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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to _________________
Commission file number 0-21168
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC
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(Exact Name of Registrant as Specified in Its Charter)
NEW YORK 13-3253392
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(State or Other Jurisdiction of (I.R.S. Employer Identification
Incorporation or Organization) Number)
5 East 80th Street, New York, New York 10021
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(Address of principal executive offices)
(212) 717-6544
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(Registrant's Telephone Number, Including Area Code)
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(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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:
Indicate by check whether the registrant has filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by
court. Yes ___ No ___ N/A
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: 15,213,442.
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PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
----------------- -----------------
(unaudited) (Note 1)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 7,870,400 $ 9,225,400
Accounts receivable 92,400 92,400
Inventories 148,900 148,100
Prepaid expenses and other assets 89,100 76,400
------------ ------------
Total Current Assets 8,200,800 9,542,300
COLORMATE(TM) UNITS 1,517,200 715,700
PROPERTY AND EQUIPMENT 322,800 344,900
SOFTWARE DEVELOPMENT COSTS 248,400 124,200
PATENT COSTS 240,600 --
OTHER ASSETS
20,300 25,500
------------ ------------
$ 10,550,100 $ 10,752,600
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable - collateralized by equipment $ 1,800 $ 4,700
Amounts payable to related party 306,300 293,200
Accounts payable and accrued expenses:
Attorneys and accountants 511,900 361,900
Consultants 39,000 54,900
Trade 169,700 127,800
------------ ------------
Total Current Liabilities
1,028,700 842,500
------------ ------------
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
------------ ------------
SHAREHOLDERS' EQUITY:
Undesignated Class B Preferred Stock, No Par Value
Authorized - 10,000,000 shares
Issued and outstanding - None -- --
Common Stock, par value $.001 per share:
Authorized - 50,000,000 shares
Issued and outstanding - 15,213,464 (1998) and
13,814,859 (1997) shares 15,200 13,800
Capital in excess of par value 27,452,100 24,370,900
Accumulated deficit (17,959,700) (14,488,400)
------------ ------------
Total Shareholders' Equity 9,507,600 9,896,300
------------ ------------
$ 10,550,100 $ 10,752,600
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
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CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- --------------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Lease, license and service contracts $ -- $ -- $ -- $ 1,500
Interest income 103,900 48,700 224,800 105,600
Other 200 500 200 800
-------- ------------ ----------- ------------ -------------
104,100 49,200 225,000 107,900
-------- ------------ ----------- ------------ -------------
COSTS AND EXPENSES:
Food and Drug Administration ("FDA") medical regulatory
expenses 435,900 464,900 830,400 809,100
Patent application costs 3,000 159,000 127,300 282,100
Research and development costs 134,400 62,300 359,900 117,400
Compensation cost relating to options granted to 127,000 -- 418,000 --
consultants
General and administrative:
Compensation - officers and employees 212,700 155,500 416,800 348,300
Consultants 58,000 49,500 122,000 95,000
Legal fees 220,000 102,800 328,200 155,800
Accounting fees 7,000 8,000 32,300 21,600
Rent and storage 71,600 49,700 120,100 102,600
Insurance 29,300 59,800 79,400 112,300
Travel and entertainment 23,100 -- 55,100 4,000
Repairs and maintenance 4,800 29,800 25,500 58,300
Depreciation and amortization 48,600 27,400 74,500 52,600
Payroll taxes 14,400 22,400 34,900 53,600
Stock administration fees 18,500 15,700 51,400 24,800
Interest 6,600 6,800 13,300 13,600
Employee benefit plan 14,000 -- 107,200 --
Promotional expenses 162,600 7,400 227,700 17,900
Trade shows 177,500 -- 177,500 --
Other 35,600 47,500 94,800 101,600
1,804,600 1,268,500 3,696,300 2,370,600
-------- ------------ ----------- ------------ -------------
NET LOSS $ (1,700,500) $(1,219,300) $(3,471,300) $ (2,262,700)
============ =========== ============ =============
WEIGHTED AVERAGE NUMBER OF 14,856,053 11,017,407 14,564,760 10,926,681
COMMON SHARES OUTSTANDING ============ =========== ============ =============
BASIC AND DILUTED LOSS PER SHARE $ (0.11) $ (0.11) $ (0.24) $ (0.21)
============ =========== ============ =============
</TABLE>
See accompanying notes to consolidated financial statements.
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CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS 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, 1997 13,814,859 $ 13,800 $ 24,370,900 $ (14,488,400)
Six Months Ended June 30, 1998:
Net loss -- -- -- (3,471,300)
Exercise of stock options and 1,398,605 1,400 2,663,200 --
warrants
Compensation cost relating to
options granted to consultants -- -- 418,000 --
------------ --------- ------------ --------------
Balances, June 30, 1998 15,213,464 $ 15,200 $ 27,452,100 $ (17,959,700)
============ ========= ============ ==============
See accompanying notes to consolidated financial statements.
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CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended June 30,
------------------------------------------
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,471,300) $ (2,263,000)
Adjustments to reconcile net loss to net
cash flows from operating activities:
Depreciation and amortization 74,500 52,600
Compensation cost relating to options granted to consultants 418,000 --
Changes in operating assets and liabilities:
Accounts receivable -- (5,000)
Inventories (800) 100
Prepaid expenses and other current assets (12,700) (33,400)
Other assets (2,300) (2,300)
Accounts payable and accrued expenses 176,000 230,300
Security Deposits 7,500 (1,500)
------------------ ------------------
Net cash flows from operating activities (2,811,100) 2,022,200
------------------ ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Software development costs (124,200) --
Capitalized patent costs (240,600) --
Purchases of property and equipment (45,500) (83,000)
Purchase of Colormate Units (808,400) --
------------------ ------------------
Net cash flows from investing activities (1,218,700) (83,000)
------------------ ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock net of related costs 2,664,600 561,300
Proceeds (payments) of amounts payable to related party 13,100 (15,900)
Payments of notes payable (2,900) (2,400)
------------------ ------------------
Net cash flows from financing activities 2,674,800 543,000
------------------ ------------------
NET CHANGE IN CASH AND EQUIVALENTS (1,355,000) (1,562,200)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 9,225,400 5,352,400
------------------ ------------------
CASH AND EQUIVALENTS, END OF PERIOD $ 7,870,400 $ 3,790,200
================== ==================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest Paid $ 100 $ 4,300
=================== =====================
</TABLE>
See accompanying notes to consolidated financial statements.
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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-K for the fiscal year ended December 31,
1997 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-K for the fiscal year ended December 31,
1997.
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.
Principles of Consolidation - The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiary. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Patent Application Costs - Patent application costs had been expensed
previously because the Company was unable to determine the future
recoverability of such costs. In the first quarter of 1998, the Company
was able to determine future recoverability of such costs, due to marketing
plans and potential business proposals. Accordingly, the Company has begun
capitalizing certain patent application costs, commencing January 1, 1998, and
will amortize the costs over the remaining patent lives, generally 10 to 15
years. The Company will assess the continuing carrying value of these assets
when events and circumstances warrant.
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 further commercialize its
proprietary technology and products and the Company's ability to obtain
adequate revenues and/or outside financing.
Operating Difficulties -- Since 1989, the Company has incurred losses from
operations and net cash outflows from operations, and has owned Colormate(TM)
System units since June 1991 whose ultimate recoverability depends upon the
Company's future marketing success. The Company expects to license its patents
and proprietary technology, rent or sell its equipment and market its related
services and products to ultimately overcome these difficulties. In the event
the Colormate(TM) System units and related proprietary technology are not
successfully leased/licensed and/or the products are not successfully marketed
in the future, the principal effect may be a substantial write-down of the book
value of such units.
On July 30, 1997, the Company was granted clearance by the FDA for commercial
marketing of the Colormate(TM) Bilirubin Device for the non-invasive detection
and monitoring of bilirubin infant jaundice in newborns by health
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care professionals in hospitals, pediatricians' offices or by home healthcare
agencies. Since that date, the Company has had discussions with several
companies interested in distributing the Colormate(TM) Bilirubin Device and is
currently negotiating with certain of these companies to reach a definitive
agreement. It is not possible at the present time to determine the impact of
this development on future cash flows.
