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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A-3
(Mark One)
/X/ Annual report under Section 13 or 15(d) of the Securities Exchange Act of
1934
For the fiscal year ended December 31, 1998
/ / Transition report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the transition period from ____________________ to ____________________
Commission file number 0-21168
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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
Incorporation or Organization) Identification Number)
5 East 80th Street, New York, New York 10021
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(Address of Principal Executive Offices) (Zip Code)
(212) 717-6544
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(Registrant's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $0.001 per share
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Purchase Rights for Class B Series 1 Preferred Stock, par value $0.001
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(Title of Class)
Indicate by check mark whether the registrant: (1) filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K./ /
As of April 13, 1999, 15,477,471 shares of Common Stock, par value $0.001 per
share (the "Common Stock") of the registrant were outstanding and the aggregate
market value of the voting stock (computed based on the average of the last bid
and asked price on such date) held by non-affiliates was approximately
$77,138,355.
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EXPLANATORY NOTE
This Report on Form 10-K/A-3 amends and restates in their entirety the text of
Items 1, 7, 8, 12 and 14 of the Company's Annual Report on Form 10-K for the
year ended December 31, 1998 which was filed with the Securities and Exchange
Commission on April 15, 1999 and amended on November 12, 1999.
PART I
THIS ANNUAL REPORT ON FORM 10-K, INCLUDING ITEM 1 ("BUSINESS") AND ITEM 7
("MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS"), 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 __ TO __, 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 MARKETING AND
DISTRIBUTION PARTNERS, THE OBTAINING AND MAINTAINING OF AND COMPLIANCE WITH ANY
NECESSARY 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.
Item 1. Business
General
Chromatics Color Sciences International, Inc. (the "Company") was formed in 1984
to research, develop and commercialize certain intellectual property rights,
proprietary technology and instrumentation in the field of color science
(collectively, the "Intellectual Properties"). The Intellectual Properties
provide color measurement to a laboratory standard of accuracy, analysis and
classification of human skin, tissue, fluid, hair, teeth or biological subject
which facilitates the detection and monitoring of conditions affecting their
coloration and the classification and organization by color of various
consumer-sensitive products such as cosmetics, tooth enamel, hair color,
hosiery, clothing fashion accessories and textiles. The Company has incorporated
certain of the Intellectual Properties into a proprietary color measurement
system and software marketed for various commercial applications as the
"ColorMate(Registered Trademark) System."
The Company has developed a ColorMate(Registered Trademark) device to measure
the incremental change of the yellow content of the skin color in newborns to
monitor newborn bilirubinemia (infant jaundice) (defined as bilirubin levels or
infant jaundice in a range above that which would be considered average in a
newborn). On July 30, 1997 the Company received U.S. Food and Drug
Administration ("FDA") clearance for commercial marketing of the
ColorMate(Registered Trademark) device for non-invasive monitoring of newborn
bilirubinemia (infant jaundice) in infants by healthcare professionals in the
hospital, institutional, pediatricians' office or home setting (the
"ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System").
The Company's efforts are currently primarily focused on successfully
commercializing this medical application of its Intellectual Properties.
Infant jaundice occurs in most newborns because of a combination of increased
bilirubin production, a waste product that is normally produced from the
breakdown of red blood cells, and decreased clearance of bilirubin by the liver.
Infant jaundice primarily affects infants within the first three to ten days of
life. Almost all newborn babies develop some degree of infant jaundice and very
high bilirubin levels, if left untreated, may, in extreme cases, lead to
permanent brain damage or death. Prior to birth, the bilirubin in an infant is
processed by the mother's liver and excreted. Following its birth, an infant
must eliminate bilirubin independent of its mother, and it may take an infant's
system several days to begin eliminating the bilirubin faster than it is
produced. Infants who are born prematurely, who are underfed or who belong to
certain ethnic groups are at an increased risk of developing newborn infant
jaundice. The initial screening of bilirubin levels is the observation of the
yellowing of the skin by professional care providers, which is a subjective
determination prone to errors due to differing skin colors. If the initial
clinical assessment suggests the possibility of significant elevated bilirubin
levels, the current procedure requires that a blood sample be
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obtained from the infant, usually by lancing the infant's heel (heelstick).
These laboratory measurements are time-consuming, costly and a traumatic process
for the infant. In addition, repeated blood drawing in very low birth weight
babies with extremely small blood volumes may result in the need for blood
transfusion. Since infant jaundice is normally present in infants 36 to 72 hours
following birth, infants who are sent home after a short hospital stay pursuant
to managed care guidelines in the United States are at risk because the
condition may not have presented itself prior to release. Thus the Company
believes a non-invasive instrument that monitors infant jaundice in infants
represents a significant improvement in patient care.
Prior to marketing the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System, the Company's activities principally involved licensing the
Intellectual Properties, leasing the ColorMate(Registered Trademark) System and
marketing its own line of precisely color coordinated proprietary cosmetics ("My
Colors by Chromatics (Registered Trademark)") and proprietary color charts and
material swatchpacks (collectively, the "Beauty Aid Products) in the cosmetics,
hair color, beauty aid and fashion industries (i) in a national sales program
with Avon Products, Inc. and in limited test markets with Clairol, Inc. and
Hanes Hosiery, Inc. (all conducted prior to June 1991), (ii) under a product
development agreement with Gordon Laboratories, Inc. ("Gordon") and (iii) under
a license and lease agreement with Nordstrom, Inc. ("Nordstrom"). Presently, as
the result of its efforts to market commercially the ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System for medical application,
the Company has not initiated any new relationships to distribute its Beauty-Aid
Products. Once the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System has achieved commercial distribution, the Company will renew
its efforts for commercial distribution of its Beauty-Aid Products.
Current Products
The Company has developed the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System for monitoring newborn infant jaundice
in infants of all races, including when under phototherapy. This device uses a
color measurement instrument in combination with certain apertures, calibration
systems, accessories and software which have been developed by the Company for
this specific medical application. The ColorMate (Registered Trademark)
TLc-BiliTest(Registered Trademark) System received FDA clearance for use in
monitoring newborn infant jaundice by measuring the color of the skin of the
newborn and periodically monitoring incremental changes in the skin color. The
FDA-cleared device includes the ColorMate(Registered Trademark) device for
monitoring newborn infant jaundice when operated using external power sources
with a computer and printer, and when operated as a battery-operated, hand-held,
optional computer assisted device. (This device together with the Company's
disposable calibration components is hereafter referred to as the
"ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System.")
The ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System is
a proprietary color measurement system containing a light source and optical
filters. Color measurements are obtained from an infant by placing the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System on
different physical sites of the newborn for five to ten seconds. Accuracy of the
color measurements is ensured by the TLc-Lensette(Trademark), a proprietary
disposable color-calibration and verification standard consisting of a device
containing a dye deposit specially colored and treated paper, which is used
prior to each baby's measurement. Each color measurement of the skin is analyzed
by the Company's proprietary technology to provide an estimate in milligrams per
deciliter (the laboratory scale used for blood serum tests) correlating to the
newborn's serum bilirubin concentration within a clinically useful range.
The ColorMate(Registration Trademark) TLc-BiliTest(Registered Trademark) System
as currently marketed by the Company's medical division has a list price of
$3,000 to $5,000 depending on the model any may be lease or used under the
limited time offer for use and evaluation of the system, all with either
purchase of minimum monthly supplies of the TLc-Lensette(Trademark) calibration
standards at $10 per unit or minimum monthly charges of $10 per use under a
Managed Use Program.
Marketing and Distribution
In September 1997, the Company released the results of market research studies
which analyzed the existing market for methods currently used to monitor newborn
infant jaundice in infants in the United States and in the developed countries
of Europe, South America and Canada combined, and Asia. The study indicated that
the World Health Organization published annual birthrate is approximately
4,000,000 births in the United States, with approximately 10% of these births
being premature infants. The Company estimates that individual bilirubin
heelstick blood tests on newborn infants, which are not part of a general panel
blood test, total approximately 15,000,000 tests performed annually in the
United States, based on data made available by the World Health Organization,
the American Academy of Pediatrics, independent market studies commissioned by
the Company and business proposals from potential marketing partners.
Internationally, using the World Health Organization birth rates, independent
market studies and research obtained from companies currently marketing neonatal
medical devices in foreign countries, the Company estimates that the current
European market for infant bilirubin tests is approximately the same size as the
United States; South America and Canada combined represent approximately 25% of
the United States market size, and the Southern Chinese and entire Japanese
markets combined represent approximately the same size of market as the United
States.
The Company intends to exploit the primary markets for its ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System in the monitoring of
newborn infant jaundice, which include hospitals, other medical institutions and
pediatricians' offices and home healthcare agencies in the United States and
other countries around the world. In order to successfully market and sell its
ColorMate(Registered
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Trademark) TLc-BiliTest(Registered Trademark) System for monitoring of newborn
infant jaundice, the Company must either develop an extensive marketing and
sales force or enter into arrangements with third parties to market and sell
this product. These arrangements could take the form of lease/license
arrangements, marketing and distribution arrangements, joint ventures or
acquisitions. The Company's strategy is to effect the sales and distribution of
its ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System
through collaborative distributors. The Company believes that by aligning with
larger, more established medical company distributors, in specific market
segments, it can more effectively and quickly penetrate the medical marketplace.
There can be no assurance that the Company will be able to successfully enter
into additional marketing and sales agreements with third parties on acceptable
terms.
The Company has agreed on definitive basic terms with two potential marketing
and distribution partners for the exclusive distribution of the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System in the
hospital, pediatrician and home healthcare markets. Both of these proposals
include terms requiring minimum annual placements of the ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System and TLc-Lensette(Trademark)
calibration standards and/or charges per use. The Board is reviewing both sets
of terms as well as recommendations of its advisors and the Company anticipates
selecting one of these distributors shortly.
In order to provide the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System to hospitals and physicians already placing orders, and to
expedite evaluation of the product by the medical community, the Company has
taken a series of significant steps to increase awareness of its products in the
medical community and to initiate its own sales and servicing of the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System with
United States physicians and clinicians in hospitals.
In November 1998, the Company opened its medical division, supervised by Sheila
Kempf, Vice President Medical 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 over 13 years experience in the medical marketing field. The Company
also hired neonatal nurse clinical specialists to provide training to hospital
staffs using the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System. The newly formed medical division provides sales and support
for the ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark)
System delivered to customers in the medical community, including hospitals,
pediatricians, clinics and home health care agencies, and performs delivery,
training and in-servicing for customers initially generated by the Company's
presentations to the medical community.
In January 1999, the Company formed a five-person sales unit to be led by Dennis
A. McClinton, Vice President of Sales. Mr. McClinton has an 18-year background
in sales of fetal and neonatal intensive care unit monitoring products at
Marquette Medical Systems and will head a staff that averages ten years
experience in that field. The new unit is responsible for the initial sales
activity for the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System.
In January 1999, the Company appointed Medical International, Inc. as its
exclusive distributor of the ColorMate(Registered Trademark) TLc-
BiliTest(Registered Trademark) System in certain states; in February 1999, the
marketing efforts of this distributor commenced.
The Company launched the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System to the Chinese medical community at the Sinomed 1998
Exhibition, the 7th China International Medical Equipment and Facilities
Exhibition ("Sinomed"). 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(Registered Trademark) TLc-BiliTest(Registered Trademark) System at
two hospitals in Beijing. 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(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. Under the M.O.U., the M.O.H. has
recently completed the first stage of its nationwide study and is compiling the
results in connection with developing 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. There can be no assurance as to the timing of the actions
anticipated to be taken by M.O.H.
The Company also announced that it signed a letter of intent with the China
National Medical Equipment and Supplies, Import and Export Corporation, for the
distribution of the Company's ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System including investigations for
acceptable price structures for marketing the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System in China. 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 has hired two Chinese representatives of the Company
to expedite any potential manufacturing, marketing and distribution of the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System in
China.
Regulatory Clearances.
In June 1996, the Company retained government regulatory consultants and legal
counsel to oversee compliance with applicable federal and state regulations for
commercialization of the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System, and for complying with any applicable European Community and
other foreign government requirements. The initial clinical studies conducted at
Mt.
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Sinai Hospital were completed with positive results and on November 14, 1996 the
Company filed its application with the FDA for the medical application of its
technologies, specifically, the non-invasive monitoring of newborn infant
jaundice. On July 30, 1997, the Company received confirmation of marketing
clearance pursuant to a "substantial equivalence" determination order, dated
July 24, 1997, from the FDA's Center for Devices and Radiological Health (the
"CDRH"), authorizing the Company to commercially distribute the system in the
United States. The "substantial equivalence" order states that the Company must
comply with all relevant statutes enforced by and regulations promulgated by the
FDA, including Quality System Regulation ("QSR") requirements, labeling, and the
statutory prohibitions against adulteration and misbranding. The order also
states that the system is a "Class II device" which may be subject to additional
"special controls." The Company intends to maintain substantial compliance with
any applicable requirements and any special controls for purposes of commercial
distribution.
The Company's FDA market clearance authorizes use of the Company's technology as
an aid to the physician in monitoring the status of newborn babies for the
development of newborn infant jaundice.
The Company believes a non-invasive instrument that monitors infant jaundice in
infants represents a significant improvement in patient care. Following a
physician's examination of a newborn within the first hours of birth, newborn
babies would be measured initially and monitored periodically by the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System for
incremental changes in the yellow content of their skin color. Because the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System can
provide effective non-invasive monitoring of newborn infant jaundice, it may
have significant marketing advantages over the invasive, repeated, daily blood
testing techniques currently used, which in many cases leads to blood
transfusion of the infant. See "Risk Factors." However, because the medical
community is relatively slow to adopt new technologies, there can be no
assurance that practitioners will perceive a need for, or accept, the Company's
technology, or be willing to commit funds to its development or the purchase of
any such completed technology.
Since receiving FDA marketing clearance in the United States, the Company has
undertaken the procedures to obtain required international regulatory clearances
for its ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark)
System. To market its ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System in the European Union, the Company sought ISO-9001/EN46001
certification and the right to affix the CE mark. ISO-9001/EN46001 certification
recognizes that the Company has established a quality system for the design,
development, manufacturing, servicing and distribution of its medical device.
The CE mark is a symbol of quality and compliance with applicable European Union
medical device directives. In March 1999, the Company received ISO-9001/EN46001
certification and passed a product inspection of its ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System in February 1999 for
purposes of receiving the right to affix the CE mark to such product. The
Company is awaiting a certification from the appropriate European authority to
allow release for European Union distribution. The Company also has applied for
and is awaiting the right to self-certify the product, without the need for
third party specific product inspection and certification, for purposes of
affixing the CE mark for European Union distribution.
Manufacturing
One element of the Company's business strategy is to outsource the production of
the components and final assembly of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System and its TLc-Lensette(Trademark)
disposable calibration and verification standard to third-party manufacturers.
In November 1998, the Company reached an agreement with Nova Biomedical
Corporation for the production of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. Nova Biomedical is a medical device
production contractor, is ISO 9001/EN46001 certified, and has advised the
Company that it is in substantial compliance with all applicable regulatory
requirements for the contract manufacture of medical devices for the U.S. and
European Union distribution, including requirements under the FDA's Quality
System Regulation ("QSR") and the requirements applicable to the manufacture of
medical devices for the European Union (including ISO 9001 and EN46001).
Under this renewable, four-year medical device manufacturing agreement, the
contract manufacturer is the exclusive manufacturer/assembler and packager of
two models (a battery powered model and an electrically powered model) of the
Company's ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark)
System for distribution in the United States (subject to limited volume
exceptions with respect to one model of the instrument). The manufacturer also
has a right of first refusal to match third party bids to manufacture/assemble
and package a third model of such instrument and a further right of first
refusal to match third party bids to manufacture/assemble and package the two
models referenced above for distribution outside the United States. In this
regard, subject to any failure of Nova Biomedical to exercise its right of first
refusal to match third party bids (thus permitting the Company to use other
manufacturers), Nova Biomedical is the Company's sole source of supply for the
instruments. Under the agreement, the Company is responsible for providing to
Nova Biomedical, for assembly and packaging, certain component parts.
