to incur significant costs in obtaining or maintaining such
regulatory registrations or approvals. Delays in obtaining any registrations of
approvals required to market the Company's products, failure to receive these
registrations or approvals, or future loss of previously obtained registration
or approvals could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company and any third party with which it has made arrangements will be
required to adhere to applicable FDA regulations regarding GMP and similar
regulations in other countries, which include testing, control, and
documentation requirements. Ongoing compliance with GMP and other applicable
regulatory requirements will be strictly enforced in the United States through
periodic inspections by state and federal agencies, including the FDA, and in
foreign jurisdictions by comparable agencies. Failure to comply with applicable
regulatory requirements could result in, among other things, warning letters,
fines, injunctions, civil penalties, recall or seizure of products, total or
partial suspension of production, refusal of the government to grant premarket
clearance or premarket approval for devices, withdrawal of approvals previously
obtained and criminal prosecution. The restriction, suspension or revocation of
regulatory approvals or government enforcement actions due to any other failure
to comply with regulatory requirements would have a material adverse effect on
the Company's business, financial condition and results of operations.
The Company's products created from its proposed medical applications and
methods constitute "medical devices" as defined under the Act, and will be
subject to regulation by the FDA and the corresponding agencies of the states in
which the Company may in the future sell its proposed medical applications and
methods. Accordingly, the Company is required to comply with FDA statutes and
regulations governing the manufacture, distribution and labeling of its products
and any third party manufacturers with which it may reach agreement must comply
with certain GMP regulations and other relevant laws and regulations in the
processing or manufacture of the products as medical devices. In addition,
manufacturers of medical devices are obligated to report to the FDA whenever
they obtain information reasonably suggesting that one of their products may
have caused or contributed to serious injury or death or has malfunctioned and
is likely to cause death or serious injury if the malfunction recurs. The
Company must register its facilities as a device establishment and list its
devices with the FDA. If the FDA believes that its legal requirements have not
been fulfilled, it has extensive enforcement powers, including the ability to
bar or seize products from the market, to prohibit the operation of
manufacturing facilities, to require recalls of devices from customer locations
and to impose civil monetary or criminal penalties.
Product Liability. The development, manufacture and sale of medical
products entail significant risks of product liability claims. The Company
maintains its own product liability insurance with respect to cosmetic and
beauty aid applications. There can be no assurance that such insurance will be
adequate to protect the Company from claims that may be brought against it by
users of the Colormate(TM) units or its Products. When the Company implements
its business plan for medical applications for its Intellectual Properties, it
will be entering a field where it may become subject to product liability claims
by patients and/or doctors and might become a defendant in product liability
and/or malpractice litigation. The Company does not have malpractice insurance
for such applications and does not intend to obtain such insurance prior to
achieving commercialization of such proposed medical applications. Even if the
Company obtains such insurance, there can be no assurance that it could retain
such insurance or that such insurance would be sufficient to protect the Company
against any such liabilities.
The Company has not established, and the Company does not intend to
establish, any reserves against any of the foregoing liabilities. In the event
of an uninsured or inadequately insured product liability or malpractice claim
in the future based on the performance of the Company's Colormate(TM) units or
Products, the Company's business and financial condition could be materially
adversely affected and the Company could be forced to cease operations.
Control; Dependence on Management. Darby Simpson Macfarlane, Chief
Executive Officer of the Company, owns shares of Common Stock and Preferred
Stock aggregating 2,000,813 of the shares eligible to vote on matters presented
to the shareholders which amount is sufficient to permit her to significantly
influence, if not control, the election of directors or to approve any matter
submitted to a vote of shareholders, and otherwise be in control of the Company.
The Company is dependent primarily on the services of Darby Simpson Macfarlane
and David Kenneth Macfarlane, Vice President, Research & Development. The loss
of either of their services could have
18
<PAGE>
a material adverse effect on the Company. Although the Company has purchased
key-man life insurance policies in the amounts of $1,000,000 on the lives of
both Mrs. and Mr. Macfarlane, there can be no assurance that the proceeds from
such policies would enable the Company to retain suitable replacements for them.
Lack of Public Market; Possible Volatility of Stock Price. There is no
assurance that a regular trading market for the Company's securities will be
sustained. The market price for the Company's Common Stock may be significantly
affected by such factors as the Company's financial performance, the results of
the Company's efforts to license its Intellectual Properties and to market its
Products, and various factors affecting the color science industry and the
beauty aid and cosmetics industries generally. Additionally, in recent years,
the stock market has experienced a high level of price and volume volatility for
many companies, particularly small and emerging growth companies traded in the
over-the-counter market, and these wide price fluctuations are not necessarily
related to the operating performance of these companies. Accordingly, there may
be significant volatility in the market for the Company's securities.
Exercise of Warrants. The price which the Company will receive for the
Common Stock issued upon exercise of the remaining Warrants issued to the
placement agent in the 1995 Private Placement is expected to be substantially
less than the market price of the Common Stock at the time such Warrants are
exercised. For the life of such Warrants, the holders thereof are given, at
little or no cost, the opportunity to profit from a rise in the market price of
the Common Stock, if any, without assuming the risk of ownership. So long as
such Warrants remain unexercised, the terms under which the Company could obtain
additional equity financing may be adversely affected. Moreover, the holders of
such Warrants may be expected to exercise them at a time when the Company would,
in all likelihood, be able to obtain any needed capital by a new offering of
securities on terms more favorable than those provided by such Warrants. To the
extent of any exercise of the Warrants, the interests of the Company's
shareholders will be diluted proportionately.