Management expects that the Company will have sufficient liquidity at least
until July 1, 1999, even if no revenues from operations are generated and no
additional financing is obtained. If the Company is able to profitably market
its Intellectual Properties, Colormate(TM) units, 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) System units for all applications will
be marketed interchangeably, as the only difference 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 and/or successfully market its products and
technologies, at such point in time, it may have to cease operations.
Legal Proceedings -- In June 1998, the Company and certain of its officers and
directors were sued in two separate class actions ("Actions") brought in United
States District Court, Southern District of New York, entitled (i) L.F. Monk v.
Chromatics Color Sciences International, Inc., Darby S. Macfarlane, Arthur
Guiry, David K. Macfarlane and Leslie Foglesong and (ii) Daniel R. Marquis, on
behalf of himself and all others similarly situated v. Chromatics Color
Sciences International, Inc., Darby S. Macfarlane, Arthur Guiry and Leslie
Foglesong. Based on the Asentio Report discussed under "Recent Events" below,
the plaintiffs in the Actions, on behalf of a class of the Company's
stockholders, claim unspecified damages arising from alleged violations of the
anti fraud provisions of the federal securities laws, relating to (i) the
alleged misleading nature of prior public disclosures and announcements made by
the Company and (ii) sales of company stock by the individual defendants
allegedly while in possession of material adverse non-public information
regarding the Company's financial condition, prospects and the capabilities and
potential market for the Company's Colormate(TM) Bilirubin Device. A motion has
been made to consolidate the two Actions and to approve a group of shareholders
and lead plaintiffs and to approve the selection by the group of lead counsel.
Additional actions may be brought against the Company and its officers and
directors arising from the matters described above. The Company has directors
and officers insurance which may cover a portion of the liability asserted in
the Actions. The Company believes the Actions are without merit and intends to
defend the Actions vigorously. No assurance can be given that the resolution of
the Actions and/or future actions will not have a material adverse effect on
the Company's results of operations and liquidity.
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Note 3 -- Colormate Units
Colormate(TM) Systems -- 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.
Following the FDA marketing clearance in 1997, the Company has decided to use
certain components from the existing Colormate(TM) units for use in the
Colormate(TM) Bilirubin Device. The costs will be expensed as incurred,
remaining components will not be valued and the cost currently assigned to the
existing Colormate(TM) units ($500 per unit) will be assigned to the
Colormate(TM) Bilirubin Device, as the current replacement cost of these
components exceeds the book value of the Colormate(TM) units.
Current and Non-Current Assets: -- In connection with the Company's efforts to
distribute the Colormate(TM) Bilirubin Device, the Company commenced purchasing
equipment and component parts in the second quarter of 1998 (approximately
$800,000 in the quarter). At this time, the Company is uncertain as to whether
it will sell or lease such equipment to customers; accordingly, the cost of
such items, as well as units previously obtained from Avon Products, Inc. in
connection with a prior license agreement, has been classified as a non-current
asset in the accompanying consolidated balance sheets.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following is intended to update the information contained
in the Company's Form 10-K for the year ended December 31, 1997 (the "Form
10-K") and presumes that readers have access to, and will have read,
Management's Discussion and Analysis contained in the Form 10-K.
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THIS
QUARTERLY REPORT ON FORM 10-Q CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E
OF THE SECURITIES EXCHANGE ACT OF 1934. WHEN USED IN THIS REPORT, THE WORDS
"BELIEVE," "ANTICIPATE," "THINK," "INTEND," "PLAN," "WILL BE," "EXPECT" AND
SIMILAR EXPRESSIONS IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS
REGARDING FUTURE EVENTS AND/OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY
ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED IN
"RISK FACTORS" BELOW AT PAGES 14 TO 27, WHICH COULD CAUSE ACTUAL EVENTS OR THE
ACTUAL FUTURE RESULTS OF THE COMPANY TO DIFFER MATERIALLY FROM ANY
FORWARD-LOOKING STATEMENT. SUCH RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHER
THINGS, THE AVAILABILITY OF ANY NEEDED FINANCING, THE COMPANY'S ABILITY TO
IMPLEMENT ITS BUSINESS PLAN FOR VARIOUS APPLICATIONS OF ITS TECHNOLOGIES,
INCLUDING MEDICAL AND INDUSTRIAL APPLICATIONS, THE COMPANY'S ABILITY TO ENTER
INTO AGREEMENTS WITH MANUFACTURING, MARKETING AND DISTRIBUTION PARTNERS, THE
OBTAINING OF AND COMPLIANCE WITH REGULATORY APPROVALS OR CLEARANCES APPLICABLE
TO 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. IN LIGHT OF THE SIGNIFICANT RISKS AND UNCERTAINTIES
INHERENT IN THE FORWARD-LOOKING STATEMENTS INCLUDED HEREIN, THE INCLUSION OF
SUCH STATEMENTS SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE COMPANY OR
ANY OTHER PERSON THAT THE OBJECTIVES AND PLANS OF THE COMPANY WILL BE ACHIEVED.
Overview
Chromatics Color Sciences International, Inc., (the
"Company") was formed in 1984 to research and develop and to commercialize
certain intellectual property rights, proprietary technology and
instrumentation in the field of color science (collectively, the "Intellectual
Properties") for marketing to a variety of industries, including, but not
limited to, the medical, dental, biological, cosmetic, hair color, beauty-aid
and fashion industries. The Intellectual Properties relate to the application
of color science technology to the scientific measurement and analysis of human
skin, tissue, fluid, hair, teeth or biological subject, the classification of
such measurements, the detection and monitoring of conditions affecting the
coloration of such human skin, tissue, fluid, hair, teeth or biological
subjects and the scientific classification and color-oriented organization of
various consumer-sensitive products such as cosmetics, tooth enamel, hair
color, hosiery, fashion, textiles, etc. The Company has incorporated
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certain of the Intellectual Properties into a proprietary color measurement
system and software marketed for various commercial applications as the
Colormate(TM) System (the "Colormate(TM) System"). The Company has developed
Intellectual Properties which it believes are capable of detecting and
monitoring certain chromogenic diseases and disorders which are defined by the
Company as those which are diagnosed or monitored by the coloration of human
skin, tissue or fluid being affected ("Chromogenic Diseases"). In this regard,
the Company developed a Colormate(TM) device to measure the incremental change
of the yellow content of the skin color in newborns to monitor bilirubin infant
jaundice. On July 30, 1997, the Company received U.S. Food and Drug
Administration ("FDA") clearance for commercial marketing of the Colormate(TM)
device for the non-invasive monitoring of bilirubin infant jaundice in newborns
by health care professionals in hospitals, pediatricians' offices or by home
healthcare agencies (the "Colormate(TM) Bilirubin Device" or the Colormate(TM)
TLc - Bilitest(TM)). The Company's efforts are currently focused on seeking to
commercialize this medical application of its Intellectual Properties for
non-invasive detection and monitoring of bilirubin infant jaundice. See "Risk
Factors".
The Company also has developed its own line of scientifically
color coordinated proprietary cosmetics ("My Colors by Chromatics(TM)") and
scientifically color coordinated proprietary color charts and material
swatchpacks for use in the cosmetics, beauty, dental and fashion industries.
The Company's Colormate(TM) System products, cosmetic line and material
swatchpacks for the cosmetic, beauty and fashion industries are referred to
herein collectively as the "Beauty-Aid Products."
Prior to receipt of the FDA marketing clearance, the
Company's marketing activities have principally involved licensing the
Intellectual Properties, including conducting laboratory product chromaticity
studies ("Chromaticity Studies"), leasing the Colormate(TM) System and
marketing the Beauty-Aid Products in the cosmetic, hair color, beauty aid and
fashion industries (i) in a national sales program (the "Avon Project") with
Avon Products, Inc. ("Avon"), and in limited test markets with Clairol, Inc.
("Clairol") and Hanes Hosiery, Inc. ("Hanes"), all conducted prior to June
1991, and (ii) under a current agreement with Gordon Laboratories, Inc.
("Gordon Laboratories") and under certain leases and licenses to beauty-related
businesses and beauty salons. Although the Company from time to time has been
engaged in preliminary discussions (including limited consumer testing and
laboratory Chromaticity Study activities) for use of its technology in the
cosmetics, dental and beauty aid fields, there can be no assurance that any
final agreements will be reached. In this regard, the Company has completed
research and development for the working prototype of a hand-held less
expensive light-emitting diode ("LED") model of the Colormate(TM) System (the
"Colormate(TM) LED Device") which the Company anticipates will enhance its
marketing efforts.