In February 1999, the first manufacturing run of the Company's
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System (under
the FDA's QSR as well as ISO-9001/EN46001 manufacturing regulatory requirements)
for monitoring newborn jaundice was completed by Nova Biomedical. The Company
commenced shipping the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System to those hospitals having placed purchase orders for the
systems under a limited time price offer which allowed the hospitals to obtain
the device and evaluate its performance during a trial period. The Company also
has begun in-servicing at hospitals and with physicians who have placed
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initial orders.
The Company believes, based on discussions with suppliers of components used in
its ColorMate(Registered Trademark) TLc- BiliTest(Registered Trademark) System
and published price lists, that the components can be purchased in quantities of
1,000 or more on terms acceptable to the Company. However, there can be no
assurance the Company will be able to obtain such terms or order in such
qualities, and manufacture of limited quantities of the ColorMate(Registered
Trademark) units would be significantly more expensive due to the higher unit
cost of components ordered in quantities of less than 1,000.
To the extent the Company successfully markets the ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System for medical application,
the Company will use the nonproprietary and proprietary components of a portion
of the existing ColorMate(Registered Trademark) units in its possession for the
production of a limited number of such devices under the FDA's QSR and
ISO-9001/EN46001 for early stage marketing and sales efforts and for commercial
use.
In August 1995, the Company established a research and development facility in
Spokane, Washington. This office is staffed, in addition to support personnel,
by two engineers who are former principals of R.B.H. Electronics, one of the
companies which originally engineered and manufactured the Company's original
ColorMate(Registered Trademark) units. These engineers currently are primarily
engaged in developing the mass manufacture prototypes of the Bilirubin LED
Device and the ColorMate(Registered Trademark) LED Device. The Bilirubin LED
Device is expected to require additional regulatory clearances or approvals.
Intellectual Properties, Patents and Patent Applications Pending
The Company owns U.S. Patent No. 4,909,632 (expiring in 2007) entitled "Method
for Selecting Personal Compatible Colors," U.S. Patents Nos. 5,311,293 (expiring
in 2007), 5,313,267 (expiring in 2011) both entitled "Method and Instrument For
Selecting Personal Compatible Colors" and 5,671,735 (expiring in 2014) entitled
"Method and Apparatus for Detecting and Measuring Conditions Affecting Color."
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 15 pending United States patent
applications. The Company also has filed patent applications in a number of
foreign jurisdictions which correspond, at least in part, to the Company's
United States patents. The Company has been granted European Patent No. 0446512
entitled "Method for Selecting Personal Compatible Colors." That European patent
has been nationalized in Austria, Belgium, France, Germany, Great Britain,
Italy, Luxembourg, The Netherlands, Spain, Sweden, Switzerland and
Liechtenstein. The Company also has Australian, Taiwanese, Canadian, Korean and
Mexican patents corresponding, at least in part, to its U.S. Patent No.
4,909,632, Taiwanese and Korean patents corresponding, at least in part, to its
U.S. Patent No. 5,313,267 and a Singapore patent and two Taiwanese patents
corresponding, at least in part, to its U.S. Patent No. 5,671,735 (collectively,
together with the United States patents, the "Patents"). The Company has not yet
been granted any other foreign patents for its Intellectual Properties.
The proprietary information claimed by the Patents includes, among other things:
(i) a method of detecting a medical condition that involves a symptomatic,
detectable change in a test subject's skin coloration, such as a method for
monitoring newborn bilirubinemia (infant jaundice) in an infant test subject,
(ii) a method and instrument for identifying skin color and categories of
individuals, (iii) a method of determining color compatibility of an
individual's skin with non-skin matter and (iv) a method of assigning a skin
color compatibility classification to non-skin matter and color charts and
sample assemblages made by that method. Proprietary information claimed by the
Patents is incorporated in the proprietary software and measurement system used
in the ColorMate(Registered Trademark) units. Although many of the individual
hardware components of the ColorMate(Registered Trademark) System and the
ColorMate(Registered Trademark) TLc-BiliTest (Registered Trademark) System are
public and not proprietary to the Company, the color measurement sensor is
manufactured to proprietary specifications of the Company and when those
individual hardware components are assembled in conjunction with the Company's
proprietary software they form the ColorMate(Registered Trademark) System and
the ColorMate(Registered Trademark) TLc-BiliTest (Registered Trademark) System,
the operation of which is covered by the claims of the Company's patents. The
Company's TLC-Lensette (Trademark) disposable color-calibration and verification
standard is entirely proprietary to the Company because the proprietary color
formulation used is uniquely capable of effectively calibrating the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) system for
use on all human skin colors.
The Company has registered its trademarks COLORMATE, MY COLORS BY CHROMATICS,
TLC-BILITEST and the Baby Face Design in the United States Patent and Trademark
Office ("USPTO"). The Company believes it also has established common law rights
in the following marks: CCBRC, SITE FLAG, TLC, TLC BILI, TLC-LENSETTE, TLC
LENSPAK, TLC SOFT AND TLC TOUCH and has filed applications with the USPTO to
register the following marks: SITE FLAG and TLC BILI. Further, the Company
believes it has copyright protection for all of the software used in the
ColorMate(Registered Trademark) System and the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. After the respective expiration date
of each of the Company's Patents, 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 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 key employees, consultants and advisers confidentiality
obligations in connection with their employment, consulting or advisory
relationship with the Company. See "Risk Factors Protection of Intellectual
Property."
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Competition
The medical device industry in general is intensely competitive. Now that the
Company believes it is in substantial compliance with QSR and other FDA
requirements and is beginning to market and distribute its ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System for monitoring newborn
infant jaundice in the United States, the Company will compete with other
providers of infant jaundice diagnostic and monitoring products.
As the Company implements its business plan to commercialize the 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 Company will be competing with established
companies which have greater financial, technical, manufacturing, marketing,
research and development and management resources, including with respect to the
monitoring of infant jaundice, companies such as Minolta Co., Ltd. ("Minolta"),
Air Shields, Respironics, Inc. ("Respironics"), which recently acquired
Healthdyne Technologies, Inc. ("Healthdyne"), and SpectRx, Inc. ("SpectRx"),
among others. In addition, the invasive laboratory blood test detection methods
currently in use for bilirubin infant jaundice, have already achieved acceptance
by and are in widespread use in the medical community, unlike the Company's
proposed method. See "Risk Factors."
The Company believes that Minolta developed and Air Shields markets a screening
device, the Minolta Jaundice Meter, to measure the amount of bilirubin in the
skin of a newborn infant to determine whether a serum bilirubin measurement is
required. The Company believes that the measurements obtained by the Minolta
device, unlike the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System, are not used when the infant is being treated by phototherapy
for hyperbilirubinemia, and are affected by the infant's race and skin color,
which the Company believes significantly limits its use in a heterogeneous
population. As a result, the Company believes that the Minolta device is
currently in limited use in the United States and that it is not used at all for
infants who are receiving phototherapy. There can be no assurance that Minolta
will not effect improvements to its device in the future to overcome these
apparent limitations. See "Risk Factors."
Based on public filings, the Company believes that in June 1996, SpectRx entered
into a collaborative arrangement with Respironics in which Respironics was
responsible for regulatory clearance and sales of SpectRx's device for infant
jaundice analysis in the United States and Canada. Based on these filings
SpectRx's infant jaundice device is intended to be a hand-held instrument, which
incorporates a microspectrometer to collect spectroscopic information from the
infant's skin. In February 1999, SpectRx announced that it had obtained 510(k)
clearance for its device and that it would commence U.S. marketing of its device
shortly. SpectRx also announced that during the third quarter of 1998 it entered
into a distribution agreement with Atom Medical Corporation for distribution of
the company's infant jaundice product in Japan, pending regulatory clearance
from Japan's Ministry of Health and Welfare. Also, during the third quarter of
1998 SpectRx announced receipt of regulatory clearance to market its infant
jaundice product in Canada and shipments to Respironics for sale in Canada
commenced in the same quarter. The Company believes that the measurements
obtained by the SpectRx device, unlike the ColorMate(Registered Trademark) TLc-
BiliTest(Registered Trademark) System, are not used when the infant is being
treated by phototherapy for hyperbilirubinemia, which the Company believes
significantly limits its use in monitoring bilirubin infant jaundice. See "Risk
Factors."
The Company's success depends in large part on the acceptance by the medical
community of the Company's new technology. There can be no assurance that the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System will
effectively compete with any currently used systems. Furthermore, many of the
Company's competitors have substantially greater financial, research, technical,
manufacturing, marketing and distribution resources than the Company and have
greater name recognition and lengthier operating histories in the health care
industry. 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. Furthermore, there can
be no assurance that the Company's competitors will not succeed in developing,
during commercialization of the Company's products, devices and technologies
that permit more efficient, less expensive non-invasive analysis 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 infant jaundice or
otherwise render the Company's products obsolete. Such competition could have a
material adverse effect on the Company's business, financial condition and
results of operation.
The Company's ability to compete is affected by its product development and
innovation capabilities, its ability to obtain additional regulatory clearances,
as necessary, the marketing and manufacturing capabilities of the Company and
its third party vendors, its ability to protect the proprietary technology of
its products, its ability to attract and retain skilled employees, and, for
products sold in managed care environments, its ability to maintain current
distribution relationships and establish new distribution relationships.
Government Regulations
The Company's advertising, sales practices, cosmetic products 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
ColorMate(Registered Trademark) units and products abroad. In addition, the
research, development, testing, production and marketing of the Company's
medical products are
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subject to extensive governmental regulation in the United States at the
federal, state and local levels, and in certain other countries, that regulate
direct selling activities. Non-compliance with applicable requirements may
result in recall or seizure of products, total or partial suspension of
production, refusal of the government to allow clinical testing or commercial
distribution of products, civil monetary penalties, injunction and criminal
prosecution.
The FDA regulates the development, production, distribution and promotion of
medical devices in the United States. The medical products being developed for
manufacture and sale by the Company are subject to regulation as medical devices
by the FDA. Pursuant to the Federal Food, Drug and Cosmetic Act (the "Act"), a
medical device is classified as a Class I, Class II or Class III device. Class I
devices are subject to general controls, including establishment registration,
device listing, premarket notification (510(k)) clearance (in some cases),
labeling requirements, QSR requirements, prohibitions on adulteration and
misbranding, and reporting of certain adverse events (known as medical device
reporting or "MDR"). In addition to general controls, Class II devices may be
subject to special controls that could include performance standards, postmarket
surveillance, patient registries, guidelines, recommendations and other actions
as the FDA deems necessary to provide reasonable assurance of safety and
effectiveness of the device. Class III devices must meet the most stringent
regulatory requirements and must be approved as safe and effective by the FDA
before they can be marketed. Such premarket (PMA) approval can involve extensive
preclinical and clinical testing to prove safety and effectiveness of the device
and generally is more costly and time consuming than a 510(k) submission.
Unless otherwise exempt, all medical devices introduced to the market since 1976
are required by the FDA, as a condition of marketing, to secure 510 (k)
clearance or premarket approval through a PMA. A product will be cleared by the
FDA under a 510(k) if it is found to be substantially equivalent in terms of
safety, effectiveness, technology and intended use to another legally marketed
medical device that was on the market prior to May 28, 1976 (that subsequently
did not require a PMA application) or to a product that has previously received
a 510(k) and is lawfully on the market. If a product is not substantially
equivalent to such a medical device, and not otherwise exempt, the FDA must
first approve a PMA application before it can be marketed. An approved PMA
indicates that the FDA has determined the product has been proven, through the
submission of clinical data and manufacturing and other information, to be safe
and effective for its labeled indications. The PMA process typically takes more
than a year and typically requires the submission of significant quantities of
clinical data and supporting information. The process of obtaining a 510(k)
currently takes, on average, approximately four months from the date of
submission (based on FDA's fiscal year 1998 figures). However, the review
process for a particular product may be shorter or substantially longer
depending upon the circumstances. Moreover, there can be no assurance that a
510(k) will be cleared. A 510(k) must include submission of supporting
information, including design details and draft labeling, and may be required to
contain safety and efficacy data, possibly from clinical trials. Product
modifications intended to be made to a cleared device also may require filing
and clearance of a new 510(k) submission or filing and approval of a PMA
supplement, during which time the modified product cannot be commercially
distributed.
The 510(k) clearance order obtained from the FDA's CDRH indicates that the
Company's ColorMate(Registered Trademark)TLc- BiliTest(Registered Trademark)
System is a Class II device, subjecting it to "general controls" and "special
controls." Currently, the Company is unaware of any special controls applicable
to the ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark)
System. The Company is not currently developing, manufacturing or distributing
any Class III devices, although it may do so in the future. The Company also is
subject to additional FDA and foreign statutes and regulations and/or may be
subject to additional clearances or approvals to the extent the Company
continues its efforts to test, manufacture and license the Intellectual
Properties and lease the ColorMate(Registered Trademark) units to the medical
community in additional or significantly modified forms or for new uses. The
Company is subject to regulation by various governmental agencies that regulate
direct selling activities. See "Risk Factors."
Although the Company has received FDA clearance on its ColorMate(Registered
Trademark)TLc-BiliTest(Registered Trademark) System 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
device for monitoring newborn infant jaundice by healthcare professionals in the
United States, the Company also must comply with the other applicable statutes
enforced, 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 requirements, and the
statutory prohibitions against adulteration and misbranding.
The process of obtaining marketing clearance or approval for new medical
products from the FDA can be costly and time consuming, and there can be no
assurance that such clearance or approval 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 or significantly modified products or to expand
permitted uses of existing products. Regulatory clearance or approval 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. There can be no
assurance the Company will be able to maintain substantial compliance with FDA
requirements.
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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
and maintain 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. To
market its ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark)
System in the European Union, the Company sought ISO-9001/EN46001 certification
and the right to affix the CE mark. ISO-9001/EN46001 certification recognizes
that the Company has established a quality system for the design, development,
manufacturing, servicing and distribution of its medical device. The CE mark is
a symbol of quality and compliance with applicable European Union medical device
directives. In March 1999, the Company received ISO-9001/EN46001 certification
and passed a product inspection in February 1999 for purposes of receiving the
right to affix the CE mark to such specific inspected product. The Company is
awaiting a certification from the appropriate European authority to allow
release of such specific inspected product for European Union distribution. The
Company also has applied for and is awaiting the right to self-certify the
product, without the need for third party specific product inspection and
certification, for purposes of affixing the CE mark for European Union
distribution. Failure to maintain ISO-9001/EN46001 certification, CE mark rights
or other foreign regulatory registrations or approvals for the Company's medical
products would prevent the Company from marketing its medical products abroad,
which would 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 certifications, rights, registrations 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. The FDA
revised the QSR requirements in 1996 which increases the cost of regulatory
compliance for the Company. 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 failure to comply with regulatory
requirements, could have a material adverse effect on the Company's business,
financial condition and results of operations.
Future products developed by the Company and products currently under
development may require FDA clearance through either 510 (k) or PMA application
procedures. There can be no assurance that marketing clearances or approvals
will be obtained on a timely basis or at all. Delays in receiving such
clearances or approvals could have a material adverse effect on the Company.
The FDA also regulates the commencement and conduct of clinical investigations
to determine the safety and effectiveness of unapproved investigational devices,
including investigations involving new intended uses of previously cleared or
approved devices. Clinical investigations are regulated by the FDA under the
Investigational Device Exemptions ("IDE") regulations. The IDE regulations
include significant requirements that must be met, including, but not limited
to, informed patient consent, IRB review and approval of research protocols,
reporting obligations to the FDA, recordkeeping requirements and prohibitions
against commercialization of investigational devices. A sponsor must obtain FDA
approval of an IDE application before starting the investigation, unless the
device is found to be a non-significant risk ("NSR") device by the sponsor and
each IRB that reviews and approves the study. The FDA, however, has the
authority to determine that a study designated as involving an NSR device by the
sponsor and IRBs involves a significant risk device, and to require that an IDE
application be submitted and approved before the study can resume. In addition,
a study of an NSR device must still comply with the above-referenced and certain
other IDE requirements. A violation of the IDE regulations can result in a
variety of sanctions, such as warning letters, prohibition against additional
clinical research, the refusal to accept data and criminal prosecution. The
Company also may provide devices for use in FDA approved or recognized clinical
trials as a contract manufacturer.
There can be no assurance that any clinical study will comply with all elements
of the FDA's IDE regulations, that a study will provide evidence of the safety
or effectiveness of the device, or that a study will ultimately result in the
approval of the device.