Outstanding Voting Preferred Stock. The Company has outstanding 1,380,000
shares of Series A Convertible Preferred Stock. Each share of Preferred Stock
has voting rights equivalent to each share of Common Stock and is convertible to
Common Stock if (i) the Company's earnings (i.e. pre tax operating income,
before interest expense, but excluding extraordinary items and revenues or
earnings generated by acquired businesses) for any two consecutive calendar
years ending on December 31, 1998 exceed $20,000,000 or (ii) the closing bid
price of the Common Stock has been at least $46.67 on 30 consecutive trading
days at any time ending on December 31, 1998. Further, the Preferred Stock has a
$13,800 liquidation preference and earns an annual non-cumulative dividend of
$0.001 per share. The voting rights, conversion rights, dividend rights and
liquidation preference of the Preferred Stock may adversely affect the trading
value or the market price of the Common Stock.
19
<PAGE>
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) (1) 15 - Letter on unaudited interim financial information.
(2) 27 - Financial Data Schedule.
(b) Reports on Form 8-K.
The Company's Current Reports on Form 8-K, dated July 16, 1997,
August 4, 1997 and September 18, 1997 (each, "Form 8-K"),
heretofore filed by the Company with the Securities Exchange
Commission, are incorporated by reference in this Form 10-QSB.
The Form 8-K filed on July 16, 1997 was filed in connection with
the extension by Company of the expiration date of certain of the
Company's remaining outstanding Redeemable Common Stock Purchase
Warrants which include (i) up to 1,150,000 Warrants issued as
part of the Company's February 1993 initial public offering, (ii)
up to 240,000 Warrants issued in connection with a private
placement occurring prior to the initial public offering, and
(iii) up to 115,000 Warrants issued to IAI upon its exercise of
the Unit Purchase Options issued to IAI in connection with the
initial public offering. The Form 8-K filed on August 4, 1997 was
filed in connection with the receipt by the Company of a
"substantial equivalence" determination order, in the form of a
letter dated July 24, 1997 from the Center for Devices and
Radiological Health, FDA, authorizing the Company to commercially
distribute its Colormate(TM) device for non-invasive monitoring
of bilirubin infant jaundice in the United States in response to
the Company's premarket notification (510(k)) submission
requesting marketing clearance for the device from the agency.
The Form 8-K filed on September 18, 1997 in connection with the
Company's completion of its analysis of the existing market for
bilirubin
20
<PAGE>
tests on newborn infants in the United States, and the
approximate size of that market in the developed countries of
Europe, South America and Canada combined, and Asia.
21
<PAGE>
<TABLE>
EXHIBIT INDEX
<CAPTION>
Exhibit No. Document Page
----------- -------- ----
<C> <S> <C>
15 Letter on Unaudited Interim Financial Information 24
27 Financial Data Schedule 25
</TABLE>
22
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC.
Date: November 13, 1997 /s/ Darby S. Macfarlane
---------------------------------
Darby S. Macfarlane
Chief Executive Officer
Date: November 13, 1997 /s/ Leslie Foglesong
---------------------------------
Leslie Foglesong
Treasurer and Chief Financial and
Principal Accounting Officer
23
<PAGE>
EXHIBIT NO. 15
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC.:
We have reviewed the consolidated balance sheet of Chromatics Color Sciences
International, Inc. and Subsidiary as of September 30, 1997 and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for the nine- and three-month periods ended September 30, 1997 and 1996.
These financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the consolidated financial statements referred to above for them to
be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet as of December 31, 1996, and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for the year then ended, and in our report dated February 19,
1997, we expressed an unqualified opinion on those consolidated financial
statements, indicating that the financial statements were prepared on a going
concern basis that might not be appropriate due to significant operating losses.
In our opinion, the information set forth in the accompanying consolidated
balance sheet as of December 31, 1996, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
WISS & COMPANY, LLP
Livingston, New Jersey
October 28, 1997
24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
The schedule contains summary financial information extracted from the
consolidated financial statements and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 3,936,100
<SECURITIES> 0
<RECEIVABLES> 92,400
<ALLOWANCES> 0
<INVENTORY> 223,300
<CURRENT-ASSETS> 4,349,500
<PP&E> 1,237,600
<DEPRECIATION> (257,600)
<TOTAL-ASSETS> 5,353,900
<CURRENT-LIABILITIES> 822,900
<BONDS> 0
13,800
0
<COMMON> 7,800
<OTHER-SE> 4,509,400
<TOTAL-LIABILITY-AND-EQUITY> 5,353,900
<SALES> 1,000
<TOTAL-REVENUES> 160,000
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 3,502,200
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 20,200
<INCOME-PRETAX> (3,362,400)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,362,400)
<EPS-PRIMARY> (.45)
<EPS-DILUTED> 0
</TABLE>