In 1997, the Company furthered implementation of its
long-range plans to exploit certain medical applications for its technology. In
this regard, the Company submitted a marketing application for its
Colormate(TM) unit for a certain medical application with the FDA on November
14, 1996. The application, known as a premarket notification or 510(k)
submission, was accepted officially for filing and review by the FDA on
November 18, 1996. The application requested, and on July 30, 1997, the Company
received from the FDA's Center for Devices and Radiological Health ("CDRH"),
marketing clearance pursuant to a "substantial equivalence" determination
order, in the form of a letter dated July 24, 1997, authorizing the Company to
commercially distribute its Colormate(TM) Bilirubin Device for non-invasive
detection and monitoring of bilirubin infant jaundice in newborns by healthcare
professionals. 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. See "Risk
Factors."
Since inception the Company has financed its operations
through (i) private placements of its securities, (ii) collaborative research
and development arrangements with licensees, (iii) cash receipts from lease and
licensing agreements, (iv) loans from private investors and certain
shareholders, (v) the February 1993 initial public offering (the "IPO") and
(vi) the proceeds of exercise of stock options and warrants. Over the past two
years, the Company has used substantial portions of the proceeds of such
exercise, and proceeds from the private placement in 1995 and 1996 of its
securities, to further its long-range business plan with respect to the medical
application of its technologies and for the development of the Colormate(TM)
units, including a transcutaneous bilirubinometer.
The Company has incurred significant research and development
and marketing expenses since inception, resulting in losses from operations
since 1990 and, prior to its IPO, negative shareholders' equity. In particular,
over the past two years, the
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Company has incurred significant FDA related expenses, research and development
expenses and marketing start-up expenses relating to the Colormate(TM)
Bilirubin Device. The Company also has not achieved significant operating
revenues from marketing its Intellectual Properties, Beauty-Aid Products and
Colormate(TM) units in the cosmetic and beauty aid industries since termination
of the Avon Project in 1991, and has never generated any revenue from licensing
its Intellectual Properties or the Colormate(TM) System in any industry other
than the cosmetics, haircolor, beauty aid and fashion industries. See Note 1 of
Notes to Financial Statements and "Risk Factors."
Since 1990 limited revenues have been derived from licenses,
leases, service contracts and Beauty-Aid 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. ("IMS"). In 1997 and the first two quarters
of 1998, the Company did not generate any lease, license and service contract
revenues from IMS. To the extent the Company receives payments from licensees,
distributors or other sources, such payments may occur 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. From December 31, 1990 until the IPO, the Company had been primarily
engaged in (a) pursuing the Company's litigation against Avon, (b) developing
and testing further applications of the Intellectual Properties and
Colormate(TM) units, such as the clinical research studies for medical
applications, and (c) obtaining additional financing to support marketing of
the Company's Intellectual Properties, systems, Beauty-Aid Products and related
services.
The Company's ability to generate revenues in the future will
depend on its success in marketing its Intellectual Properties, the related
Chromaticity Studies capabilities, the Colormate(TM) Bilirubin Device, the
Colormate(TM) units and the Beauty-Aid 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 would be a
write-down of the book value of the Colormate(TM) units and an impairment of
the Company's ability to obtain future financing, which could result in
diminution in the value of an investment in the Company. There can be no
assurance the Company will be able to establish such arrangements, timely place
such units or identify alternative markets. See "Risk Factors."
Recent Events
The Company experienced a series of significant developments
during the second and third quarters of 1998, summaries of which are provided
below. See also "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Risk Factors" for additional information.
During the first and second quarters of 1998, a significant
"short position" built up in the Company's publicly traded common stock. In June
1998, a series of negative, and what the Company believes to be false, press
reports were issued by Asensio and Company, Inc. ("Asensio") (a short-seller
which publicly admitted it held a 300,000 share short position in the Company's
stock) amid increased trading volume and short-selling activity in the Company's
stock. The Company publicly responded to these reports, denying Asensio's
allegations and providing additional support for the Company's prior public
statements. The public trading price of the Company's stock decreased from
12 1/4 to 4 1/2 in the two days immediately following Asensio's reports (and
decreased from a high of 17 5/8 on May 4, 1998 before such reports and increased
trading activity, to a low of 3 3/4 on June 30, 1998). Following the release of
the Asensio reports, the Company and
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certain of its officers were sued in federal class actions alleging violations
of the securities laws based on Asensio's allegations. The Company believes the
suits are without merit and intends to defend them vigorously. The Company is
also exploring all of its legal remedies against those persons it believes have
unlawfully harmed the Company. See "Risk Factors" and "Legal Proceedings."
As a result of these recent actions and in order to assist
the Company in connection with certain related investor relations and public
relations matters, the Company recently retained Rubenstein Associates, Inc., in
addition to the existing public relations services provided by Hill & Knowlton.
Although the Company has been in ongoing negotiations to reach
a definitive agreement for global distribution of the Colormate(TM) TLc -
Bilitest(TM), the Company has experienced delays in concluding these
negotiations in order to provide additional due diligence and supporting
materials requested as a result of the recent flurry of press reports and legal
activity surrounding the Asensio allegations. While the Company's board of
directors, executive, financial consultants and legal advisors intend to
evaluate the distribution proposals, accommodate due diligence requests and
review applicable legal documentation, due to the requests from the medical
community for the Colormate(TM) TLc - Bilitest(TM) generated by the Company's
recent exhibitions of the Colormate(TM) TLc - BiliTest(TM) to the medical
community the Company is currently negotiating for the assembly of the
Colormate(TM) TLc - BiliTest(TM) with a contract manufacturer.
In this regard, the Company has recently opened a medical
marketing, sales and distribution support division in Connecticut. The Company
has entered into an office lease for this division and has hired Sheila Kempf as
Vice President of this medical division, in addition to two regulatory
personnel, two registered nurses, administrative staff and is in the process of
hiring national sales managers for this division. Ms. Kempf is a former Vice
President - Marketing of Corometrics, a Marquette Medical Inc. company, and a
former director of Marketing for Sensors and accessories of Nelcor Puritan
Bennet, Inc. and has extensive experience for over 13 years in the medical
marketing field. Ms. Kempf holds a bachelor of science nursing degree from
Villanova University and a masters degree from Columbia Unviversity. The newly
formed division will initially ensure support for the Colormate(TM) TLc -
BiliTest(TM) delivered to customers in the medical community, including
hospitals, pediatricians, clinics and home health care agencies, and will
perform delivery, training and in-servicing for customers initially generated by
the Company's presentations at the Pediatric Academic Societies, Sinomed and
International Congress of Pediatric exhibitions. The division will additionally
be available to provide the training, technical and marketing support
anticipated in the transition period expected when the Company enters into any
contracts with potential global distributors, oversee the setup of the new
offices to be opened in Beijing China (for which 2 employees have been hired, as
discussed below), coordinate the business relationships with the Ministry of
Health in China and develop the marketing plans for the home health care markets
for the Colormate(TM) TLc - Bilitest(TM) worldwide.
In support of its marketing efforts to the medical community,
the Company began independent multi-center studies of the Colormate Bilirubin
Device. These studies were successfully completed at William Beaumont Hospital
(Detroit) and showed a high correlation between the results of the Company's
technology and standard blood serum testing. Such studies are currently ongoing
at Parkland Hospital (Dallas); preliminary results of this study continue to
show the same high correlation, as compared to standard blood serum testing, as
was achieved in the completed studies.
The Company has recently hired two employees in South Africa
and has initiated arrangements for the conducting of clinical trials of the
Colormate(TM) TLc - Bilitest(TM) in monitoring bilirubinemia in several
hospitals in South Africa, including Baragwanath Hospital (Johannesburg) and
King Edward Hospital (Durban). These trials are anticipated to commence in the
third quarter of 1998, although there can be no assurance of the exact timing.
In addition, in 1998 and early 1999 the Company anticipates commencing
multicenter studies of the Colormate(TM) TLc - Bilitest(TM) in monitoring
bilirubinemia in a number of hospitals located in the United States, England,
China, Israel, Brazil and Argentina although there can be no assurance of the
exact timing of implementation at each hospital. These studies, as well as those
to be conducted in South Africa, are being coordinated by Dr. Jeffrey Maisels
pursuant to international testing protocols developed by Dr. Maisels.