A federal law commonly known as the "anti-kickback statute" prohibits the offer,
solicitation, payment or receipt of anything of value (direct or indirect, overt
or covert, in cash or in kind) which is intended to induce business for which
payment may be made under a federal health care program, i.e., any plan or
program that provides health benefits, whether directly or indirectly, through
insurance, or otherwise, which is funded directly, in whole or in part, by the
United States Government (e.g., Medicare, Medicaid and CHAMPUS). The type of
remuneration covered
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by the anti-kickback statute is very broad. It includes not only kickbacks,
bribes and rebates, but also proscribes any remuneration, whether made directly
or indirectly, overtly or covertly, or in cash or in kind. Moreover, prohibited
conduct includes not only remuneration intended to induce referrals, but also
remuneration intended to induce purchasing, leasing, arranging or ordering of
any goods, facilities, services, or items paid for by a federal health care
program.
In part to address concerns regarding the implementation of the anti-kickback
statute, in 1991, the federal government published regulations that provide
exceptions or "safe harbors" for certain transactions that are deemed not to
violate the anti-kickback statute. Among the safe harbors included in the
regulations are transactions involving discounts or the payment of certain
administrative fees to group purchasing organizations. While the failure to
satisfy all the criteria for a safe harbor does not necessarily mean that an
arrangement is unlawful, engaging in a business practice for which there is a
safe harbor may be regarded as suspect if the practice fails to meet each of the
prescribed criteria of the safe harbor. Violations of the statute are punishable
by civil and criminal penalties and/or exclusion of the provider from
participation in the federal health care programs. Also, there is the risk that,
in a civil lawsuit to enforce a contract that contains a structure in violation
of the anti-kickback statute, a court might conclude that the contract is
unenforceable as against public policy. Congress directed the Secretary of the
United States Department of Health and Human Services ("HHS") to issue advisory
opinions regarding compliance with the anti-kickback statute. Failure of a party
to seek an advisory opinion, however, may not be introduced into evidence to
prove that the party intended to violate the anti-kickback statute. Several
states also have statutes or regulations prohibiting financial relationships
with referral sources that are not limited to services for which a federal
health care program pays.
While the Company believes its marketing programs meet the requirements of the
anti-kickback statute and its implementing regulations, there is no guaranty
that the HHS Office of the Inspector General would view all of the Company's
marketing arrangements as meeting all of the requirements of the appropriate
safe harbors. The Company has not sought, and has no present intention to seek,
an HHS advisory opinion regarding any aspect of its current marketing
arrangements. A finding of noncompliance with the anti-kickback laws by federal
or state regulatory officials, including noncompliance with appropriate safe
harbors, could have a material adverse effect on the Company.
The Company's products are intended to be purchased or leased by health care
providers or suppliers which submit claims for reimbursement for such products
or their use to third-party payors such as Medicare, Medicaid and private health
insurers. In the United States, patients, hospitals and physicians who purchase
medical devices, generally rely on such third-party payors to reimburse them for
all or a portion of the cost of the medical device or its use. Reimbursement for
devices (or their use) that have received FDA clearance has generally been
available in the United States. Third-party payors are increasingly challenging
the prices charged for medical products and services. There can be no assurance
that the Company's 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 or their use, and the level of
reimbursement made available, will be an important factor in establishing
pricing, structure 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. Although
the Company has no knowledge that third-party payors will adopt measures that
would limit coverage of, or reimbursement for, its products or their use, any
such measures that were applied to the Company's products could have a material
adverse effect on the Company.
American Medical Association ("AMA") CPT codes are generally used to facilitate
the processing of insurance reimbursement claims and to provide a simplified
reporting procedure. However, assignment of a code does not assure that the
insurer will provide reimbursement or that the AMA endorses the medical
procedure at issue. In March 1998, the Company was assigned AMA CPT Code 82250
for processing claims for use of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. The same code is assigned for the
reimbursement of laboratory blood tests currently used to monitor newborn
bilirubinemia (infant jaundice). Subsequently, the AMA informed the Company that
CPT Code 84999 ("Unlisted Chemistry Procedure"), not Code 82250, was the
assigned code. However, the AMA indicated that it was reviewing coding in this
area generally. The Company believes the original Code 82250 is correct and will
continue its efforts to have the AMA reassign this code, or apply for a new
code. There can be no assurance that the Company will be reassigned the original
CPT Code 82250. Claims for reimbursement under CPT Code 84999 may not be as
easily processed for reimbursement as claims made under CPT Code 82250.
If the Company moves forward with European Union commercialization plans, and if
the Company obtains necessary regulatory marketing approvals from other foreign
countries, 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.
The Company is unable to predict what changes will be made in the reimbursement
methods utilized by third-party health care payors. Although the Company
anticipates that hospitals and physicians will justify the use of the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System by
clinical benefits that the Company believes will be derived from the use of the
ColorMate(Registered Trademark) TLc-
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BiliTest(Registered Trademark) System, there can be no assurance that this will
be the case.
Because the cost of health care delivery has been rising steadily and because
the cost of a significant portion of medical care in the United States and other
countries is typically funded by governmental insurance programs, there have
been a number of government initiatives to reduce health care costs. Congress
and various state legislatures have proposed changes in laws and regulations
that, if ever enacted, could effect major restructuring of the health care
industry. Although many of these proposals may seek to maintain or expand access
to health care services, the common objective of the proposed legislation is to
achieve cost containment in the health care sector. Changes in governmental
support of health care services, the methods by which such services are
delivered, the prices for such services or the regulations governing such
services or mandated benefits all may have a material adverse effect on the
Company. Even if the ultimate impact of any such changes on net sales is
positive, no assurance can be given that the costs of complying with possible
new requirements would not have a negative impact on the Company's future
earnings. No assurance can be given that any such legislation will not have a
material adverse effect on the Company.
Year 2000
Until recently computer programs were generally written using two digits rather
than four to define the applicable year. Accordingly, such programs may be
unable to distinguish properly between the year 1900 and the year 2000. This
could result in system failures or data corruption for the Company or its
vendors which could cause disruptions of operations, including, among other
things, a temporary inability to process transactions or engage in business
activities or to receive information, services or payment from vendors.
The Company's internal computing systems are primarily limited to hardware and
software for its financial systems, such as general ledger and accounts
receivable and payable systems, and word processing and database systems. The
Company is not dependent on large legacy systems and does not use mainframes.
The Company's management is continuing to conduct an assessment of the Company's
operations from an internal, vendor and customer perspective. The assessment
addresses all of the Company's material computer systems, applications and any
other material systems that the Company believes may be vulnerable to the year
2000 issue and significantly affect the Company's operations. This assessment
includes contacting third parties with whom the Company has a material
relationship to determine their year 2000 readiness. The Company's assessment is
not yet complete and there can be no assurances that any such problems will not
arise.
The total costs associated with the Company's year 2000 compliance are not
expected to be material to the Company's financial position. However,
satisfactory remediation of year 2000 issues is dependent upon many factors,
some of which are not completely within the Company's control. The Company's
current estimates of the impact of year 2000 compliance on its financial
position do not include costs that may result from the failure of third parties
with whom the Company has a material relationship to be year 2000 compliant.
Should the Company's internal systems or systems of one or more significant
third parties fail to achieve year 2000 compliance, the Company's business and
its operations could be materially adversely affected.
Employees
The Company currently employs 41 persons on a full-time basis, 20 of which are
medical marketing or regulatory personnel. None of the Company's employees is
represented by a union. The Company believes that its relationship with its
employees is good. The Company intends to hire additional employees and
consultants to carry out its proposed marketing plans. Such persons will be
compensated with salaries, or on a fee or commission basis, as applicable. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Recent Events
On April 15, 1999, the Company issued an aggregate of $5,000,000 14% senior
convertible debentures due April 15, 2002 (the "Debentures") in a private
placement. Payments of interest on the outstanding principal amount of the
Debentures are due on the earlier of the maturity date or upon any conversion of
the Debentures into the Company's Common Stock. The accrued interest may be paid
either in cash, shares of the Company's Common Stock or a combination of Common
Stock and cash, at the option of the Company.
The outstanding principal amount of the Debentures (together with accrued
interest thereon) is convertible until after the first anniversary of the
closing. At that time, the Debentures are convertible into shares of Common
Stock, at the option of the holder or holders thereof, at the conversion price
of $5.00. However, at any time prior to April 14, 2000, such portion of the
Debentures may be converted, at the option of the holder or holders thereof, as
shall result in the issuance, upon such conversion, of not more than an
aggregate of 200,000 shares of Common Stock. Subject to applicable securities
laws, the holder or holders of such shares, in the aggregate, may only sell not
more than an aggregate of 50,000 shares of such Common Stock issued upon such
conversion during any one-month period ending prior to April 14, 2000. At any
time after the 18-month anniversary of the closing, the Company may prepay the
entire amount of the Debentures or any portion thereof for a prepayment price
equal to the original principal amount of the Debentures plus all accrued and
unpaid interest. At any time after the 18-month anniversary of the closing and
prior to the Maturity Date, in the event the average closing bid price (as
reported on the Nasdaq SmallCap Market
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or such other principal market or exchange on which the Common Stock is then
traded) of the Company's Common Stock for any 10 consecutive trading days equals
or exceeds $10.29, the Company can require conversion of the outstanding
principal amount (together with accrued interest) of the Debentures into Common
Stock at a conversion price of $5.00 per share.
For as long as the Debentures are outstanding, the Company's obligation to pay
the principal of and interest on the Debentures shall be senior in right of
payment and priority to any current or future (i) obligations of the Company to
commercial banks, institutional lenders or other lenders for borrowed money,
(ii) obligations of the Company to commercial banks, institutional lenders or
other lenders under guarantees by the Company of obligations of wholly-owned
subsidiaries of the Company to any such lenders and (iii) convertible preferred
equity or convertible debt security issued by the Company.
The Company is required to file a registration statement for all of the shares
of Common Stock issuable upon the conversion of the outstanding principal amount
of and accrued interest on the Debentures within 60 days of the closing, and to
use best efforts to cause such registration statement to be effective within 120
days from the closing.
An "Event of Default" under the Debentures shall constitute any of the
following: (i) failure by the Company to make any payment (whether principal,
interest or otherwise) on the Debentures when due and such default continues for
ten days; (ii) breach of any of the representations or warranties made by the
Company in the Debentures or Subscription Agreement therefor, or in any written
statements furnished by the Company in connection with the financing; (iii) the
Company shall fail to perform its agreements or obligations under the Debentures
or the Subscription Agreement and such failure shall continue for 30 days; (iv)
the Company shall (1) make an assignment of the benefit of its creditors or
commence proceedings for its dissolution; or (2) apply for or consent to the
appointment of a trustee, liquidator, custodian or receiver thereof, or for a
substantial part of its property or business; (v) a trustee, liquidator,
custodian or receiver shall be appointed for the Company or for a substantial
part of its property or business without its consent and shall not be discharged
within ninety (90) days after such appointment; (vi) bankruptcy, reorganization,
insolvency or liquidation proceedings or other proceedings for relief under any
bankruptcy law or any law of the relief of debtors shall be instituted by or
against the Company and, if instituted against the Company, shall not be
dismissed within ninety (90) trading days after such institution or the Company
shall by any action or answer approve of, consent to, or acquiesce in any such
proceeding or admit the material allegations of, or default in answering a
petition filed in any such proceeding; or (vii) the Company shall dispose of all
or substantially all of its assets in one or more transactions or shall redeem
more than a de minimis amount of its outstanding shares of capital stock.
Following the occurrence of any Event of Default which is not waived by the
Debenture holders, the holders may accelerate the maturity of the Debentures,
whereupon all principal and interest thereunder shall be immediately due and
payable. See "Risk Factors."
The Company has agreed on definitive basic terms with two potential marketing
and distribution partners for the exclusive distribution of the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System in the
hospital, pediatrician and home healthcare markets. Both of these proposals
include terms requiring minimum annual placements of the ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System and TLc-Lensette(Trademark)
calibration standards and/or charges per use. The Board is reviewing both sets
of terms as well as recommendations of its advisors and the Company anticipates
selecting one of these distributors shortly.
On December 31, 1998, the Company's Board of Directors adopted a Shareholders'
Rights Plan (the "Plan") designed to protect shareholders from various abusive
or coercive takeover tactics, including attempts to acquire control of the
Company at an inadequate price. The Plan is also intended to provide additional
protection from partial or two-tiered takeover attempts, coercive stock
accumulation programs, street-sweeps, squeeze-outs and other tactics that may be
used to gain control of the Company without offering an adequate price to all
shareholders. The Plan is similar to plans adopted by many public companies.
Under the Plan, each shareholder will receive a dividend of one right for each
share of the Company's outstanding Common Stock (a "Right"). Subject to the
terms of the rights agreement between the Company and its transfer agent (the
"Rights Agreement"), each Right will entitle the holder to purchase one
one-hundredth of a share of the Company's new Class B Series 1 Preferred Stock
at an initial exercise price of $28. Until the Rights become exercisable, they
will be represented by, and trade with, the outstanding Common Stock; the
Company does not anticipate issuing separate certificates for the Rights at this
time.
Initially, the Rights are attached to the Company's Common Stock and are not
exercisable. They become detached from the Common Stock, and become immediately
exercisable, (i) following expiration of the Board of Directors' right to redeem
the Rights during the ten-day window period (the "Window Period"), or any
extension of the Window Period, after any person or group (other than the
exempted shareholder) becomes the beneficial owner of 20 percent or more of the
Company's Common Stock (other than acquisitions which are approved in advance by
the Board of Directors), or (ii) ten days after any person or group announces a
tender or exchange offer that would result in that same beneficial ownership
level (other than pursuant to certain permitted offers).
If a person (other than the exempted shareholder or pursuant to a pre-approved
acquisition) becomes a 20 percent owner in the Company, all Rights holders,
other than such person, will be entitled to purchase shares of the Company's
stock at a discounted price. If the Company is
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acquired in a merger after such an acquisition, all Rights holders except the
buyer also will be entitled to purchase stock in the buyer at a discount.
The Plan exempts any existing shareholder (including Darby Macfarlane, the
Company's founder and Chief Executive Officer, her heirs and entities controlled
by her, currently the owners of approximately 861,896 shares of the Company's
Common Stock, 1,380,000 shares of the Company's Class A Preferred Stock and
450,000 options granted pursuant to the Company's 1992 Stock Option Plan), so
long as the number of shares of Common Stock beneficially owned by that
shareholder does not exceed, with respect to all such exempt shareholders other
than Mrs. Macfarlane, by more than ten percent (by acquisition) the number of
shares of Common Stock beneficially owned by that shareholder as of December 30,
1998. In the case of Mrs. Macfarlane, such ownership cannot exceed by more than
one percent the sum of (i) the shares of Common Stock beneficially owned by Mrs.
Macfarlane as of December 30, 1998, plus (ii) all shares acquired upon exercise
of options issued to Mrs. Macfarlane and her heirs, relatives and entities
controlled by her, including, without limitation, options issued under the
Company's 1992 Stock Option Plan, plus (iii) all shares issued upon conversion
of the Class A Preferred Stock owned by Mrs. Macfarlane and her heirs, relatives
and entities controlled by her.
The distribution of Rights was made on January 11, 1999 to shareholders of
record of Common Stock on that date, and shares of Common Stock that are newly
issued after that date will also carry Rights until the Rights become detached
from the Common Stock. The Rights will expire on January 11, 2009. The Rights
distribution is not taxable to shareholders. The Company may redeem the Rights
for $0.001 each at any time during the Window Period, or any extension thereof,
after a buyer acquires a 20 percent position in the Company, and under certain
other circumstances.
In February 1998, at a special meeting of shareholders held at the Company's
offices in New York, New York (the "Special Meeting"), the shareholders
approved, among other things, a revision to the Company's capital structure to
effect a three-for-two forward stock split of the Company's issued and
outstanding shares of Common Stock (the "Stock Split"). The Stock Split is
effective as of February 13, 1998.
Additionally, at the Special Meeting, the shareholders approved an amendment to
the Company's Certificate of Incorporation (i) to extend for two years from
December 31, 1998 to December 31, 2000 the expiration date of the period during
which the Company's outstanding Class A Convertible Preferred Stock can become
convertible into Common Stock upon the Company's achieving certain stock
performance or earnings goals, (ii) to extend the date by which the Company is
to call the Class A Convertible Preferred Stock for redemption from December 31,
1998 to December 31, 2000, (iii) to revise the market price conversion feature
of the Class A Convertible Preferred Stock to provide for adjustment upon the
occurrence of certain events involving the Common Stock, including stock splits,
reclassifications and the payment of stock dividends, and (iv) to delete from
the formula for the calculation of the earnings goal that need to be satisfied
to trigger the conversion feature of the Class A Convertible Preferred Stock,
extraordinary items and revenues generated by businesses acquired by the
Company.
Lastly, at the Special Meeting, the shareholders approved an amendment to the
Company's 1992 Stock Option Plan, as amended (the "1992 Plan"), to increase the
number of shares of Common Stock with respect to which options may be granted
from 2,000,000 to 3,000,000.
Beauty-Aid Products
The ColorMate(Registered Trademark) System. Although it is not currently
expanding in this activity as a result of its efforts to market commercially the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System for
medical application, the Company has engaged in efforts to commercialize its
Intellectual Properties for beauty-related applications. The
ColorMate(Registered Trademark) System consists of a color measurement
instrument to be held against a subject's skin, hair, teeth or sample, a series
of filters and a computer and related proprietary software all housed in a
portable briefcase. The color measurement instrument used within the
ColorMate(Registered Trademark) unit or as a handheld battery operated
instrument is utilized in the Company's medical, cosmetic and other
applications. The instrument is held against the subject's skin, hair, teeth or
sample and performs color measurement of coloration and luminosity to a
laboratory standard of accuracy. In skin color analysis, the software then
analyzes the color measurements so obtained and assigns the subject to one of
the approximately 200 skin color categories identified by the Company through
its research and development effort.
In the beauty-related applications the ColorMate(Registered Trademark) System
matches each skin color type to a range of pre-tested compatible product colors.
The unit is equipped with a printer and can provide the subject with a record of
his or her skin color category and color compatible shades of specific products
(including the Company's cosmetic products) appropriate for that skin color
category and other product colors.
The ColorMate(Registered Trademark) System also can be used to perform
chromaticity studies of various product lines in manufactured or applied forms
(for example, tooth enamel, hair coloring, hosiery, other cosmetic lines) on
behalf of licensees. This capability permits the organization of the licensee's
products into precise color categories so that the consumer can be assisted with
proper color coordination within the licensee's product line.
My Colors by Chromatics(Registered Trademark) Cosmetics Line. The Company's
cosmetics line ("My Colors by Chromatics (Registered
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Trademark)") divides the product shades into four color classifications. The
product shades recommended by the ColorMate(Registered Trademark) System are
individually prescribed for color coordination with each of the approximately
200 skin color categories. The Company's cosmetic line is precisely formulated
and balanced to provide color coordinated products for the skin color of all
races. In the past the Company has also marketed, through the use of the
ColorMate(Registered Trademark) System, a line of fashion swatch packs
consisting of 36 objectively measured colors, coordinated with each other and
with the consumer's skin tone color to aid the consumer in selecting color
compatible fabrics and fashion accessories.
In December 1996, the Company entered into a lease and license agreement with
Gordon Laboratories, Inc. granting Gordon a license and lease of the Company's
Intellectual Properties and the ColorMate(Registered Trademark) System to
formulate and develop custom blended cosmetic foundations for use in a field
test retail program.
In September 1998, the Company entered into a lease and license agreement with
Nordstrom granting it a license and lease of the Company's Intellectual
Properties and the ColorMate(Registered Trademark) System to formulate and
recommend Nordstrom's "C2O Color to Order" line of proprietary cosmetic products
in four Nordstrom flagship department stores. The products will be introduced
and evaluated over a three-month period (commencing upon delivery of packaging
materials from Nordstrom and final cosmetic formulations) for potential extended
use, including additional store locations. In connection with this license
agreement, the Company is collaborating with a consultant to provide training,
marketing, sales, promotional and liaison services (including assisting in
development of all applicable non-color product formulas, manuals, promotional
materials and training aids) at each of the four Nordstrom stores.
In April 1992, the Company entered into an agreement with IMS, a cosmetic
marketing, manufacturing and distribution company based in Israel, for the
license of the Intellectual Properties and the lease of 24 ColorMate(Registered
Trademark) System units for use in marketing in Israel the Company's swatch
packs and IMS's chromatically balanced cosmetic products developed by the
Company through chromaticity studies utilizing the Intellectual Properties. IMS
is using the Company's Intellectual Properties and the 24 ColorMate(Registered
Trademark) System units to measure women's skin color and recommend cosmetics
for color coordination. The Company has continued to extend, on a month-to-month
basis, IMS's option to renew its lease for a five-year period in order for IMS
to evaluate the hand-held light-emitting diode (the "LED Device") version of the
ColorMate(Registered Trademark) described below upon completion of the
prototype. IMS may lease up to 200 additional ColorMate(Registered Trademark)
System units during the five-year extension of this agreement. There can be no
assurance that this agreement will be renewed for the full five-year renewal
period or that IMS will lease additional ColorMate(Registered Trademark) System
units. In 1998 the Company did not generate any revenues from IMS. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note 1 to Notes to Financial Statements.
Other Potential Products and Applications. The Company has conducted research
and development and developed engineering specifications regarding a hand-held
light-emitting diode version of the ColorMate(Registered Trademark) System (the
"LED Device"). This version may be marketed for medical use after collecting
further clinical testing and is subject to FDA clearance for the Bilirubin LED
Device. For non-medical applications, the LED Device may be marketed in various
industries including the dental, beauty aid and fashion industries and also may
be marketed directly to consumers for home and personal use. The Company expects
the new LED versions will also be capable of being manufactured at a cost
substantially less than the cost incurred in manufacturing the Company's
existing ColorMate(Registered Trademark) System units because of technological
improvements which have resulted in substantially lower component part costs.
The Company believes that the Intellectual Properties and ColorMate(Registered
Trademark) System have commercial applications in (i) healthcare relating to the
non-invasive detection and monitoring of certain chromogenic diseases, such as
skin diseases, tuberculosis and anemia and (ii) dental care (i.e., the color
matching of teeth and tooth enamel). Additional medical applications for the
Intellectual Properties require extensive and lengthy clinical testing and will
be subject to various federal and state regulatory requirements, including FDA
clearances and approvals, and may be subject to comparable foreign regulatory
approvals to the extent the Company markets such applications abroad. There can
be no assurance that the Company will obtain any additional FDA or foreign
approvals or clearances or will be able to comply with such regulatory
requirements for additional applications.
In July 1998, following institutional review board ("IRB") approval from Mt.
Sinai, Dr. Mark Lebwohl, chairman of the Department of Dermatology at Mt. Sinai,
commenced ongoing clinical trials of the non-invasive ColorMate(Registered
Trademark) System for monitoring various skin diseases and patient tolerance for
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 suffering from 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(Registered Trademark) System. The non-invasive measurement of the skin
by the Company's ColorMate(Registered Trademark) System will be tested and
verified against minimal erythema dose-testing intended to be used in support of
future applications for FDA marketing clearance of the Company's technology for
such uses.
In 1990, the Company concluded a feasibility study for Dentsply, Inc., a dental
supply company, for use of the Intellectual Properties and ColorMate(Registered
Trademark) units in the color measurement and matching of human tooth color and
tooth enamel color for dentures, bonding, inlays and caps, for use by dentists
and dental laboratories. This study concluded that the ColorMate(Registered
Trademark) units
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could accurately and reproducibly measure the colors of both human teeth and
tooth enamels, but needed further design research and engineering studies to
develop a stabilized housing system for such a small area of measurement. The
project was discontinued by both companies at that time due to an inability to
agree on financial terms for the project. The Company is in preliminary
discussions with dental supply distribution companies with respect to the
possible development of prototypes for dental applications and the marketing of
such application. There can be no assurance that the Company will be able to
commercialize this application.
The Company also believes that the Intellectual Properties and
ColorMate(Registered Trademark) System may have commercial applications in
industrial color measurement applications, in order to achieve and confirm
uniformity of color shades within a given product line or between two products
of the same line (i.e., paint, textile and food products). To that end, the
Company intends to increase its efforts to lease the ColorMate(Registered
Trademark) System and license the Intellectual Properties, including the
Company's chromaticity study capabilities, to industrial companies such as
paint, textile and food companies, that use or could use existing color
measurement technologies in the manufacturing and marketing of their own
products. Many companies in these industries currently use color measurement
instruments to ensure uniformity of product line colors (e.g., that
manufacturing facilities are producing different dye lots and/or goods of the
same color). These instruments are generally available at prices well in excess
of the price at which the Company would market the ColorMate(Registered
Trademark) System for such application, because the Company has been able to
mass manufacture its color measurement technology, thereby taking advantage of
the economies of scale and lower unit prices available through large volume
orders from component parts suppliers. In addition, the ColorMate(Registered
Trademark) System provides machine-to-machine stability and reproducibility
(i.e., that each machine will achieve results consistent with that of other
machines), whereas the competing color measurement instruments available today
generally cannot produce such consistent machine-to-machine results without
complex inter-machine calibration adjustments.
Risk Factors
Limited Operating History. The Company has a limited operating history upon
which its prospects can be evaluated. Such prospects must be considered in light
of the substantial risks, expenses and difficulties encountered by entrants into
the medical device industry, which is characterized by an increasing number of
participants, intense competition and a high failure rate. Until 1986, the
Company was principally engaged in research and development relating to the
Intellectual Properties, ColorMate(Registered Trademark) 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(Registered Trademark) TLc-BiliTest(Registered Trademark) System for
the monitoring of newborn bilirubinemia (infant jaundice), the development of
prototypes of additional versions of the ColorMate(Registered Trademark) unit
and the refinement of its technologies for other applications. From October 1990
to date, the Company has not generated any material revenues 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
successfully developed and marketed by the Company.
Operating Losses. The Company has incurred significant losses from operations
for the years ended December 31, 1998 and December 31, 1997 ($7,284,800 and
$5,053,100, respectively). The Company anticipates incurring substantially
increased operating expenses as it attempts to expand its marketing and sales
activity, incurs manufacturing expenses for the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System and otherwise continues to implement
its business plan, including for the medical application involving the
monitoring of newborn bilirubinemia (infant jaundice). There can be no assurance
the Company will not continue to incur such losses or will ever generate
revenues at levels sufficient to support profitable operations.
Although the Company anticipates that the future expenses regarding FDA
application costs and related patent application costs should be significantly
less than amounts incurred prior to receipt of the initial FDA marketing
clearance, the Company will continue to incur significant additional costs and
expenses in connection with FDA manufacturing and other regulations, state
regulatory requirements and foreign market clearances and other requirements.
Additional expenses are anticipated in connection with certain international
multicenter studies being conducted on the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. See "Business." In addition, the
Company expects to incur significant expenses relating to manufacturing
expenses, products liability insurance, legal and regulatory compliance,
including QSR/GMP quality system substantial compliance, as well as research and
development for new potential applications, and implementation of the next phase
of its efforts to successfully 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. See
"Liquidity and Capital Resources," below. The Company will also incur additional
expenses implementing additional testing and clinical trials of its technologies
for the possible monitoring of other chromogenic diseases. 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."
Need for Additional Financing; Cessation of Operations. The Company has limited
resources and has not been able to finance its activities with
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cash flow from operations since fiscal 1989. There can be no assurance that
proceeds from the Debentures or remaining proceeds from the previous exercise of
its Placement Agent Warrants and Warrants, together with any anticipated sales
revenues, future distributor payments and/or additional financing, if any, will
be sufficient to fund operations until December 31, 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(Registered Trademark) units and Beauty-Aid Products, and in
particular, its ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System for monitoring of newborn bilirubinemia (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(Registered Trademark)
unit, 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(Registered Trademark) units, and the availability of future
financing. The Company expects that, in addition to the Debentures, further
financing will be required to successfully commercialize the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System 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 significantly curtail
and/or cease operations.
Default under the Debentures. Following the occurrence of any Event of Default
under the Debentures or at any time thereafter (see "Recent Events - 1999
Financing") which is not waived by the Debenture holders, the holders may
accelerate the maturity of the Debentures, whereupon all principal and interest
thereunder shall be immediately due and payable. In the event the Company
becomes obligated to effect such payment, and does not have sufficient funds to
make such payment, the Company may be forced to cease operations and seek
protection from its liabilities under applicable bankruptcy laws.
No Assurance of Successful Commercialization of ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. 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 newborn bilirubinemia (infant
jaundice). Although the Company is aware that studies have been conducted on
non-invasive transcutaneous bilirubinometer devices other than the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System and
that some of these devices have received FDA marketing clearance, the Company
believes the ability of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System to provide non-invasive monitoring for
babies over a wide range of gestation, in babies of all racial categories and in
babies receiving phototherapy, distinguishes it from the other existing
non-invasive bilirubinometers with FDA clearance for commercial marketing. While
the Company believes the non-invasive nature of its ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System for monitoring newborn
bilirubinemia (infant jaundice) provides benefits to patients, no assurance can
be given that the medical community will accept and support the Company's
medical device. There is no assurance that the Company's ColorMate(Registered
Trademark) Device for newborn bilirubinemia (infant jaundice), or other future
medical applications of the Company's technology will be capable of being
produced in commercial quantities at acceptable costs. There can be no assurance
that the existing medical applications for monitoring newborn bilirubinemia
(infant jaundice), or for future applications 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. The medical community generally has had limited exposure to the
Company and 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 to demonstrate the
operation and efficacy of its Intellectual Properties in the medical field. Even
if the Company gains access to sufficient 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.
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Physicians and other health care professionals will not recommend or use the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System unless
they determine, based on experience, clinical data, relative cost, and other
factors, that the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System is an attractive alternative to reducing the current traumatic
blood tests that have a long history of safe and effective use. The Company has
begun conducting additional independent studies in order to achieve acceptance
in the medical community. See "Business." The Company believes that
recommendations by physicians and clinicians will be essential for the market
acceptance of these products, but there can be no assurance that any such
recommendations will be obtained. To the extent the Company is able to market
and distribute its ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System, 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 successful 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, structure 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(Registered Trademark)
TLc-BiliTest(Registered Trademark) System 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 maintained, or products for which approvals or clearances are
obtained (such as the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System) are not commercially successful, the Company's business,
financial condition and results of operations would be materially adversely
affected. 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(Registered Trademark) TLc-BiliTest(Registered
Trademark) System.
Early Stage of Development of Other Potential Medical Applications. Although the
Company has received FDA clearance to commercially market its
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System as
described above, has conducted early stage research and commenced initial
clinical studies with respect to certain other Chromogenic Diseases identified
by the Company (See "Business"), 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
further clinical trials will be necessary before commercial versions of any
additional proposed products are submitted for FDA marketing 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.
Assumptions Regarding Medical Business Plan and Strategy. The Company has
formulated its medical business plan and strategy based upon certain assumptions
provided by our medical distrubution partner regarding the size of the bilirubin
monitoring market, the Company's anticipated short term and eventual share of
this market, the price at which the Company believes it will be able to sell or
lease its products, and consumer acceptance of the Company's products. There can
be no assurance that these 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, local and foreign 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
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growth effectively could have a material adverse effect on the Company's
business, financial condition and results of operations.
Need for Additional Personnel. In order to generate and service sales of the
Company's medical products, the Company needs to attract and retain significant
additional senior and midlevel personnel experienced in marketing, sales and
regulatory matters in the medical industry. The Company currently has only 41
full-time employees, of which 20 are medical marketing or regulatory personnel.
In order to effectively implement 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. The Company has not previously licensed
its Intellectual Properties for use in any industry other than the beauty aid,
hosiery and cosmetics industries and management of the Company has not had any
experience in marketing the Intellectual Properties, ColorMate(Registered
Trademark) units or Beauty-Aid Products in any other field. Prior to licensing
the Company's Intellectual Properties in any 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. The Company's medical support and sales division was only
recently established and there can be no assurance it will successfully generate
commercial levels of sales. There can be no assurance that the Company will be
able to successfully maintain a marketing and sales force, or that it will be
able to enter into additional marketing and sales agreements with third parties
on acceptable terms.
Dependence on Marketing and Distribution Arrangements with Third Parties. The
Company has established a medical division to support its own and third party
initial marketing efforts and has entered into a separate third party
manufacturing agreement for the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. The Company's business strategy for
the commercialization of its medical products depends upon the Company's ability
to selectively enter into and maintain arrangements with leading marketing and
distribution companies in the medical field. There can be no assurance that the
Company will be able to do so. Any revenues to be received by the Company from
its ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System
will be dependent on arrangements with third parties for marketing, distribution
and sales of the products. The obligation of any potential third party to fund
or undertake the 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.