All of these medical marketing, manufacturing and support
activities were contemplated by the Company for distribution of the
Colormate(TM) TLc - Bilitest(TM), to ensure that no time was lost in the
regulatory, technical, manufacturing sales and training transition following the
Company entering into agreements with distribution partners to distribute the
Colormate(TM) TLc - Bilitest(TM). There can be no assurance the Company will be
able to successfully conclude negotiations or enter into definitive
manufacturing or distribution agreements or that its efforts to market the TLI
Bilitest(TM) will be successful.
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In July, 1998 following internal review board
approval from Mt. Sinai, Dr. Mark Lebwohl, chairman of the Department of
Dermatology at Mt. Sinai, commenced clinical trials of the Colormate
non-invasive medical technology for dermatological use in determining the
appropriate levels of phototherapy to treat various skin diseases, and patient
tolerance for such levels of phototherapy by quantifying the amount of
pigmentation and hence, photo-sensitivity in the skin of patients. This
potential dermatological application of the Company's proprietary technology
and device would be for patients for a variety of diseases including psoriasis,
excema, cutaneous T-cell lymphoma, vitiligo, and others. Post inflammatory
hyperpigmentation also would be a condition subject to monitoring by the
Colormate(TM) System. The noninvasive measurement of the skin by the Company's
Colormate (TM) system will be tested and verified against minimal erythema
dose-testing including the Fitzpatrick skin type test. The results of these
studies are intended to be used in support of future applications for FDA
marketing clearance of the Company's technology for such uses.
The Company launched the Colormate(TM) Bilirubin Device to
the Chinese medical community at the Sinomed '98 Exhibition, the 7th China
International Medical Equipment and Facilities Exhibition ("Sinomed"), held from
June 9 to June 12 in Beijing, the People's Republic of China. This exhibition
was attended by over 80,000 physicians, healthcare professionals, hospital
administrators and medical equipment manufacturers and distributors. In
conjunction with Sinomed, doctors from the Company's Medical Advisory Board
conducted seminars on the technology and use of the Colormate(TM) TLc -
Bilitest(TM) at two hospitals in Beijing, and further arrangements have been
made for clinical studies of the Colormate(TM) TLc - Bilitest(TM) by the Beijing
Children's Hospital, the largest children's hospital in China. In connection
with SINOMED, the Company signed a Memorandum of Understanding ("M.O.U.") with
the International Health Exchange Center, Ministry of Health ("M.O.H.") of the
People's Republic of China in Beijing regarding the Company's Colormate(TM) TLc
- - Bilitest(TM) non-invasive newborn bilirubin detection and monitoring device.
Under the M.O.U., the M.O.H. will launch a nationwide study and develop a plan
on the most advantageous structure to implement the device's use in the People's
Republic of China, based on the results of the study.
The Company also announced that it signed a letter of intent
with the China National Medical Equipment and Supplies, Import and Export
Corporation, M.O.H., People's Republic of China, which is interested in
supporting the distribution of the Company's device and collaborating on next
steps including investigations for acceptable price structures for marketing
the Colormate(TM) TLc - Bilitest(TM).
In support of any potential distribution partner and the
relationships established between the Company and the M.O.H., other officials,
physicians and the Chinese business community, the Company will continue to
support these collaborations with the People's Republic of China and in this
regard is in the process of opening an office in Beijing and has hired two
Chinese representatives of the Company to expedite the Company's potential for
manufacturing, marketing and distribution of the Colormate(TM) TLc -
Bilitest(TM) in China.
The Company launched the Colormate(TM) Bilirubin Device to
the European medical Community at the International Congress of Pediatrics and
the First International Congress of Pediatric Nursing, held in Amsterdam on
August 4 to August 14. The conference, held every 4 years, is one of the
largest pediatric conferences in Europe, with attendance of approximately 8,000
pediatricians, neonatologists and health care professionals. At the conference,
Dr. Ian Holzman, Chief of Newborn Medicine at Mt. Sinai Hospital, New York,
presented a paper on the results of extensive clinical trials of the Colormate
Bilirubin Device at two hospitals in New York. Dr. Holzman's paper on
the studies is expected to be published in the September 1998 issue of
Pediatrics.
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Results of Operations
The Company incurred net losses of $1,700,500 and $1,219,300
for the three month periods ended June 30, 1998 and 1997 respectively, and
$3,471,300 and $2,263,000 for the six-month periods ended June 30, 1998 and
1997, respectively, as revenues received have not been significant relative to
the Company's expenses incurred in implementing its business plan. Loss per
share increased by $.03 to $.24 per share in the 1998 six month period compared
to the 1997 six month period, despite the 1998 six month period being favorably
impacted by a significant increase of 3,638,079 weighted average number of
shares outstanding attributable to the exercise of options and Warrants. The
dollar increase in such losses in the 1998 three and six month periods as
compared to the 1997 three and six month periods 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 purchasing
equipment and component parts for its medical device research and development,
software development costs, consultants' compensation expenses relating to
option grants, legal fees, contributions to the new employee benefit plan, and
travel and entertainment and promotional and trade show expenses, primarily
attributable to the Company's preparation for the manufacturing of its
Colormate(TM) Bilirubin Device and its presentation at the Annual Convention of
the Pediatric Academic Societies and the Sinomed Conference in China. These
increased expenses were partially offset by a decrease in patent costs, as the
Company has begun capitalizing certain of these expenses in 1998. See Note 1 of
Notes to Financial Statements. Although the Company anticipates that the future
expenses regarding FDA application costs and related patent costs should be
significantly less than amounts incurred prior to receipt of the FDA marketing
clearance, the Company will continue to incur significant additional costs and
expenses in connection with Manufacturing FDA marketing clearances and state
regulatory requirements as well as foreign market clearances. Additional
expenses are anticipated in connection with certain international multi center
studies being or to be conducted on the Colormate(TM) Bilirubin Device. See
"Recent Events." In addition, the Company expects to incur significant expenses
relating to products liability insurance, manufacturing expenses, legal and
regulatory compliance, including QSR/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 the medical application of its
technology. The Company also anticipates significantly higher compensation
expenses in connection with increased hiring to staff its medical division. The
Company will also incur additional expenses in connection with the
implementation of additional testing and clinical trials of its technologies in
respect of the possible monitoring and diagnosis of other chromogenic diseases.
See "Recent Events." Further, the Company anticipates significantly higher legal
expenses in connection with its defense of certain class action suits that have
been brought against the Company and as the Company explores all of its
potential legal remedies. See "Legal Proceedings."
In the first six months of 1998, the Company focused its
resources on implementation of its long-range business plan for the FDA-cleared
medical applications of its technologies and received no revenues from
operations. The Company believes the absence of sales in the 1998 six-month
period was also attributable to 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 market in the third
quarter of 1998 although there can be no assurance of this.
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 the
medical application of its technologies and as revenues from the cosmetics,
beauty aid and fashion areas are anticipated to continue to be insignificant
relative to the Company's anticipated expenses in the foreseeable future.
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Liquidity and Capital Resources
Current assets decreased by $1,342,000 at June 30, 1998 as
compared to December 31, 1997, primarily attributable to a decrease in cash and
cash equivalents resulting from the purchase of equipment and component parts
in respect of future manufacturing ($808,000) software development costs and
capitalized patent costs.
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 six months of 1998. The 1998
increase in cash outflows from operating activities is primarily attributable
to the increase in the Company's net loss, offset by an increase in noncash
compensation costs to consultants. Cash flows from financing activities during
the 1998 period principally represent $2,665,000 from the issuance of Common
Stock (net of related costs) representing the receipt of proceeds from the
exercise of options and Warrants.
Although the Company anticipates that penetration of the
medical marketplace will be through establishing relationships with specialized
distributors, rather than through a direct sales force, the Company has
established a medical division to support its own efforts to market and
distribute the Colormate(TM) TLc - Bilitest(TM), and to support marketing
efforts in the transition period once the Company enters into distribution
arrangements. See "Recent Events" and "Risk Factors." 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 the first two quarters of 1998, such licensing, leasing and sales
yielded no revenue, primarily because the Company devoted its resources to the
commercialization of its technologies for medical application and because the
Company's new cosmetics line was not yet available.
Management expects that the Company will have sufficient
liquidity at least until July 1999, even if no revenues from operations are
generated and no additional financing is obtained. If the Company is able to
profitably market its Intellectual Properties, Colormate(TM) units and
Beauty-Aid 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 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.