Any significant dispute with or breach, inability to perform, or termination of
any arrangement with such third party would 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
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were able to perform and fund these activities, the Company's capital
requirements would increase substantially. In addition, the further manufacture,
development, marketing, distribution and sale of the product covered by such
arrangement would be significantly delayed.
Dependence on Medical Device Manufacturer. The Company does not itself
manufacture the ColorMate(Registered Trademark) units, the ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System 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 may encounter
various problems in establishing and maintaining manufacturing relationships
and/or operations, resulting in inefficiencies and delays. Specifically,
companies often encounter difficulties in scaling up production, including
problems involving production yield, quality control and assurance, and
shortages of qualified personnel. In addition, the manufacturing facilities
retained by the Company to manufacture its ColorMate(Registered Trademark)
products for medical applications are subject to FDA QSR requirements and other
regulatory requirements, international quality standards (such as ISO
9001/EN46001) and other regulatory requirements. Currently, the Company is
dependent on the sole source manufacturer of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System under the existing exclusivity
arrangements. The Company will have to maintain relationships with such
manufacturer and third party suppliers of component parts for the production of
its devices. There can be no assurance the Company will be able to maintain its
relationships with its current manufacturer, or will be able to maintain
arrangements with the other parts suppliers or assemblers on terms satisfactory
to the Company. Although the Company believes that a number of manufacturers are
capable of manufacturing and assembling the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System, any change in manufacturers, or the
retention of additional subcontractors, could result in additional costs and
delays. Difficulties encountered by the Company in subcontracting to third-party
manufacturers, scaling up production or failure by the Company to utilize
manufacturing facilities in substantial compliance with FDA requirements,
international quality standards or other regulatory requirements, could result
in a delay or termination of production or regulatory enforcement action, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
In connection with manufacturing of the ColorMate(Registered Trademark) 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. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Although the
Company's existing manufacturing agreement for the ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System does not require such
obligations, there can be no assurance the Company will be able to maintain the
existing relationship, or that the Company will be able to enter into
replacement agreements that do not provide for such obligations and are
otherwise on acceptable terms. There can be no assurance the Company will 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(Registered Trademark) units or obtain further manufacture of the
ColorMate(Registered Trademark) units or its products.
To the extent the Company obtains any required FDA clearance for and markets the
Bilirubin LED Device or markets the ColorMate(Registered Trademark) LED Device,
the Company will need to outsource the production and assembly of the components
of the Bilirubin LED Device and the ColorMate(Registered Trademark) LED Device
to third party manufacturers and assemblers. One of the components of the
Bilirubin LED Device is available from only one supplier. The Company is reliant
on that one source of supply and these products would require a major redesign
in order to incorporate any substitute components.
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(Registered Trademark)
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(Registered Trademark) 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
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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. 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. Three putative class actions were commenced against the
Company and certain of its officers and directors in the Southern District of
New York. The first two actions were commenced in June 1998 and are captioned
L.F. Monk v. Chromatics Color Sciences International, Inc., Darby S. Macfarlane,
Arthur Guiry, David K. Macfarlane and Leslie Foglesong, C.A. No. 98 CV 4111
(S.D.N.Y.) and Daniel R. Marquis v. Chromatics Color Sciences International,
Inc., Darby S. Macfarlane, Arthur Guiry and Leslie Foglesong, C.A. No. 98 CV
4335 (S.D.N.Y.). The third action was commenced in August 1998 and is captioned
Joseph Grunberg v. Chromatics Color Sciences International, Inc., Darby S.
Macfarlane, Arthur Guiry, David K. Macfarlane and Leslie Foglesong, C.A. No. 98
CIV. 5646 (S.D.N.Y.)
The complaints were consolidated pursuant to the Consolidation Order entered by
the Court in December 1998. A consolidated amended complaint in the matter now
captioned In re Chromatics Color Sciences International, Inc. Securities
Litigation, Consolidated Matter File No. 98 Civ. 4111 (SHS), was filed and
served in January 1999 (the "Action").
Plaintiffs purport to bring the Action on behalf of all purchasers of the common
stock of the Company, between July 30, 1997 and June 9, 1998, seeking damages
for the alleged violation by defendants of Section 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C. ss.78j(b), and Rule 10b-5 promulgated
thereunder, 17 C.F.R. ss.240.10b-5, and pursuant to Section 20(a) of the
Securities Exchange Act of 1934, 15 U.S.C. ss.78t(a), with respect to the
individual named defendants as "controlling persons." The complaint alleges that
the Company "embarked upon a scheme" to inflate the price of the Company's
Common Stock by making false and misleading statements concerning: (i) the new
and innovative nature of the Company's ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System; (ii) the market size and revenue
potential of the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System; and (iii) the existence and status of negotiations with
potential distributors of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. The allegations of the complaint
arise principally from a "report" prepared by Manuel I. Asensio of Asensio &
Company, Inc. that was disseminated at the close of the putative class period.
Defendants have moved to dismiss them Action. Defendants believe that the claims
asserted against them are without merit and intend to vigorously defend the
Action. No assurance can be given that the resolution of the Action and/or
future actions will not have a material adverse effect on the Company's results
of operations and liquidity. The Company has directors and officers insurance
which may cover a portion of the liability asserted in the Action. The Company
is exploring 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.
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 "Business - The Bilirubin Project." 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. To market its ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System in the European Union, the
Company sought ISO-9001/EN46001 certification and the right to affix the CE
mark. ISO-9001/EN46001 certification recognizes that the Company has established
a quality system for the design, development, manufacturing, servicing and
distribution of its medical device. The CE mark is a symbol of quality and
compliance with applicable European Union medical device directives. In March
1999, the Company received ISO-9001/EN46001 certification and passed a product
inspection in February 1999 for purposes of receiving the right to affix the CE
mark to the specific inspected product. The Company is awaiting a certification
from the appropriate European authority to allow release of the specific
inspected product for European Union
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distribution. The Company also has applied for and is awaiting the right to
self-certify the product, without the need for third party specific product
inspection and certification, for purposes of affixing the CE mark for European
Union distribution. There can be no assurance the Company will receive release
of the already inspected product, or will receive the right to self-certify
future products, which in either case would have a material adverse effect on
the Company's plan for European Union distribution.
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,
arrangements with IMS and its beauty salon placements and the Nordstrom's
contract, the Company's own attempts to license and/or lease its Intellectual
Properties and the ColorMate(Registered Trademark) 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(Registered Trademark)
units and commercial licensing of the Intellectual Properties or the sale of the
Beauty-Aid Products. In addition, other than its installation of
ColorMate(Registered Trademark) units in beauty salons and beauty-related
businesses (which are generating insignificant 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
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, including for medical
applications of its products and technologies. Further, there can be no
assurance the Company will ever develop a commercial market for the licensing or
leasing of its ColorMate(Registered Trademark) 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
monitoring of newborn bilirubinemia (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 companies, some of which are more established and
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., which recently acquired Healthdyne
Technology, Inc., and SpectRx, Inc., among others), and some of which have
greater name recognition and lengthier operating histories in the health care
industry. The Company believes the only commercially available non-invasive
bilirubinometers with FDA marketing clearance in the United States are the
Minolta Jaundice Meter and the SpectRx Bilicheck. 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 monitoring of newborn bilirubinemia (infant
jaundice) as well as dermatological diseases and tuberculosis, the principal
diseases with respect to which the Company may 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, during or after the commercialization of the Company's product, devices
and technologies that permit more efficient, less expensive non-invasive
detection and monitoring of 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 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
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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.
Now that the Company has developed 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(Registered
Trademark) TLc-BiliTest(Registered Trademark) System, 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).
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 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.
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
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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.
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, as well as
Australian, Canadian, Korean 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 that 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(Registered Trademark) Systems will provide it
with a competitive advantage in that it may be possible for a competitor
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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 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 and are pursuing patent
protection for various aspects of infant jaundice diagnostic and monitoring
products and their use, 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 patent rights of others.
Failure to Obtain and Maintain Third-Party Reimbursement. In the United States
and elsewhere, sales of medical products and their use 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 brings its
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System or
other future 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 or
their use, and the level of reimbursement made available, will be an important
factor in establishing pricing, structure 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.
American Medical Association ("AMA") CPT codes are generally used to facilitate
the processing of insurance reimbursement claims and to provide a simplified
reporting procedure. However, assignment of a code does not assure that the
insurer will provide reimbursement or that the AMA endorses the medical
procedure at issue. In March 1998, the Company was assigned AMA CPT Code 82250
for processing claims for use of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. The same code is assigned for the
reimbursement of laboratory blood tests currently used to monitor newborn
bilirubinemia (infant jaundice). Subsequently, the AMA informed the Company that
CPT Code 84999 ("Unlisted Chemistry Procedure"), not Code 82250, was the
assigned code. However, the
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AMA indicated that it was reviewing coding in this area generally. The Company
believes the original Code 82250 is correct and will continue its efforts to
have the AMA reassign this code, or apply for a new code. There can be no
assurance that the Company will be reassigned the original CPT Code 82250.
Claims for reimbursement under CPT Code 84999 may not be as easily processed for
reimbursement as claims made under CPT Code 82250.
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 newborn bilirubinemia (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(Registered
Trademark) TLc-BiliTest(Registered Trademark) System 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 marketing clearance of its
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System
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(Registered Trademark)
TLc-BiliTest(Registered Trademark) System for monitoring newborn bilirubinemia
(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(Registered Trademark)
TLc-BiliTest(Registered Trademark) System is a Class II device which may be
subject to additional special controls.
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 or significantly modified 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. 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.
In order for the Company to market its products in Europe and certain other
foreign jurisdictions, the Company and its distributors and agents must maintain
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. To
market its ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark)
System in the European Union, the Company sought ISO-9001/EN46001 certification
and the right to affix the CE mark. ISO-
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9001/EN46001 certification recognizes that the Company has established a quality
system for the design, development, manufacturing, servicing and distribution of
its medical device. The CE mark is a symbol of quality and compliance with
applicable European Union medical device directives. In March 1999, the Company
received ISO-9001/EN46001 certification and passed a specific product inspection
in February 1999 for purposes of receiving the right to affix the CE mark to the
specific inspected product. The Company is awaiting a certification from the
appropriate European authority to allow release of the inspected product for
European Union distribution. The Company also has applied for and is awaiting
the right to self-certify the product, without the need for third party specific
product inspection and certification, for purposes of affixing the CE mark for
European Union distribution. There can be no assurance the Company will receive
release of the already inspected product, or will receive the right to
self-certify future products, which in either case would have a material adverse
effect on the Company's plan for European Union distribution. Failure to
maintain ISO 9001/EN 46001 certification, CE mark rights or other foreign
regulatory approvals for the Company's medical products would prevent the
Company from marketing its medical products abroad, which would 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 is 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.
Product Liability. 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(Registered Trademark) TLc-BiliTest(Registered
Trademark) System. As the ColorMate(Registered Trademark) TLc-
BiliTest(Registered Trademark) System enters commercial use, the Company will be
in a field where it may become subject to product liability claims by patients
and/or users and might become a defendant in product liability litigation.
Although the Company has product liability insurance, there can be no assurance
that it will be able to maintain such product liability insurance or that such
insurance would be sufficient to protect the Company against any such
liabilities.
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(Registered Trademark) 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 claim in the future based on
the performance of the Company's ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System, its
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ColorMate(Registered Trademark) 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. Until recently computer programs were generally written
using two digits rather than four to define the applicable year. Accordingly,
such programs may be unable to distinguish properly between the Year 1900 and
the Year 2000. This could result in system failures or data corruption for the
Company or its vendors which could cause disruptions of operations, including,
among other things, a temporary inability to process transactions or engage in
business activities or to receive information, services or payment from vendors.
The Company's internal computing systems are primarily limited to hardware and
software for its financial systems, such as general ledger and accounts
receivable and payable systems, and word processing and database systems. The
Company is not dependent on large legacy systems and does not use mainframes.
The Company's management is continuing to conduct an assessment of the Company's
operations from an internal, vendor and customer perspective. The assessment
addresses all of the Company's material computer systems, applications and any
other material systems that the Company believes may be vulnerable to the Year
2000 issue and significantly affect the Company's operations. This assessment
includes contacting third parties with whom the Company has a material
relationship to determine their Year 2000 readiness. The Company's assessment is
not yet complete and there can be no assurances that any such problems will not
arise.
The total costs associated with the Company's Year 2000 compliance are not
expected to be material to the Company's financial position. However,
satisfactory remediation of Year 2000 issues is dependent upon many factors,
some of which are not completely within the Company's control. The Company's
current estimates of the impact of Year 2000 compliance on its financial
position do not include costs that may result from the failure of third parties
with whom the Company has a material relationship to be Year 2000 compliant.
Should the Company's internal systems or systems of one or more significant
third parties fail to achieve Year 2000 compliance, the Company's business and
its operations could be materially adversely affected.
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 2,991,896
(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 at 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
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the color science industry and the beauty aid and cosmetics industries
generally. Additionally, in recent years, the stock market has experienced a
high level of price and volume volatility for many companies, particularly small
and emerging growth companies traded in the over-the-counter market, and these
wide price fluctuations are not necessarily related to the operating performance
of these companies. Accordingly, there may be significant volatility in the
market for the Company's securities.
Exercise of Outstanding Warrants and Conversion of Debentures. 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
and the conversion of Debentures is expected to be substantially less than the
market price of the Common Stock at the time such Private Placement Warrants are
exercised or such Debentures are converted. For the life of such Private
Placement Warrants and Debentures, 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 and Debentures remain not converted, the
terms under which the Company could obtain additional equity financing may be
adversely affected. Moreover, the holders of such Private Placement Warrants and
Debentures may be expected to exercise (or convert, as applicable) 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 securities. To the extent of any exercise or conversion of such
Private Placement Warrants or Debentures, 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 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Fiscal Year 1998 Compared to Fiscal Year 1997
The Company incurred net losses of $7,284,800 and $5,053,100 for fiscal years
1998 and 1997, respectively, as revenues received have not been significant
relative to the Company's expenses incurred in implementing its business plan.
Lease, license and service revenues in 1998 represent fees paid to the Company,
primarily by Nordstrom, in connection with a test project done with the Company.
No significant future payments are anticipated from this source. The $2,231,700
increase in such losses in 1998 as compared to 1997 is primarily attributable to
the Company's 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:
consultants' compensation; (which increased by $67,300 in 1998 compared to 1997)
legal expenses incurred in respect of the Company's negotiations with its
medical device manufacturer and potential distribution partners, the recent
litigation and matters related to the short selling activities in the Company's
stock, and legal, consulting and other related expenses regarding regulatory
compliance with respect to manufacturing and other requirements for the
Company's ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark)
System (which increased by $668,800 in 1998 compared to 1997); sales, marketing
and trade show expenses, primarily attributable to the Company's presentations
at the Annual Convention of the Pediatric Academic Societies, the Sinomed
Conference in China, the International Congress of Pediatrics, the National
Association of Neonatal Nurses, the American Academy of Pediatrics and the 5th
Annual Pediatric Critical Care Medicine Conference in China (which increased by
$715,800 in 1998 compared to 1997); option grants (which increased $261,000 in
1998 compared to 1997); public relations and promotions (which increased by
$289,700 in 1998 compared to 1997); and contributions to the new employee
benefit plan. These increased expenses were partially offset by a decrease in
patent application costs, as the Company has begun capitalizing certain of these
expenses in 1998. The Company incurred research and development expenses
primarily consisting of compensation of officers, employees and consultants of
$705,000 and $435,300 for fiscal years 1998 and 1997, respectively.
Although the Company anticipates that the future expenses regarding FDA
application costs and related patent application costs should be significantly
less than amounts incurred prior to receipt of the initial FDA marketing
clearance, the Company will continue to incur significant
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additional costs and expenses in connection with FDA manufacturing and other
regulations, state regulatory requirements and foreign market clearances and
other requirements. In addition, the Company expects to incur significant
expenses relating to manufacturing expenses, products liability insurance, legal
and regulatory compliance, including QSR/GMP quality system substantial
compliance, as well as research and development for new potential applications,
and implementation of the next phase of its efforts to successfully
commercialize the medical application of its technology. The Company expects to
generate profits from the medical application of its technology both by selling
the ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System
and TLc Lensette(Trademark) to its third party distributors and by receiving a
portion of the resale price received by the distributors when such products are
sold by the distributors. The Company also anticipates significantly higher
compensation expenses in connection with increased hiring to staff its medical
division. See "Liquidity and Capital Resources," below. The Company will also
incur additional expenses implementing additional testing and clinical trials of
its technologies for the possible monitoring of other chromogenic diseases.
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 1998, the Company focused its resources on implementation of its long-range
business plan for the FDA medical application of its technologies and received
no revenues from operations. The Company believes the absence of sales in 1998
was also attributable to ongoing delays in manufacturing certain color shades of
the Company's new line of cosmetic products for its ColorMate(Registered
Trademark) System (which delays were attributable to finalizing color
formulations). Under the Nordstrom Agreement, the Company anticipates the new
cosmetics will be ready to market upon delivery of packaging materials from
Nordstrom and final cosmetic formulations.
The Company expects to generate profits from both sales of its ColorMate
(Registered Trademark) TLc-BiliTest(Registered Trademark) System and sales of
the disposable TLc-Lensette (Trademark) which calibrates the device prior to its
use. 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.
In November 1998, the Company entered into a manufacturing agreement with Nova
Biomedical Corporation for the production of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. Under this renewable, four year
medical device manufacturing agreement, the Company pays Nova Biomedical a per
unit fee for the manufacture of the ColorMate(Registered Trademark) TLc-
BiliTest(Registered Trademark) units.
Fiscal Year 1997 Compared to Fiscal Year 1996
The Company incurred net losses of $5,053,100 and $4,442,300 for fiscal years
1997 and 1996, respectively, as revenues received have not been significant
relative to the Company's expenses incurred in implementing its business plan.
The $610,800 increase in such losses in 1997 as compared to 1996 is primarily
attributable to expenses incurred in 1997 in respect of increased patent
applications costs, write-offs of certain inventory, non-cash expenses relating
to the grant of options to consultants, and increased research and development
expense. The Company incurred research and development expenses primarily
consisting of compensation of officers, employees and consultants of $435,300
and $194,400 for fiscal years 1997 and 1996, respectively. The 1997 loss was
mitigated by the capitalization of $124,200 of software development costs,
decreased FDA medical application costs, and a decrease in other expenses
described below. See Note 1 of Notes to Financial Statements for a discussion of
the effect on net losses and net losses per share attributable to (i) the
Company's outstanding convertible securities and (ii) accounting for stock-based
compensation on the intrinsic value method, rather than the fair market value
method.
The Company believes that the level of expenses relating to the FDA initial
application and related patent applications will not be recurring in the future
at previous levels and that any future expenses incurred in connection therewith
will be significantly less than the amount incurred in 1997, although no
assurance can be given of such result.
Bad debt expense decreased to $5,000 in 1997 from $257,700 in 1996 primarily
attributable to the adjustment of amounts due from IMS in 1996. Depreciation and
amortization expense decreased to $80,500 in 1997 from $178,600 in 1996,
primarily attributable to the amortization of deferred legal expenses incurred
in 1996 in respect of financing activities. Compensation expense for employees,
officers and directors decreased to $729,300 in 1997 from $810,500 in 1996,
primarily because bonuses were not paid to executive officers during 1997.
Assets increased to $10,752,600 in 1997 from $6,747,500 in 1996 primarily
attributable to increased cash and cash equivalents from the proceeds received
from the exercise of Warrants and interest income, as well as the capitalization
of software development costs. See Notes 1 and 5 of Notes to Financial
Statements.
Revenues from lease, license and service contracts decreased in 1997 as the
Company continued to focus its resources on implementation of its long range
business plan for the medical application of its technologies. The Company
receives payments from licensees, distributors or other sources sporadically
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 recurring revenues.
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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 Company's existing
activities in the cosmetics, beauty-aid and fashion areas are anticipated to
continue to be insignificant relative to its anticipated expenses in the
foreseeable future.
Liquidity and Capital Resources
Fiscal Year 1998 Compared to Fiscal Year 1997
Current assets decreased to $4,251,200 at December 31, 1998 as compared to
$9,542,300 at December 31, 1997, primarily attributable to a decrease in cash
and cash equivalents resulting from the loss incurred in 1998 and the purchase
of equipment and component parts in respect of future manufacturing and sales
and costs relating to patents and software.
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 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 non-cash compensation costs to consultants. Cash flows from
investing activities during 1998 of $2,554,200 are attributable to software
development costs of $421,800, patent costs of $540,300, purchases of property
and equipment of $87,700 and purchases and deposits on ColorMate(Registered
Trademark) TLc BiliTest(Registered Trademark) units of $1,504,400. The increase
is primarily a result of the Company's rollout of its ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System. Cash flows from financing
activities during 1998 principally represent $3,114,300 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 initially market and distribute the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System , and to support training, technical
and marketing efforts once the Company enters into distribution agreements. See
"Proposed Marketing Plan," "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(Registered
Trademark) 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 1998, such licensing, leasing and sales
yielded limited 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.
The Company anticipates incurring significant additional expenditures related to
manufacturing expenses, parts order, insurance, regulatory compliance and
staffing and marketing expenses for the sales division as production and
distribution continues. 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. Management expects that taking into account existing
resources, anticipated revenues from future sales of the ColorMate(Registered
Trademark) units, anticipated payments received under distribution agreements
and/or the proceeds of the Debentures and any additional financing, the Company
will have sufficient liquidity at least until December 31, 1999, although there
can be no assurance of such result. If the Company is able to profitably market
its Intellectual Properties, ColorMate(Registered Trademark) 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(Registered Trademark) 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 is not able to attract additional future financing, enter into a
distribution agreement generating such payments, generate significant revenue
from operations and/or successfully market its products and technologies, at
such point in time, it may have to significantly curtail and/or cease
operations.
Fiscal Year 1997 Compared to Fiscal Year 1996
In 1997, the Company continued to experience significant negative net cash flows
from operating activities. Net cash out flows from operating activities
increased by $509,200 in 1997 as compared to 1996, primarily due to the increase
in net loss in 1997 and the non-cash expense of options granted to consultants.
Cash flows from financing activities increased to $8,386,700 from $7,387,800 in
1997 as compared to 1996, primarily attributable to $8,424,800 proceeds from the
exercise of Warrants.
The Company has applied a substantial portion of the proceeds of the 1995
Private Placement and Debenture Financing to continue its implementation of its
long-range business plan for commercialization of its technologies for medical
applications in diagnosing certain diseases, including the completion of the FDA
application and the related patent applications. In this regard, the Company
hired FDA and governmental regulatory consultants (in addition to legal counsel)
to assist in obtaining marketing regulatory clearances for such medical
applications and
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is currently applying for foreign regulatory approvals of commercial use of its
technology for the monitoring of bilirubin infant jaundice. Management believes
that, if its proposed marketing plans for non-medical 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(Registered
Trademark) units, sales of swatch packs, consulting fees, and sales of
cosmetics, although there can be no prediction or assurance as to which or any
of these potential revenue sources will be successful. However, since
consummation of the IPO, the Company's marketing of its Intellectual Properties,
Beauty-Aid Products and ColorMate(Registered Trademark) units in the beauty-aid
industry have resulted in immaterial revenues.
As of December 31, 1997, management expects that the Company will have
sufficient liquidity at least until December 31, 1998, even if no revenues from
operations are generated. If the Company is able to profitably market its
Intellectual Properties, the ColorMate(Registered Trademark) units, the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System 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. 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 at such point in time it may have to cease
operations.
Year 2000
Until recently computer programs were generally written using two digits rather
than four to define the applicable year. Accordingly, such programs may be
unable to distinguish properly between the year 1900 and the year 2000. This
could result in system failures or data corruption for the Company or its
vendors which could cause disruptions of operations, including, among other
things, a temporary inability to process transactions or engage in business
activities or to receive information, services or payment from vendors.
The Company's internal computing systems are primarily limited to hardware and
software for its financial systems, such as general ledger and accounts
receivable and payable systems, and word processing and database systems. The
Company is not dependent on large legacy systems and does not use mainframes.
The Company's management is continuing to conduct an assessment of the Company's
operations from an internal, vendor and customer perspective. The assessment
addresses all of the Company's material computer systems, applications and any
other material systems that the Company believes may be vulnerable to the year
2000 issue and significantly affect the Company's operations. This assessment
includes contacting third parties with whom the Company has a material
relationship to determine their year 2000 readiness. The Company's assessment is
not yet complete and there can be no assurances that any such problems will not
arise.
The total costs associated with the Company's year 2000 compliance are not
expected to be material to the Company's financial position. However,
satisfactory remediation of year 2000 issues is dependent upon many factors,
some of which are not completely within the Company's control. The Company's
current estimates of the impact of year 2000 compliance on its financial
position do not include costs that may result from the failure of third parties
with whom the Company has a material relationship to be year 2000 compliant.
Should the Company's internal systems or systems of one or more significant
third parties fail to achieve year 2000 compliance, the Company's business and
its operations could be materially adversely affected.
31
<PAGE>
Item 8. Financial Statements and Supplemental Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Independent Auditors' Reports .............................................. 48
Consolidated Balance Sheets as of December 31, 1998 and 1997 ............... 50
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996 ........................................... 51
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1998, 1997 and 1996 ....................... 52
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 ........................................... 53
Notes to Consolidated Financial Statements ................................. 54
32
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Chromatics Color Sciences
International, Inc.
We have audited the consolidated balance sheet of Chromatics Color Sciences
International, Inc. and subsidiary as of December 31, 1998, and the related
consolidated statements of operations, changes in shareholders' equity and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Chromatics Color
Sciences International, Inc. and subsidiary as of December 31, 1998 and the
results of their operations and their cash flows for the year then ended in
conformity with generally accepted accounting principles.
BDO SEIDMAN LLP
New York, New York
March 15, 1999, except for
Note 6 which is as of April 15, 1999
33
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Chromatics Color Sciences
International, Inc.
We have audited the consolidated balance sheet of Chromatics Color Sciences
International, Inc. as of December 31, 1997 and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for
each of the two years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Chromatics Color
Sciences International, Inc. and subsidiary as of December 31, 1997, and the
results of their operations and their cash flows for each of the two years in
the period ended December 31, 1997 in conformity with generally accepted
accounting principles.
WISS & COMPANY, LLP
Livingston, New Jersey
February 17, 1998
34
<PAGE>
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------
1998 1997
---- ----
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and equivalents $3,929,800 $9,225,400
Accounts receivable 92,300 92,400
Inventories 147,300 148,100
Prepaid expenses and other assets 81,800 76,400
---------- -----------
Total Current Assets 4,251,200 9,542,300
COLORMATE(Registered Trademark) UNITS 1,820,100 715,700
PROPERTY AND EQUIPMENT 301,700 344,900
SOFTWARE DEVELOPMENT COSTS 546,000 124,200
PATENT COSTS 540,300 --
OTHER ASSETS (primarily deposits on ColorMate(Registered
Trademark) Units) in 1998 418,900 25,500
---------- -----------
$7,878,200 $10,752,600
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable - collateralized by equipment $-- $4,700
Amounts payable to related party 318,900 293,200
Accounts payable and accrued expenses:
Attorneys and accountants 673,000 361,900
Consultants 146,500 54,900
Trade 156,800 127,800
---------- -----------
Total Current Liabilities 1,295,200 842,500
---------- -----------
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:
</TABLE>
35
<PAGE>
<TABLE>
<S> <C> <C>
Authorized - 50,000,000 shares
Issued and outstanding - 15,452,442 (1998)
and 13,814,859 (1997) shares 15,400 13,800
Capital in excess of par value 28,327,000 24,370,900
Accumulated deficit (21,773,200) (14,488,400)
---------- -----------
Total Shareholders' Equity 6,569,200 9,896,300
---------- -----------
$7,878,200 $10,752,600
========== ===========
</TABLE>
See accompanying notes to financial statements.
36
<PAGE>
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year End December 31,
---------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Lease, license and service contracts $45,000 $10,500 $66,100
Interest income 372,000 238,900 220,800
Other 1,600 1,000 500
----------- ----------- -----------
418,600 250,400 287,400
----------- ----------- -----------
COSTS AND EXPENSES:
Medical regulatory expenses 1,341,500 1,148,600 1,281,500
Patent application costs 221,700 691,200 382,300
Research and development costs 705,000 435,300 194,400
Compensation costs relating to options granted to
consultants 843,400 582,400 --
Sales, marketing and trade show costs 728,100 12,300 --
General and administrative:
Compensation - officers and employees 772,200 729,300 810,500
Consultants 265,600 198,300 205,900
Legal fees 956,900 288,100 296,300
Accounting fees 51,000 35,100 51,600
Rent and storage 266,000 199,900 195,400
Insurance 194,700 220,600 195,800
Travel and entertainment 98,200 17,900 25,900
Repairs and maintenance 87,500 122,100 85,100
Depreciation and amortization 130,900 80,500 178,600
Payroll taxes 56,700 84,900 80,000
Stock administrative fees 83,300 53,300 52,500
Employee benefit plan 133,200 -- --
Public relations 299,400 9,700 --
Promotion, printing and advertising 230,800 106,800 --
Bad debt expense (recovery) -- (5,000) 257,700
Other 210,200 265,400 370,300
----------- ----------- -----------
Interest 27,100 26,800 65,900
7,703,400 5,303,500 4,729,700
----------- ----------- -----------
NET LOSS $(7,284,800) $(5,053,100) $(4,442,300)
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 14,968,019 12,601,430 8,737,509
=========== =========== ===========
BASIC AND DILUTED LOSS PER SHARE $(0.49) $(0.40) $(0.51)
=========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
37
<PAGE>
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
------------
Capital
Number of Par in Excess of Accumulated
Shares Value Par Value Deficit
------ ----- --------- -------
<S> <C> <C> <C> <C>
BALANCES, DECEMBER 31, 1995 6,992,904 $7,000 $7,862,400 $(4,993,000)
Year Ended December 31, 1996:
Net loss -- -- -- (4,442,300)
Exercise of stock options and warrants 1,073,678 1,100 2,945,600 --
Conversion of convertible debentures into
common stock 2,686,514 2,700 4,328,300 --
Other equity transactions,
net of costs -- -- 230,400 --
----------- ----------- ----------- ------------
BALANCES, DECEMBER 31, 1996 10,753,096 10,800 15,366,700 (9,435,300)
Year Ended December 31, 1997:
Net loss -- -- -- (5,053,100)
Exercise of stock options and warrants 3,061,763 3,000 8,405,500
Compensation cost relating to options granted to
consultants -- -- 582,400 --
Other equity transactions,
net of costs -- -- 16,300 --
----------- ----------- ----------- ------------
BALANCES, DECEMBER 31, 1997 13,814,859 13,800 24,370,900 (14,488,400)
Year Ended December 31, 1998:
Net loss -- -- -- (7,284,800)
Exercise of stock options and warrants 1,637,583 1,600 3,112,700 --
Compensation cost relating to options granted to
consultants -- -- 843,400 --
----------- ----------- ----------- ------------
BALANCES, DECEMBER 31, 1998 15,452,442 $15,400 $28,327,000 $(21,773,200)
=========== =========== =========== ============
</TABLE>
See accompanying notes to financial statements.