Risk Factors
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 Beauty-Aid Products. From
early 1986 through October 1987, the Company was engaged in limited
test-marketing of certain of the Intellectual Properties and Beauty-Aid
Products through its former licensees. From October 1987 until June 1991, the
Company was principally engaged in the Avon Project. Since 1991, the Company
has been engaged in the research and development of its Colormate(TM) Bilirubin
Device for the monitoring of bilirubin infant jaundice, the development of
prototypes of additional versions of the Colormate(TM) unit and the refinement
of its technologies for other applications. 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, many of which are beyond the Company's
control, such as unanticipated development, manufacturing and regulatory delays
and expenses. 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 and marketed by the Company.
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Operating Losses. The Company has incurred significant losses
from operations for the year ended December 31, 1997 and the six months ended
June 30, 1998, ($5,053,100 and $3,471,300, respectively), as well as in prior
periods. 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 business plan for the
medical application involving the monitoring of hyperbilirubinemia. 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, that remaining
proceeds from the previous exercise of its Placement Agent Warrants and
Warrants will be sufficient to fund operations beyond July 1, 1999, 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 Beauty-Aid Products, and in particular, its
Colormate(TM) Bilirubin Device for monitoring of bilirubin infant jaundice, 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 the successful marketing of the Colormate(TM)
Bilirubin Device, its ability to obtain significant commercial sales of the
Beauty-Aid Products and/or licensing and leasing fees from its Intellectual
Properties and the Colormate(TM) units, and the availability of future
financing. The Company expects that additional financing will be required to
commercialize the Colormate(TM) Bilirubin Device and any additional medical
application of its technologies. 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 Colormate(TM)
Bilirubin Device. The Company's current ability to generate revenues and to
achieve profitability and positive cash flow in the immediate future
substantially will depend on the successful introduction of the medical
application of its technology to monitor bilirubin infant jaundice. Although the
Company is aware that studies have been conducted on non invasive
transcutaneous bilirubinometer devices other than the Colormate(TM) Tlc -
Bilitest(TM), the company believes that the clinical studies conducted
demonstrating the ability of the Colormate(TM) Tlc-Bilitest(TM) to accurately
provide an estimate of serum bilirubin levels in babies over a wide range of
gestation, in babies of all racial categories and in babies receiving
phototherapy, distinguishes it from the only other existing non-invasive
Bilirubinometer with FDA clearance for commercial marketing. The Company
believes its Colormate(TM) Bilirubin Device provides a new alternative for the
monitoring and screening of bilirubin infant jaundice, but there can be no
assurance that it will gain market acceptance. There is no assurance that the
Company's Colormate(TM) Bilirubin Device for monitoring bilirubin infant
jaundice, or other future medical applications of the Company's technology, will
be capable of being produced in commercial quantities at acceptable costs, or
even if all regulatory and reimbursement approvals are obtained, will be
successfully marketed or achieve any significant degree of market acceptance
among physicians, health care payors and others. To date, except for the FDA
marketing clearance, the independent hospital clinical studies and related
information regarding the Company's Colormate(TM) Bilirubin Device, and the
Company's presentations in May 1998 of the Colormate(TM) Bilirubin Device at the
Annual Convention of the Pediatric Academic Societies, in June 1998 at the
Sinomed Exhibition in China, and in August 1998 at the International Congress of
Pediatrics and the First International Congress of Pediatric Nursing in
Amsterdam, the medical community generally has had no exposure to the Company or
its proposed medical application. 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 application.
Physicians and other health care professionals will not
recommend or use the Colormate(TM) Bilirubin Device unless they determine,
based on experience, clinical data, relative cost, and other factors, that the
Colormate(TM) Bilirubin Device is an attractive alternative to current
traumatic blood tests that have a long history of safe and effective use. The
Company has begun to conduct additional independent studies in order to achieve
acceptance in the medical community. See "Recent Events." The Company believes
that recommendations by physicians and clinicians will be essential for the
market acceptance of these products, and there can be no assurance that any
such recommendations will be obtained. To the extent the Company is able to
market and distribute its
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Colormate(TM) Bilirubin Device for non-invasive monitoring of bilirubin infant
jaundice, broad market acceptance of the Company's device will require the
training of numerous physicians and clinicians, and the time required to
complete such training could result in a delay of commercial distribution to the
medical market. Moreover, obtaining and maintaining health care payors' approval
of reimbursement for the Company's products, and the level of reimbursement made
available will be an important factor in establishing pricing structures and
market acceptance. 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, pediatrician's
offices and home health care facilities, also might be reluctant to purchase
products from a company that has not 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
Colormate(TM) Bilirubin Device due to institutional budgetary constraints.
User acceptance of these products will depend on many
factors, including physician recommendations, the degree, rate and severity of
potential complications, the cost and benefits compared to competing products or
alternative medical treatments, available reimbursement and other
considerations. In addition, the Company's pricing policies could adversely
impact market acceptance of these products as compared to competing products and
alternative treatments. If any of the Company's marketing or development
programs are not successfully completed, required regulatory approvals or
clearances are not obtained or maintained, or products for which approvals or
clearances are obtained (such as the Colormate(TM) TLc - Bilitest(TM) are not
commercially successful, the Company's business, financial condition and results
of operations would be materially adversely affected.
Presently, the Company conducts its research and development
through its Spokane, Washington office. There can be no assurance that the
Company will be able to successfully address any problems that may arise during
the commercialization process of its Colormate(TM) Bilirubin Device.
Early Stage of Development of Other Potential Medical
Applications. Although the Company has received FDA clearance to commercially
market its Colormate(TM) Bilirubin Device as described above, has conducted
early stage research and recently commenced initial clinical studies with
respect to certain other Chromogenic Diseases identified by the Company (See
"Recent Events"), the Company's clinical and research development programs for
other medical applications of its technology are at a very preliminary stage
and substantial additional research and development and clinical trials will be
necessary before commercial versions of any additional proposed products can be
submitted for FDA clearance and produced for other such medical applications.
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/commercialization process. In
addition, there can be no assurance that any of the Company's proposed 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.
Risks Associated With Medical Business Plan and Strategy;
Need for Additional Personnel. The Company has formulated its medical business
plan and strategy based upon certain assumptions regarding the size of the
bilirubin monitoring market, the Company's anticipated share of this market,
the price at which the Company believes it will be able to sell its products,
and consumer acceptance of the Company's products. There can be no assurance
that the Company's assumptions will prove to be correct. The Company's ability
to operate in the future will depend upon many factors, including technological
advances and product obsolescence; levels of competition, including the entry
into the market of additional competitors and increased success by existing
competitors; changes in general economic conditions; increases in operating
costs including costs of production, supplies, personnel or equipment; and
changes in requirements and regulations promulgated by applicable federal,
state and local regulatory authorities. There can be no assurance that the
Company will successfully obtain or apply the human, operational and financial
resources needed to manage a developing business. Failure by the Company to
manage its growth effectively could have a material adverse effect on the
Company's business, financial condition and results of operations.
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In order to meet the anticipated market demand for the
Company's medical product, the Company needs to attract and retain additional
personnel. The Company currently has only 29 full-time employees, of which 11
are medical marketing or regulatory personnel. In order to effectively launch
its marketing and sales strategy for the medical market, the Company will need
to hire additional sales, marketing, technical and operations personnel. The
success of the Company will also be dependent upon its ability to hire, train
and retain new and existing personnel. The Company will compete with other
companies with greater financial and other resources for such qualified
personnel. There can be no assurance that the Company will be able to hire and
retain additional personnel to support the Company's marketing, sales, research
and product development efforts.
Lack of Marketing and Sales Experience. In order to
successfully market and sell its Colormate(TM) units, including the
Colormate(TM) Bilirubin Device, the Company must either develop a medical
marketing and sales force or enter into arrangements with third parties to
market and sell the devices. See "Recent Events." Prior to licensing the
Company's Intellectual Properties in any other industry, including 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. 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 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.
In addition, the Company's Colormate(TM) Bilirubin Device, as well as any
future medical applications marketed by the Company, 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, pediatrician's offices and home health care
services). While the Company believes the non-invasive nature of its
Colormate(TM) Bilirubin Device for monitoring bilirubin infant jaundice
provides benefits to patients, no assurance can be given that the medical
community will accept and support the Company's medical device.