38
<PAGE>
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(7,284,800) $(5,053,100) $(4,442,300)
Adjustments to reconcile net loss to
net cash flows from operating activities:
Depreciation and amortization 130,900 80,500 178,600
Provisions for losses on accounts receivable -- (10,000) 7,800
Provision for slow moving inventories -- 75,000 100,000
Compensation cost relating to options granted to consultants 843,400 582,400 --
Changes in operating assets and liabilities:
Accounts receivable 100 5,000 220,500
Inventories 800 300 (31,800)
Prepaid expenses and other current assets (5,400) 12,800 9,600
Other assets 6,600 1,900 34,400
Accounts payable and accrued expenses 431,700 95,200 207,400
Other -- (10,500) 4,500
----------- ----------- -----------
Net cash flows from operating activities (5,876,700) (4,220,500) (3,711,300)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Software development costs (421,800) (124,200) --
Capitalized patent costs (540,300)
Purchases of property and equipment (87,700) (169,000) (151,500)
Purchase of ColorMate(Registered Trademark) Units and deposits thereon (1,504,400) -- --
----------- ----------- -----------
Net cash flows from investing activities (2,554,200) (293,200) (151,500)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock net of related costs 3,114,300 8,424,800 3,076,100
Proceeds from debentures 4,331,000
Proceeds (payments) of amounts payable to related parties 25,700 (32,800) (14,900)
Payments of notes payable (4,700) (5,300) (4,400)
----------- ----------- -----------
Net cash flows from financing activities 3,135,300 8,386,700 7,387,800
----------- ----------- -----------
NET CHANGE IN CASH AND EQUIVALENTS (5,295,600) 3,873,000 3,525,000
CASH AND EQUIVALENTS, BEGINNING OF YEAR 9,226,400 5,352,400 1,827,400
----------- ----------- -----------
CASH AND EQUIVALENTS, END OF YEAR $3,929,800 $9,225,400 $5,352,400
========== ========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid 1,400 33,700 39,600
Conversion of debentures into common stock $ -- $ -- $4,331,000
========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
39
<PAGE>
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -- Nature of Business and Summary of Significant Accounting Policies:
Since its formation in 1984, the Company has been principally engaged in
color science technology research and development and licensing activities,
seeking mass market applications for its proprietary technology and
instrumentation. 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 sufficient revenues
and/or outside financing.
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. Estimates relate primarily to inventory
valuation and recoverability of the Company's tangible and intangible assets.
Principles of Consolidation - The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiary. All
significant intercompany transactions have been eliminated in consolidation.
Patent Application Costs -- Patent application costs had been expensed in
1997 and 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.
ColorMate(Registered Trademark) 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.
40
<PAGE>
Following the Food and Drug Administration ("FDA") marketing clearance in
1997, the Company has decided to use certain components (consisting of sensors,
miniature printers, cables, power supplies and certain other items) from the
existing ColorMate(Registered Trademark) units for use in the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System. The
costs (which are not expected to be material) incurred in extracting the
components from the existing ColorMate(Registered Trademark) units for use in
the ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System
will be expensed as incurred and the inventory value currently assigned to the
existing ColorMate(Registered Trademark) units ($500 per unit) will, upon
extraction of the component parts for current use, be reclassified to the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System, as
the current replacement cost of these components exceeds the book value of the
ColorMate(Registered Trademark) units. Management believes the cost of the
recovered components will be realized from future sales.
In connection with the Company's efforts to distribute the
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System and in
anticipation of entering into the manufacturing agreement, the Company commenced
purchasing equipment and component parts in the second quarter of 1998
(approximately $1,504,000 in the aggregate for 1998). The Company paid
approximately $400,000 in deposits to the supplier in advance of receiving the
materials. The materials were received in early 1999. 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.
Lease, License and Service Revenues - Lease, license and service revenues
consist of short term contracts relating to the ColorMate(Registered Trademark)
II System Units reported on a straight-line basis over the terms of the
contracts, which generally have terms of 12 months.
Inventories - Inventories, consisting primarily of finished goods, are
stated at the lower of first-in, first-out cost or market.
Property and Equipment and Depreciation - Property and equipment are
stated at cost. Depreciation is computed using principally the straight-line
method over estimated useful lives of 5 to 7 years. The Company continually
evaluates the life and carrying amount of such equipment in light of current
conditions. No writedowns have been required through December 31, 1998.
Software Development Costs - Once technological feasibility is
established, the costs of developing software to be marketed as part of a
product is capitalized and will be amortized on the basis of estimated future
revenues with annual minimum charges, which is similar to the straight line
basis over the estimated remaining useful life
Long-lived assets - Long-lived assets, such as intangible assets and
property and equipment, are evaluated for impairment when events or changes in
circumstances indicate that the carrying amount of the assets may not be
recoverable through the estimated undiscounted future cash flows from the use of
these assets. When any such impairment exists, the related assets will be
written down to fair value. No impairment losses have been necessary through
December 31, 1998.
Reclassification - Certain amounts previously reported have been
reclassified to conform to current year presentation.
Cash Equivalents - The Company considers certificates of deposit, money
market funds and all other highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents.
Financial Instruments - Financial instruments include cash and
equivalents, accounts receivable, other assets, accounts payable and accrued
expenses. The amounts reported for financial instruments are considered to be
reasonable approximations of their fair values. The fair value estimates
presented herein were based on market information available to management as of
December 31, 1998.
Concentration of Credit Risk/Major Customers, Supplier and Manufacturer -
The Company maintains its cash balances with financial institutions insured by
the Federal Deposit Insurance Corporation to a maximum of $100,000. The
Company's balances exceed such amount. The Company generated approximately 39%
of its revenues from one customer in 1996. No customer exceeded 10% of revenues
in 1997 or 1998.
The Company is dependent upon one supplier for a major part of its
ColorMate(Registered Trademark) TLc-BiliTest(Registered Trademark) System and
one company to manufacture the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. The loss of these companies would
materially adversely affect the Company.
41
<PAGE>
Loss Per Share - The Company adopted SFAS No. 128, "Earnings Per Share,"
("EPS") which requires a presentation of basic EPS and diluted EPS. Basic EPS
excludes dilution and is computed by dividing earning available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS assumes conversion of convertible debt and the issuance of
common stock for all other potentially dilutive equivalent shares outstanding.
Diluted EPS is not shown since it is anti-dilutive.
Stock-Based Compensation - Statement of Financial Accounting Standards No.
123 "Accounting for Stock-Based Compensation," ("FAS 123") encourages, but does
not require, companies to record compensation cost at fair value for stock-based
employee compensation plans. The Company has chosen to continue to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. Accordingly, compensation cost for
options granted by the Company is measured as the excess, if any, of the quoted
market price of the Company's stock at the date of the grant over the amount an
employee must pay to acquire the stock. The fair value of option grants is
discussed in Note 5.
Income Taxes - Deferred tax assets and liabilities reflect the net tax
effects of temporary differences between the carrying amount of assets and
liabilities for financial reporting purposes and the amounts for income tax
purposes. A valuation allowance is provided for the net deferred tax assets if
it is more likely than not that some or all of the deferred tax assets will not
be realized.
Research and Development - These costs are expensed as they are incurred.
Recent Accounting Standards - In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. This statement will be adopted in the Company's 2000
fiscal year. While management is still reviewing the statement, it believes the
adoption of this statement will not have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
Note 2 -- Management's Plans to Overcome Operating Difficulties:
Since 1989, the Company has incurred losses from operations and net cash
outflows from operations, and has owned ColorMate(Registered Trademark) 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(Registered Trademark) 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 and continued significant operating
losses.
On July 30, 1997, the Company was granted clearance by the FDA for
commercial marketing of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System for the non-invasive monitoring of
newborn bilirubinemia (infant jaundice) by health 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(Registered Trademark) TLc-BiliTest(Registered
Trademark) System 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.
42
<PAGE>
The Company anticipates incurring significant additional expenditures
related to manufacturing expenses, parts order, insurance, regulatory compliance
and staffing and marketing expenses for the sales division as production and
distribution commences over the next two quarters. Management expects that
taking into account existing resources, anticipated revenues from future sales
of the ColorMate(Registered Trademark) units, anticipated payments received
under any future distribution agreements and/or the proceeds of the Debentures
(see Note 6) and any additional financing, the Company will have sufficient
liquidity at least until December 31, 1999.
If the Company is able to profitably market its ColorMate(Registered
Trademark) TLc-BiliTest(Registered Trademark) System, Intellectual Properties,
ColorMate(Registered Trademark) 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(Registered Trademark) 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 is not able to attract additional future financing, enter into
distribution agreements generating such payments, generate significant revenue
from operations and/or successfully market its products and technologies, at
such point in time, it may have to significantly curtail operations.
Note 3 -- Related Party Transactions, Commitments and Contingencies:
Related Party Transactions - In connection with the Avon Settlement and
her employment agreement, Mrs. Macfarlane, the Company's CEO and a principal
shareholder, is to receive a bonus of $361,200, of which $98,800 has been paid.
The remaining $262,400 accrues interest at the rate of 10% per annum. In
December 1997, Mrs. Macfarlane agreed to delay demand for payment until January
1999, and has since temporarily waived repayment at this time. At December 31,
1998, $318,900, including interest, remained due.
Employment Agreements - In December 1997, the Company agreed with Mrs.
Macfarlane to extend her employment at an annual salary of $175,000 through
December 31, 2000.
On April 10, 1995, the Company hired Arthur Guiry as its new president at
an annual salary of $200,000 through April 10, 2000. In addition, Mr. Guiry
received an aggregate of 300,000 incentive and non-qualified options at an
exercise price of $2.25, expiring April 10, 2000. The options vest at the rate
of 100,000 per year commencing April 10, 1996 and are now fully vested.
Lease Agreements - The Company leases office and warehouse space. Most of
the leases are on a month to month basis, with aggregate monthly rentals of
approximately $27,000. Total rent and storage expense was $266,000, $199,900 and
$195,400 in 1998, 1997 and 1996, respectively. Approximately $30,000 per year
related to rent paid to Mrs. Macfarlane under a month to month lease agreement.
Retirement Plan - In 1997, the Company adopted a defined contribution plan
which provided for discretionary Company contributions for qualified employees.
The expense relating to this plan was $0 and $93,246 in 1997 and 1998,
respectively.
Legal Proceedings -- Three putative class actions were commenced against
the Company and certain of its officers and directors in the Southern District
of New York. The first two actions were commenced in June 1998 and are captioned
L.F. Monk v. Chromatics Color Sciences International, Inc., Darby S. Macfarlane,
Arthur Guiry, David K. Macfarlane and Leslie Foglesong, C.A. No. 98 CV 4111
(S.D.N.Y.) and Daniel R. Marquis v. Chromatics Color Sciences International,
Inc., Darby S. Macfarlane, Arthur Guiry and Leslie Foglesong, C.A. No. 98 CV
4335 (S.D.N.Y.). The third action was commenced in August 1998 and is captioned
Joseph Grunberg v. Chromatics Color Sciences International, Inc., Darby S.
Macfarlane, Arthur Guiry, David K. Macfarlane and Leslie Foglesong, C.A. No. 98
CIV. 5646 (S.D.N.Y.)
43
<PAGE>
The complaints were consolidated pursuant to the Consolidation Order
entered by the Court in December 1998. A consolidated amended complaint in the
matter now captioned In re Chromatics Color Sciences International, Inc.
Securities Litigation, Consolidated Matter File No. 98 Civ. 4111 (SHS), was
filed and served in January 1999 (the "Action").
Plaintiffs purport to bring the class action on behalf of all purchasers
of the common stock of the Company, between July 30, 1997 and June 9, 1998,
seeking damages for the alleged violation by defendants of Section 10(b) of the
Securities Exchange Act of 1934, 15 U.S.C. ss.78j(b), and Rule 10b-5 promulgated
thereunder, 17 C.F.R. ss.240.10b-5, and pursuant to Section 20(a) of the
Securities Exchange Act of 1934, 15 U.S.C. ss.78t(a), with respect to the
individual named defendants as "controlling persons." The complaint alleges that
the Company "embarked upon a scheme" to inflate the price of the Company's
Common Stock by making false and misleading statements concerning: (i) the new
and innovative nature of the Company's ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System; (ii) the market size and revenue
potential of the ColorMate(Registered Trademark) TLc-BiliTest(Registered
Trademark) System; and (iii) the existence and status of negotiations with
potential distributors of the ColorMate(Registered Trademark)
TLc-BiliTest(Registered Trademark) System. The allegations of the complaint
arise principally from a "report" prepared by Manuel I. Asensio of Asensio &
Company, Inc. that was disseminated at the close of the putative class period.
Defendants filed a motion to dismiss the complaint on April 30, 1999.
Defendants believe that the claims asserted against them are without merit and
intend to vigorously defend this action. No assurance can be given that the
resolution of the Action and/or future actions will not have a material adverse
effect on the Company's results of operations and liquidity. The Company has
directors and officers insurance which may cover a portion of the liability
asserted in the Action. The Company is exploring its legal remedies in respect
to 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.
Note 4 -- Income Taxes:
The Company had a deferred tax asset at December 31, 1998 and 1997 of
approximately $10,000,000 and $7,000,000, respectively. These amounts relate
primarily to net operating loss and tax credit carryforwards. These assets have
been offset by valuation allowances since their realizability can not be
determined. At December 31, 1998, the Company had net operating loss
carryforwards of approximately $26,600,000 for Federal income tax purposes which
expire through December 31, 2012. In addition, the Company had research and
development tax credit carryforwards of approximately $50,000 at December 31,
1998 available to offset future Federal income taxes. The utilization of such
loss and tax credit carryforwards may be limited due to changes in control.
Included in the net operating loss carryforwards is approximately $5,500,000
relating to the exercise of stock options. The benefits, if any, from the
utilization of this amount will be credited to additional paid-in capital.
Note 5 -- Capital Stock and Options:
Stock Split - In February 1998, the Company effected a three-for-two split
(the "Stock Split"). All share and per share data included in this report have
been restated to reflect the stock split.
Preferred Stock - The Company's shares of Class A Convertible Preferred
Stock are entitled to non-cumulative dividends, if declared, at $.001 per annum.
In February 1998, the shareholders approved an amendment to the Class A
Convertible Preferred Stock to provide that in the event either the Company's
earnings before interest, income taxes and extraordinary items exceed
$20,000,000 for two consecutive calendar years, or the closing bid price exceeds
$31.11 for 30 consecutive trading days at any time through December 31, 2000,
each share of Class A Preferred Stock shall be convertible into .979 shares of
Common Stock. Such shares shall otherwise be called for redemption during 120
days following December 31, 2000 at $.01 per share plus any declared but unpaid
dividends.
44
<PAGE>
In addition, the shareholders approved an amendment to the Company's
Certificate of Incorporation to (1) revise the market price conversion feature
of the Class A Convertible Preferred Stock to provide for adjustment upon the
occurrence of certain events involving the Common Stock, and (2) revise the
calculation of the earnings goal needed to trigger the conversion feature of the
Class A Convertible Preferred Stock by deleting the exclusion therefrom of
extraordinary items and revenues and earnings generated by businesses acquired
by the Company.
The Company also has 10,000,000 shares of Class B Preferred Stock which
may be issued with such rights and preferences as the Board of Directors may
determine upon issuance. In January 1999, the Company amended its Certificate of
Incorporation to fix the relative rights, preferences and limitations with
respect to the Class B Preferred Stock pursuant to the Shareholders' Rights Plan
(the "Plan") adopted in December 1998 by the Board of Directors.
Under the Plan, each shareholder will receive a dividend of one right for
each share of the Company's outstanding common stock (a "Right"). Subject to the
terms of the rights agreement between the Company and its transfer agent (the
"Rights Agreement"), each Right will entitle the holder to purchase one
one-hundredth of a share of the Company's new Class B Series 1 Preferred Stock
at an initial exercise price of $28. Until the Rights become exercisable, they
will be represented by, and trade with, the outstanding common stock; the
Company does not anticipate issuing separate certificates for the Rights at this
time.
Initially, the Rights are attached to the Company's common stock and are
not exercisable. They become detached from the Common Stock, and become
immediately exercisable, (i) following expiration of the Board of Directors'
right to redeem the Rights during the 10 day window period (the "Window
Period"), or any extension of the Window Period, after any person or group
(other than the exempted shareholder) becomes the beneficial owner of 20 percent
or more of the Company's common stock (other than acquisitions which are
approved in advance by the Board of Directors), or (ii) ten days after any
person or group announces a tender or exchange offer that would result in that
same beneficial ownership level (other than pursuant to certain permitted
offers).
The distribution of Rights was made on January 11, 1999 to shareholders of
record of common stock on that date, and shares of common stock that are newly
issued after that date will also carry Rights until the Rights become detached
from the common stock. The Rights will expire on January 11, 2009. The Rights
distribution is not taxable to shareholders. The Company may redeem the Rights
for $0.001 each at any time during the Window Period, or any extension thereof,
after a buyer acquires a 20 percent position in the Company, and under certain
other circumstances.