Need for Manufacturing, Marketing and Distributing
Arrangements with Third Parties. Although the Company has established a
medical division to support its own marketing efforts, 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 manufacturing, marketing and distribution companies in the medical
field. There can be no assurance that the Company will be able to do so. If the
Company enters into arrangements with a third party for the marketing,
distribution and sale of its Colormate(TM) Bilirubin Device, any revenues to be
received by the Company from these products will be dependent on this third
party. The obligation of any potential third party to fund or undertake the
manufacturing, marketing, distribution and/or 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.
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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 a material
adverse effect upon the Company's business, financial condition and results of
operations.
The Company does not itself manufacture the Colormate(TM)
units, the Colormate(TM) Bilirubin Device or the Beauty-Aid Products, and in
the past has been wholly dependent on third-party OEMs of parts, assemblers,
cosmetics suppliers and textile suppliers. The Company will have to establish
relationships with such third-party suppliers, manufacturers and assemblers for
the production of its devices. Although the Company is negotiating with certain
manufacturers/assemblers, the Company does not have any current arrangements
with manufacturers or assemblers for the mass production of any additional
Colormate(TM) devices, 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 current estimates of its costs for the
Colormate(TM) units are based on mass manufacturing cost estimates for the
devices received from potential contract manufacturers. Costs of parts in
manufacturing smaller quantities of Colormate(TM) units could involve
significantly greater costs.
In connection with any future manufacturing of the
Colormate(TM) units, the Company could be required to make significant advance
payments, obtain letters of credit, cause potential customers or licensees to
advance funds under their agreements entered into with the Company or otherwise
secure its payment obligations to third-party 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.
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 has not achieved significant levels of cosmetics sales from its
Colormate(TM) unit locations, and expects based on the deminimus 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. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations." 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, 1997, most of the inventory of the
Company's cosmetics products was in excess of requirements based on the recent
level of sales. After giving effect to the $100,000 write off in 1996 and the
$75,000 write off in 1997, 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 completed its
inventory of a new line of chromatically balanced and color coordinated
cosmetics in the first two quarters of 1998,
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and although there can be no assurance, expects to commence marketing its new
line of custom blended foundations in the third quarter of 1998. Although there
can be no assurance, the Company believes these factors may enhance its ability
to achieve 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 incur significant expenses on sales and
marketing activities, including hiring finders, new personnel and consultants,
and entering into arrangements with retailers and distribution companies having
a regional or national presence. There can be no assurance the Company's
marketing plan will be successful.
Legal Proceedings. In June 1998, the Company and certain of
its officers and directors were sued in two separate class actions ("Actions")
brought in United States District Court, Southern District of New York,
entitled (i) L.F. Monk v. Chromatics Color Sciences International, Inc., Darby
S. Macfarlane, Arthur Guiry, David K. Macfarlane and Leslie Foglesong and (ii)
Daniel R. Marquis, on behalf of himself and all others similarly situated v.
Chromatics Color Sciences International, Inc., Darby S. Macfarlane, Arthur
Guiry and Leslie Foglesong. Based on the Asensio report the plaintiffs in the
Actions, on behalf of a class of the Company's stockholders, claim unspecified
damages arising from alleged violations of the anti fraud provisions of the
federal securities laws, relating to (i) the alleged misleading nature of prior
public disclosures and announcements made by the Company and (ii) sales of
company stock by the individual defendants allegedly while in possession of
material adverse non-public information regarding the Company's financial
condition, prospects and the capabilities and potential market for the Company's
Colormate(TM) Bilirubin Device. A motion has been made to consolidate the two
Actions and to approve a group of shareholders and lead plaintiffs and to
approve the selection by the group of lead counsel.
Additional actions may be brought against the Company and its
officers and directors arising from the matters described above. The Company
has directors and officers insurance which may cover a portion of the liability
asserted in the Actions. The Company believes the Actions are without merit and
intends to defend the Actions vigorously. No assurance can be given that the
resolution of the Actions and/or future actions will not have a material
adverse effect on the Company's results of operations and liquidity. The
Company is exploring all legal remedies in respect of what it believes to be
false allegations against the Company made by short sellers of its stock; the
Company expects to incur significant expenses in this regard. See "Recent
Events."
Potential International Operations. The Company believes that
sales of products to customers outside of the United States represents a
significant potential source of growth. Following compliance with applicable
foreign regulatory requirements, the Company expects to market its medical
products internationally through affiliates and distributors. The primary
targeted markets for the Company's products outside the United States are
Western Europe, Canada, Asia, South Africa and South America. See "Recent
Events." The Company also intends to contract with a number of foreign
manufacturers to provide certain of its sourcing needs for its medical device.
Although there can be no assurance it will be able to do so.
Foreign operations are subject to special risks that can
materially affect potential sales, including currency exchange rate devaluations
and fluctuations, the impact of inflation, exchange controls, labor unrest,
political instability, import and export duties and quotas, domestic and
international customs and tariffs, unexpected changes in regulatory
environments, potentially adverse tax consequences and other risks. Changes in
certain exchange rates could have a material adverse effect on the Company.
Prior Marketing Attempts. Other than the Company's marketing
efforts with Avon, its current 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 Beauty-Aid Products
independently and/or through licensees never proceeded beyond the 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 Beauty-Aid Products. In
addition, other than its installation of Colormate(TM) units in beauty salons
and beauty-related businesses (which are not generating current revenue), 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
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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 Beauty-Aid Products or for any medical applications of its technologies.
Competition. To the extent the Company implements its
business plan to commercialize a medical application for its Intellectual
Properties, it will be entering a field characterized by rapidly changing
technology, intense competition and extensive research and development. The
medical products market in general is highly competitive. The Company's ability
to compete in the bilirubin infant jaundice market depends primarily on the
acceptance by the medical community of the Company's new technology, which can
be influenced by factors such as price, product quality and features, technical
capability, breadth of product line and distribution capabilities. The Company
will be competing with established companies which have greater financial,
technical, manufacturing, marketing, research and development and management
resources than the Company (including companies such as Minolta Co., Ltd.,
Respironics, Inc. and SpectRx, Inc., among others), which have greater name
recognition and lengthier operating histories in the health care industry and
which have actively pursued development of non-invasive monitoring of bilirubin
infant jaundice. The Company believes the only commercially available
non-invasive Bilirubinometer with FDA marketing clearance in the United States
is the Minolta Jaundice Meter. In addition, there will be other companies with
which the Company will compete regarding other potential medical applications
which the Company may pursue. Furthermore, the monitoring methods currently in
use for bilirubin infant jaundice as well as dermatological diseases and
tuberculosis, the principal diseases with respect to which the Company intends
to seek regulatory marketing clearance, 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.
There can be no assurance that the Company will be able to
effectively compete against these and other competitors, including those
competitors who intend to promote their versions of non-invasive devices.
Additionally, there can be no assurance that the Company's competitors will not
succeed in developing, either before or after the commercialization of the
Company's product, devices and technologies that permit more efficient, less
expensive non-invasive detection and monitoring of bilirubin infant jaundice.
It is also possible that one or 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 products obsolete. 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's products. In addition, many medical supply
companies with which the Company's proposed medical application and device 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 application, such as pediatricians and hospitals. In addition,
many of the Company's competitors offer broader product lines than the Company,
which may be a competitive advantage in obtaining contracts with health care
purchasing groups. No assurance can be given that the Company will successfully
and effectively market its medical products against these and other competitors
or contract with health care providers.
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
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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 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
Beauty-Aid 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 depends on
its ability to obtain and maintain patent protection for its products and
processes, to preserve its trade secrets, and to operate without infringing
upon the proprietary rights of third parties. The validity and breadth of
claims covered in medical technology patents involve complex legal and factual
questions and therefore, may be highly uncertain. No assurance can be given
that the scope of any patent protection under the Company's current patents, or
under any patent the Company might obtain in the future, will exclude
competitors or provide competitive advantages to the Company; that any of the
Company's patents will not be held invalid if subsequently challenged; or that
others will not claim rights in or ownership of the patents and other
proprietary rights held by the Company.
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. The Company has developed
intellectual property rights in color analysis, calibration and verification in
a number of fields including medical, biological, dental, cosmetic and
materials testing. The intellectual property rights include trade secrets, know
how and 14 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 litigation 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.
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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 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 coloration, 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 European Patent No. 0446512, nationalizations of that European
Patent in Austria, Belgium, France, Germany, Great Britain, Italy, Luxembourg,
The Netherlands, Spain, Sweden and Switzerland and Liechtenstein, a Singapore
registration of that European Patent, as well as Australian, Brazilian and
Mexican Patents corresponding, at least in part, to its U.S. Patent No.
4,909,632, Taiwanese and Colombian Patents corresponding, at least in part, to
its U.S. Patent No. 5,313,267 and two Taiwanese Patents corresponding, at least
in part, to its U.S. Patent No. 5,671,735. 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 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 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 to accurately 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,
particularly with respect to newly developed technology. In addition,
re-examination or interference proceedings may be instituted in the United
States Patent and Trademark Office ("USPTO"). There can be no assurance that
the Company will not become subject to patent infringement claims
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brought by third parties, or re-examination of previously issued patents by the
USPTO or interference proceedings instituted in the USPTO to determine the
priority of inventions. The defense and prosecution of intellectual property
suits, USPTO re-examination and 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 the Company and 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, disputed rights to be licensed from
such third parties or prevent the Company from selling its products in certain
markets, or at all. If third-party patents containing claims affecting the
Company's technology were issued, and such claims were determined to be valid,
there can be no assurance that the Company would be able to obtain licenses to
such patents at costs reasonable to the Company, if at all, or be able to
develop or obtain alternate technology. 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.
The Company is aware that others have obtained or are
pursuing patent protection for various aspects of the design, production and
manufacturing of bilirubin infant jaundice diagnostic and monitoring products,
including products that are non-invasive. There can be no assurance that the
Company's technology, current or future products or activities will not be
deemed to infringe upon the rights of others.
Failure to Obtain and Maintain 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 Colormate(TM) Bilirubin Device 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 or continue to be available, or sufficient
to allow the Company to sell its medical device products on a competitive basis.
Moreover, obtaining and maintaining health care payors' approval of
reimbursement for the Company's products, and the level of reimbursement made
available will be an important factor in establishing pricing structures and
market acceptance. The Company is unable to predict what changes will be made in
the reimbursement methods utilized by third-party health care payors.
Furthermore, the Company could be adversely affected by changes in reimbursement
policies of governmental or private health care payors.
On March 16, 1998, the Company announced that the American
Medical Association had assigned AMA Code CPT 82250 as the applicable code to be
used for processing insurance reimbursement claims for uses of the Colormate(TM)
Bilirubin Device, which is the same code used for laboratory blood testing
currently used to monitor bilirubinemia. AMA CPT codes are generally used to
facilitate claims processing and to provide a simplified reporting procedure;
the codes do not assure that an insurer will reimburse claims, or that the AMA
endorses the medical procedure at issue. However, following a review conducted
by the CPT Laboratory Advisors Committee which resulted in the committee
advising confirmation of CPT 82250 for the test performed by the Company's
device, the AMA CPT Editorial and Information Services determined to submit to
the CPT Executive Committee for review in August 1998 the assignment of CPT
Code 82250, and has advised the Company that until such final review is
completed, it is the AMA's position that CPT Code 84999 ("Unlisted Chemistry
Procedure") is the appropriate code. The Company believes the original code
82250 is correct, and has submitted additional supporting materials to the AMA.
There can be no assurance the Company will be granted the original CPT Code
82250. Claims for reimbursement under the CPT Code 84999 will not be as
easily processed for reimbursement as claims made under AMA CPT Code 82250.
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Since receiving FDA marketing clearance in the United States,
the Company has undertaken the procedures to obtain required international
regulatory clearances for its monitoring technology for bilirubin infant
jaundice. If the Company obtains the necessary foreign regulatory clearances,
market acceptance of the Company's products in international markets will be
dependent in part, upon the availability of reimbursement within prevailing
health care payment systems. Reimbursement and health care payment systems in
international markets vary significantly by country and include both government
sponsored health care and private insurance. Although the Company intends to
seek international reimbursement approvals, there can be no assurance that such
approvals will be obtained in a timely manner, if at all.
Failure to obtain and maintain third-party reimbursement
coverage for use of the Colormate(TM) Bilirubin Device will have a material
adverse effect on the Company's ability to commercialize its technology for
medical applications.
Government Regulations. The Company's advertising, sales
practices and cosmetics and medical 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, and the Federal Communications Commission, under various laws such
as 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 products abroad. The Company will also
be subject to regulation by various governmental agencies that regulate direct
selling activities.
Although the Company has received FDA clearance on its
Colormate(TM) Bilirubin Device pursuant to a "substantial equivalence"
determination order, in the form of a letter dated July 24, 1997 from the FDA's
CDRH, authorizing the Company to commercially distribute its Colormate(TM)
Bilirubin Device for monitoring bilirubin infant jaundice by healthcare
professionals in the United States, the Company also must comply with the other
applicable statutes and applicable rules and regulations, promulgated by the
FDA, in order to legally market the device. 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 (QSR requirements), medical device reporting, labeling,
and the statutory prohibitions against adulteration and misbranding. The order
also states that the Colormate(TM) Bilirubin 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 is unaware of any applicable special
controls at this time.
In the United States, the FDA regulates the introduction of
medical devices as well as, among other things, manufacturing, labeling and
recordkeeping procedures for such products. The process of obtaining marketing
clearance for new medical products from the FDA can be costly and time
consuming, and there can be no assurance that such clearance will be granted
for the Company's future products on a timely basis, if at all, or that FDA
review will not involve delays that would adversely affect the Company's
ability to commercialize additional products or to expand permitted uses of
existing products. Regulatory clearance to market a product from the FDA may
entail limitations on the indicated uses of the product. The ability to market
can be challenged (and possibly withdrawn) by the FDA due to failure to comply
with regulatory standards or the occurrence of unforeseen problems following
initial clearance. The Company may be required to file further marketing
applications with the FDA under certain circumstances, such as the addition of
product claims or product redesign. The FDA also could limit or prevent the
manufacture or distribution of the Company's products, and has the power to
require the recall of such products, given certain circumstances. FDA
regulations depend heavily on administrative interpretation, and there can be
no assurance that future interpretation made by the FDA or other regulatory
bodies, will not adversely affect the Company. The FDA will and various state
agencies may inspect the Company and its facilities from time to time to
determine whether the Company is in compliance with regulations relating to
medical device manufacturing companies, including regulations concerning
manufacturing, testing, quality control and product labeling practices. A
determination that the Company is in violation of such regulations could lead
to the imposition of civil penalties, including fines, product recalls, product
seizures, or, in extreme cases, criminal sanctions.
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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, among other things, governing product standards,
packaging requirements, labeling requirements, import restrictions, tariff
regulations, duties and tax requirements. These regulations vary from country
to country. After mid-1998, the Company will be prohibited from selling its
Colormate(TM) Bilirubin Device in Europe until such time as the Company
receives the right to affix the CE mark, which is a symbol of quality and
compliance with applicable European medical device directives. ISO 9001/EN
46001 certification is one option for pursuing the CE mark under the CE mark
certification process requirements. There can be no assurance that the Company
will be successful in obtaining ISO 9001/EN 46001 certification or CE mark
rights. Failure to receive ISO 9001/EN 46001 certification, CE mark rights or
other foreign regulatory approvals could have a material adverse effect on the
Company's business, financial condition and results 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 or 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 may rely on its
third-party foreign distributors to comply with certain foreign regulatory
requirements. The inability or failure of the Company or such foreign
distributors to comply with varying foreign regulations or the imposition of
new regulations could restrict the sale of the Company's products
internationally and thereby adversely affect the Company's business, financial
condition and results of operations.
The Company and any third party with which it has made
contract manufacturing or other regulated arrangements will be required to
adhere to applicable FDA regulations, including the QSR requirements and
similar regulations in other countries, which include, among other things,
testing, control, and documentation requirements. Ongoing compliance with QSR
requirements and other applicable regulatory requirements will be strictly
enforced in the United States through periodic inspections by federal and
possibly state 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, injunctions, civil
monetary 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, possible rescission or withdrawal of clearances
or approvals previously obtained and criminal prosecution. The restriction,
suspension or revocation of regulatory clearances or 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.
If the FDA believes that any of its legal requirements have
not been fulfilled, it has extensive enforcement powers, including but not
limited to 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 seek civil monetary or criminal penalties.
Product Liability and Malpractice. The medical products
industry is subject to substantial product liability litigation, and the
Company faces an inherent business risk of exposure to product liability claims
in the event that the use of its products is alleged to have resulted in
adverse effects to a patient or product user. Any such claims could have a
material adverse effect on the Company, including on market acceptance of its
Colormate(TM) Bilirubin Device. Once the Colormate(TM) Bilirubin Device is in
commercial use, the Company will be entering a field where it may become
subject to product liability claims by patients and/or users 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 application. Even if the Company obtains such insurance, there can be
no assurance that it will be able to maintain such insurance or that such
insurance would be sufficient to protect the Company against any such
liabilities.
25
<PAGE>
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 Beauty-Aid
Products.
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 Beauty-Aid Products, the Company's business and
financial condition could be materially adversely affected and the Company
could be forced to cease operations.
Year 2000 Compliance. Like many corporations, the Company
is reliant on technology. As the millennium approaches, the Company is preparing
all of its computer systems to be Year 2000 compliant and is reviewing all
systems to ensure that they do not malfunction as a result of Year 2000. In this
process, the Company expects to both upgrade some systems and replace others.
The Company currently is evaluating the total cost of this effort and expects
that most of these costs will be expensed as incurred in compliance with
generally accepted accounting principles. The Company does not expect these
costs to be material, although there can be no assurance that such costs will
not exceed the Company's esitmates. However, there can be no assurance that the
Company will identify all Year 2000 problems it may have in advance of their
occurrence or that the Company will be able to successfully remedy any problems
that are discovered. In addition, any revenue stream and financial stability of
future customers may be adversely impacted by Year 2000 problems, which could
adversely affect the Company's operations.
Control; Dependence on Management. Darby Simpson Macfarlane,
Chief Executive Officer of the Company, owns shares of Common Stock and Series
A preferred stock, par value $0.001 per share (the "Preferred Stock")
aggregating 2,241,896 (excluding currently exercisable stock options) of the
shares eligible to vote on matters presented to the shareholders, which amount
is sufficient to permit her to significantly influence 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
and Development. The loss of either of their services could have 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.
No Assurance of continued Nasdaq Smallcap Market Listing;
Risk of Application of Penny Stock Rules. The trading of the Company's stock in
the Nasdaq SmallCap Market will be conditioned upon the Company's continuing to
meet certain asset, capitalization, earnings and stock price tests. To maintain
eligibility for trading on the Nasdaq SmallCap Market, the Company will be
required to maintain, among other things, net tangible assets of a least
$2,000,000; a minimum bid price for the listed securities of $1.00 per share; a
market value of the public float of at least $1,000,000; and at least two
market makers for its securities. If the Common Stock were to be delisted from
the Nasdaq SmallCap market, the prices and the holders' ability to sell such
securities would be adversely affected. If the Common Stock were delisted and
the Company desired to have it relisted, the Company would be required to
satisfy the more stringent initial listing requirements of the Nasdaq SmallCap
Market.
If the Company is delisted from the Nasdaq SmallCap Market
and the price per share dropped below $5.00, then unless the Company satisfied
certain net assets tests, the Common stock would become subject to certain penny
stock rules promulgated by the Securities and Exchange Commission (the
"Commission"). The penny stock rules require a broker-dealer, prior to a
transaction in a penny stock not otherwise exempt from the rules, to deliver a
standardized risk disclosure document prepared by the Commission that provides
information about penny stocks and the nature and level of risks in the penny
stock market. The broker-dealer must also provide the customer with current bid
and offer quotations for the penny stock, the compensation of the broker-dealer
and its salesperson in the transaction and monthly account statements showing
the market value of each penny stock held in the customer's account. In
addition, the penny stock rules require that prior to a transaction in a penny
stock not otherwise exempt from such rules, the broker-dealer must make a
special written determination that the penny stock is a suitable investment for
the purchaser and receive the purchaser's written agreement to the transaction.
These disclosure requirements may have the effect of reducing the level of
trading activities in the secondary market for stock that becomes subject to the
penny stock rules. If the Common Stock becomes subject to the penny stock rules,
investors may find it more difficult to sell their Common Stock.
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
26
<PAGE>
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 Private Placement 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 Private Placement Warrants are exercised. For the life of such
Private Placement 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 Private
Placement Warrants remain unexercised, the terms under which the Company could
obtain additional equity financing may be adversely affected. Moreover, the
holders of such Private Placement 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 Private Placement Warrants. To the extent of any exercise of
the Private Placement 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 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) for any two consecutive calendar years ending on
December 31, 2000 exceed $20,000,000 or (ii) the closing bid price of the
Common Stock has been at least $31.11 on 30 consecutive trading days at any
time ending on December 31, 2000. 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.
Additional Authorized Preferred Stock. The Company's Amended
Certificate of Incorporation (the "Certificate of Incorporation") authorizes
the Board of Directors to issue, without shareholder approval, up to 10,000,000
shares of preferred stock with voting, conversion and other rights and
preferences that could adversely affect the voting power or other rights of the
holders of Common Stock. The issuance of preferred stock or of rights to
purchase preferred stock could be used to discourage an unsolicited acquisition
proposal. In addition, the possible issuance of preferred stock could
discourage a proxy contest, make more difficult the acquisition of a
substantial block of the Company's Common Stock or limit the price that
investors might be willing to pay in the future for shares of the Company's
Common Stock.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
No disclosure is required under this Item 3.
27
<PAGE>
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
In June 1998, the Company and certain of its officers and directors
were sued in two separate class actions ("Actions") brought in United States
District Court, Southern District of New York, entitled (i) L.F. Monk v.
Chromatics Color Sciences International, Inc., Darby S. Macfarlane, Arthur
Guiry, David K. Macfarlane and Leslie Foglesong and (ii) Daniel R. Marquis, on
behalf of himself and all others similarly situated v. Chromatics Color
Sciences International, Inc., Darby S. Macfarlane, Arthur Guiry and Leslie
Foglesong. The plaintiffs in the Actions, on behalf of a class of the Company's
stockholders, claim unspecified damages arising from alleged violations of the
anti fraud provisions of the federal securities laws, relating to (i) the
alleged misleading nature of prior public disclosures and announcements made by
the Company and (ii) sales of company stock by the individual defendants
allegedly while in possession of material adverse non-public information
regarding the Company's financial condition, prospects and the capabilities and
potential market for the Company's Colormate(TM) Bilirubin Device. A motion has
been made to consolidate the two Actions and to approve a group of shareholders
and lead plaintiffs and to approve the selection by the group of lead counsel.
Additional actions may be brought against the Company and its officers
and directors arising from the matters described above. The Company has
directors and officers insurance which may cover a portion of the liability
asserted in the Actions. The Company believes the Actions are without merit and
intends to defend the Actions vigorously. No assurance can be given that the
resolution of the Actions and/or future actions will not have a material
adverse effect on the Company's results of operations and liquidity. The
Company is exploring all of its legal remedies in respect of what it believes to
be false allegations against the Company made by short sellers of its stock; the
Company expects to incur significant expenses in this regard. See "Recent
Events."
Item 2. Changes in Securities and Use of Proceeds.
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) 27 - Financial Data Schedule.
(b) Reports on Form 8-K.
None.
28
<PAGE>
EXHIBIT INDEX A
Exhibit No. Document Page
----------- -------- ----
27 Financial Data Schedule 31
29
<PAGE>
SIGNATURES
In accordance with the requirements of the 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: August 14, 1998 /s/ Darby S. Macfarlane
-------------------------------------------
Darby S. Macfarlane
Chief Executive Officer
/s/ Leslie Foglesong
Date: August 14, 1998 -------------------------------------------
Leslie Foglesong
Treasurer and Chief Financial
and Principal Accounting Officer
30
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This 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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 7,870,400
<SECURITIES> 0
<RECEIVABLES> 92,400
<ALLOWANCES> 0
<INVENTORY> 148,900
<CURRENT-ASSETS> 8,200,800
<PP&E> 2,171,000
<DEPRECIATION> (331,000)
<TOTAL-ASSETS> 10,550,100
<CURRENT-LIABILITIES> 1,028,700
<BONDS> 0
13,800
0
<COMMON> 15,200
<OTHER-SE> 9,492,400
<TOTAL-LIABILITY-AND-EQUITY> 10,550,100
<SALES> 0
<TOTAL-REVENUES> 225,003
<CGS> 0
<TOTAL-COSTS> 3,683,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 13,300
<INCOME-PRETAX> (3,471,300)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,471,300)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,471,300)
<EPS-PRIMARY> (0.24)
<EPS-DILUTED> (0.24)
</TABLE>