Stock Option Plan - The Company has a Stock Option Plan which currently
provides for options to purchase up to 4,500,000 shares of Common Stock. The
Plan provides for the granting of incentive stock options to all employees and
non-incentive stock options to all employees and certain consultants at an
exercise price equal to at least the fair market value of a share of Common
Stock at the date of grant for incentive options (other than for the holders of
more than 10% of the outstanding Common Stock which must be at least 110% of the
fair market value on the date of grant) and at least 85% of the fair market
value on the date of grant for non-incentive options. Stock options are
generally exercisable in 33-1/3% annual increments commencing one year after the
date of grant and generally expire five years after the date of grant.
The Company estimates the fair value of each stock option at the grant
date by using the Black-Scholes option-pricing model with the following weighted
average assumptions used for grants in 1996, 1997 and 1998, no dividend yield,
expected volatility of 76%, 76% and 60%, risk free interest rates of 5% to 7%
and expected lives of approximately 2.5 years. The grant date fair market value
for options granted in 1997 and 1996 was $6.46 and $4.48, respectively. If
compensation cost for the Company's stock option plan had been determined in
accordance with SFAS No. 123, net loss would have been increased in 1996, 1997
and 1998 by approximately $544,000, $424,000 and $470,000, respectively and loss
per share would have been increased by $.05, $.05 and $.03, respectively.
45
<PAGE>
The following table summarizes information about stock options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
average
remaining
Number Outstanding contractual Weighted Weighted average
as of 12/31/98 life (years) average price Number exercisable exercise price
-------------- ------------ ------------- ------------------ --------------
<S> <C> <C> <C> <C> <C>
Range of
Exercise Prices: 1,159.049 2.64 $2.80 1,140,716 $2.80
$1.02 - $2.92 1,176,999 4.33 5.23 232,499 4.77
$2.96 - $5.42 546,750 4.08 7.73 33,750 7.74
$7.00 - $8.25 228,750 3.91 9.47 64,750 9.51
------------- ------- ---- ---- ------ ----
$9.25 - $10.00
3,111,548 3.62 $5.08 1,470,715 $3.52
========= ==== ===== ========= =====
</TABLE>
Transactions under the stock option plan are summarized as follows:
Weighted average
Shares exercise price
------ --------------
Shares under option at December 31, 1995 1,023,750 2.17
Granted (at $2.75 to $2.92 per share) 1,140,000 2.90
Exercised (187,500) 1.64
Canceled (at $2.96 per share) (3,750) 2.96
---------
Shares under option at December 31, 1996 1,972,500 2.64
Granted (at $5.00 to $10.00 per share) 791,250 7.04
Exercised (671,502) 2.34
---------
Shares under option at December 31, 1997 2,092,248 4.40
Granted (at $4.88 to $9.25 per share) 1,432,500 6.40
Exercised (165,700) 3.85
Canceled (at $7.46 to $8.25 per share) (247,500) 7.82
--------- ----
Shares under option at December 31, 1998 3,111,548 5.08
========= ====
Options exercisable at December
1996 530,000
1997 1,201,082
1998 1,470,715
Weighted average fair value of options granted
during:
1998 $2.26 per share
46
<PAGE>
The Company granted options to consultants and certain other professionals
who provide services to the Company. These options have been valued in
accordance with FAS 123 and are being expensed over the vesting period of the
options. The amounts expensed in 1997 and 1998 amounted to $582,400 and
$843,400, respectively. The activity for these options is included in the table
above.
At December 31, 1998 warrants to purchase 478,273 shares of common stock
at $1.67 per share were outstanding. These warrants, issued to a placement agent
in previous years in connection with equity financings, expire as follows: (i)
124,299 warrants issued on January 6, 1995 expire January 6, 2002; (ii) 408
warrants issued on March 13, 1995 expire March 13, 2002; (iii) 93,628 warrants
issued on May 4, 1995 expire May 4, 2002; and (iv) 259,938 warrants issued on
June 8, 1995 expire June 8, 2002. At December 31, 1997, warrants to purchase
1,966,061 shares of Common Stock at exercise prices of $1.67-$3.33 were
outstanding.
Note 6 -- Subsequent Events:
On April 15, 1999 the Company issued an aggregate of $5,000,000 14% senior
convertible debentures due April 15, 2002 (the"Debentures") in a private
placement. Payments of interest on the outstanding principal amount of the
Debentures are due on the earlier of the maturity date or upon any conversion of
the Debentures into the Company's Common Stock. The accrued interest may be paid
either in cash, shares of the Company's Common Stock or a combination of Common
Stock and cash, at the option of the Company.
The outstanding principal amount of the Debentures (together with accrued
interest thereon) is convertible until after the first anniversary of the
closing. At that time, the Debentures are convertible into shares of Common
Stock, at the option of the holder or holders thereof, at the conversion price
of $5.00. However, at any time prior to April 14, 2000, such portion of the
Debentures may be converted, at the option of the holder or holders thereof, as
shall result in the issuance, upon such conversion, of not more than an
aggregate of 200,000 shares of Common Stock. Subject to applicable securities
laws, the holder or holders of such shares, in the aggregate, may only sell not
more than an aggregate of 50,000 shares of such Common Stock issued upon such
conversion during any one month period ending prior to April 14, 2000. At any
time after the 18 month anniversary of the closing, the Company may prepay the
entire amount of the Debentures or any portion thereof for a prepayment price
equal to the original principal amount of the Debentures plus all accrued and
unpaid interest. At any time after the 18 month anniversary of the closing and
prior to the Maturity Date, in the event the average closing bid price (as
reported on the Nasdaq SmallCap Market or such other principal market or
exchange on which the Common Stock is then traded) of the Company's Common stock
for any 10 consecutive trading days equals or exceeds $10.29, the Company can
require conversion of the outstanding principal amount (together with accrued
interest) of the Debentures into Common Stock at a conversion price of $5.00 per
share.
47
<PAGE>
PART III
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth, as of April 13, 1999, the beneficial ownership
of the Common Stock: (i) by each stockholder known by the Company to
beneficially own more than 5% of the Common Stock; (ii) by each director of the
Company; (iii) by the Company's Chief Executive Officer; and (vi) by all
executive officers and directors of the Company as a group. Amounts presented
give effect to the February 1998 three-for-two forward Stock Split (including
shares issuable upon the exercise of stock options and/or warrants). Except as
otherwise indicated below, each named beneficial owner has sole voting and
investment power with respect to the shares of Common Stock listed.
<TABLE>
<CAPTION>
Class A
Name and Address of Preferred Stock(1) Percent Common Stock
Beneficial Owner Number of Shares of Class Number of Shares Percent of Class
- ---------------- ---------------- -------- ---------------- ----------------
<S> <C> <C> <C> <C>
Darby Simpson Macfarlane 1,380,000(2) 100%
10 Old Jackson Avenue, #28 1,611,895(3) 9.93%
Hastings-on-Hudson, NY 10706
David Kenneth Macfarlane 1,380,000(2) 100%
5 East 80th Street 1,611,895(4) --
New York, NY 10021
Leslie Foglesong(5) 165,000 *
116 Lafayette Avenue
Brooklyn, NY 11217
Edmund Vimond 12,500 *
6967 Country Lakes Circles
Sarasota, FL 34243
Edward Mahoney 12,500 *
2044 Palisades Drive
Pacific Palisades, CA 90272
Arthur Guiry(6) 105,000 *
The Willows
11-5 Jackson Avenue
Scarsdale, New York 10583
Janssen-Meyers Associates, L.P.(7) 1,206,934 7.59%
17 State Street
New York, NY 10001
All directors and executive officers 1,380,000 100% 1,906,895 11.57%
as a group (6 persons)(8)
</TABLE>
(1) The Class A Preferred Stock is a voting security which votes together
with the Common Stock as a single class and is entitled to one vote per
share. The shares of Class A Preferred Stock are convertible into shares
of Common Stock if (i) the Company's earnings for any two calendar years
during the period ending on December 31, 2000 exceeds $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 prior to December 31, 2000. The
conversion ratio is .979 shares of Common Stock for each share of Class A
Preferred Stock. If neither condition to conversion is satisfied by
December 31, 2000, the Class A Preferred Stock will be redeemed by the
Company at a price of $.01 per share.
(2) Represents 1,380,000 shares of Class A Preferred Stock beneficially
owned by Mr. and Mrs. Macfarlane.
(3) Includes 861,895 issued and outstanding shares of the Common Stock
beneficially owned by Mrs. Macfarlane, 450,000 shares
48
<PAGE>
issuable upon the exercise of options granted to Mrs. Macfarlane and
300,000 shares issuable upon the exercise of options granted to Mr.
Macfarlane which options are currently exercisable. As a result of a
certain voting agreement between them, Mrs. Macfarlane is entitled to sole
voting power and sole power of disposition over all shares of common stock
held or acquired by Mr. Macfarlane.
(4) Includes 861,895 issued and outstanding shares of the Common Stock
beneficially owned by Mrs. Macfarlane, 450,000 shares issuable upon the
exercise of options granted to Mrs. Macfarlane and 300,000 shares issuable
upon the exercise of options granted to Mr. Macfarlane which options are
currently exercisable.
(5) Includes 150,000 shares issuable upon the exercise of options which
are currently exercisable.
(6) Represents 105,000 shares issuable upon the exercise of options which
are currently exercisable.
(7) Based on a representation letter from Janssen-Meyers Associates, L.P.
dated March 19, 1999, and includes 636,250 shares of Common Stock held by
Peter Janssen (an affiliate of Janssen-Meyers Associates, L.P.), 145,750
shares of Common Stock and 314,347 warrants held by Janssen-Meyers
Associates, L.P. which, in each case, are currently exercisable, 108,647
warrants held by limited partners of Janssen-Meyers Associates, L.P. and
1,940 warrants held by Meyers Janssen Securities Corp., which, in each
case, are currently exercisable. Peter Janssen and Bruce Meyers are deemed
to be the beneficial owners of the shares of Common Stock and warrants
held by Janssen-Meyers Associates, L.P.
(8) Includes 1,005,000 shares issuable upon the exercise of options which
are currently exercisable.
Mellon Bank Corporation filed a Schedule 13G, dated February 5, 1999,
indicating that as of January 26, 1999, Mellon Bank Corporation ceased to
be the beneficial owner of more than five percent of the Company's Common
Stock.
49
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) and (d)1. Financial Statements
The following Financial Statements of the Company are included
in Part II, Item 8 of this report:
Independent Auditors' Reports
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
(a) and (d)2. Financial Statements Schedules
All schedules have been omitted because they are not
applicable, are not required or because the required
information is included in the Financial Statements or notes
thereto.
(b) Reports on Form 8-K:
Form 8-K**, dated November 12, 1998, announcing that the
Company executed a manufacturing agreement under which the
manufacturer is the exclusive manufacturer/assembler and
packager of the two models of the Company's instrument.
(c) The following exhibits are included in this report:
Number Description of Document
- ------ -----------------------
3.1 Restated Articles of Incorporation of the Company, as
amended. (incorporated by reference to Exhibit 3.1 to
the Form 10-Q filed November 15, 1999).
3.2 By-Laws of the Company (incorporated by reference to
Exhibit 3.2 to the Registration Statement).
4.1 Specimen form of the Common Stock Certificate
(incorporated by reference to Exhibit 4.1 to the
Registration Statement).
4.2 Shareholders' Rights Plan, adopted by the Company on
December 31, 1998 (incorporated by reference as Exhibit
1 to the Form 8-A dated January 5, 1999).
9.1 Voting Proxy dated December 13, 1995, of David Kenneth
Macfarlane to Darby Simpson Macfarlane (incorporated by
reference to Exhibit 2 to Schedule 13D of Darby
Macfarlane and Ken Macfarlane dated February 12, 1996).
50
<PAGE>
Number Description of Document
- ------ -----------------------
9.2 Voting Trust Agreement dated December 13, 1995, between
David Kenneth Macfarlane and Darby Simpson Macfarlane
(incorporated by reference to Exhibit 3 to Schedule 13D
of Darby Macfarlane and Ken Macfarlane dated February
12, 1996).
10.1* Form of Employment Agreement between the Company and
Darby Simpson Macfarlane (incorporated by reference to
Exhibit 10.1 to the Registration Statement).
10.2* Form of Employment Agreement between the Company and
David Kenneth Macfarlane (incorporated by reference to
Exhibit 10.2 to the Registration Statement).
10.3* Consulting Agreement, dated February 25, 1992, between
the Company and Dr. Fred W. Billmeyer, Jr. (incorporated
by reference to Exhibit 10.4 to the Registration
Statement).
10.4 Form of Indemnity Agreement between the Company and its
directors and officers (incorporated by reference to
Exhibit 10.6 to the Registration Statement).
10.5 Know-How Agreement, dated September 3, 1992, between the
Company, Darby Simpson Macfarlane and David Kenneth
Macfarlane (incorporated by reference to Exhibit 10.12
to the Registration Statement).
10.6 Assignment, dated September 3, 1992 from Darby Simpson
Macfarlane to the Company regarding Intellectual
Property (incorporated by reference to Exhibit 10.13 to
the Registration Statement).
10.7** Agreement, dated April 16, 1992, between the Company and
IMS Cosmetics, Inc. (incorporated by reference to
Exhibit 10.14 to the Registration Statement).
10.8 U.S. Patent No. 4,909,632 relating to Method for
Selecting Personal Compatible Colors (incorporated by
reference to Exhibit 10.17 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended December
31, 1994).
10.9 U.S. Patent No. 5,311,293 relating to Method and
Instrument for Selecting Personal Compatible Colors
(incorporated by reference to Exhibit 10.18 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1994).
10.10 U.S. Patent No. 5,313,267 relating to Method and
Instrument for Selecting Personal Compatible Colors
(incorporated by reference to Exhibit 10.19 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1994).
10.11 The Australian Patent relating to Method of Selecting
Personal Compatible Color (incorporated by reference to
Exhibit 10.20 to the Company's Annual Report on Form
10-KSB for the fiscal year ended December 31, 1994).
51
<PAGE>
10.12 European Community Patent No. 0446512 relating to Method
for Selecting Personal Compatible Colors (incorporated
by reference to Exhibit 10.21 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended December
31, 1994).
10.13 U.S. Patent No. 5,671,735 relating to Method and
Apparatus for Detecting and Measuring Conditions
Affecting Color (incorporated by reference to Exhibit
10.13 to the Amendment to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1998).
10.14 Assignment, dated October 30, 1992, between Darby
Simpson Macfarlane and the Company relating to the Avon
litigation (incorporated by reference to Exhibit 10.19
to the Registration Statement).
10.15 Know-How Assignment, dated October 30, 1992, from Pink &
Peach Computer Corp. to the Company (incorporated by
reference to Exhibit 10.20 to the Registration
Statement).
10.16 1992 Stock Option Plan (incorporated by reference to
Exhibit 10.1 to the Registration Statement on Form 8-A
(File No. 333-51697).
52
<PAGE>
Number Description of Document
- ------ -----------------------
10.17 Consulting Agreement dated January 6, 1995, between the
Company and Janssen-Meyers Associates, L.P.
(incorporated by reference to Exhibit 10.27 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1994).
10.18 Warrant Agreement dated January 6, 1995, between the
Company and Janssen-Meyers Associates, L.P.
(incorporated by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1994).
10.19 Warrant Agreement dated March 13, 1995, between the
Company and Janssen-Meyers Associates, L.P.
(incorporated by reference to Exhibit 10.29 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1994).
10.20** Manufacturing Agreement, dated November 3, 1998, between
the Company and a third party manufacturer (incorporated
by reference as Exhibit 10.1 to the Form 8-K dated
November 12, 1998).
10.21 Rights Agreement, dated January 11, 1999, between the
Company and Continental Stock Transfer & Trust Company
(incorporated by reference as Exhibit 1 to the Form 8-A
dated January 5, 1999).
10.22 Subscription Agreement, dated April 15, 1999; Form of
14% Convertible Debentures Due April 15, 2002
(incorporated by reference to the Form 8-K filed April
30, 1999).
10.23+ Consent and Waiver, dated June 8, 1999, made by Gary W.
Schreiner in favor of the Company.
10.24+ License Agreement, dated September 1, 1998, between the
Company and Nordstrom., Inc.
10.25+ Agreement, dated December 13, 1996, between the Company
and Gordon Laboratories, Inc.
18.1 Letter, dated April 21, 1998, from Wiss & Company, LLP
informing the Company that it would not stand for
re-election as the Company's principal accountants
(incorporated by reference as Exhibit 16 to the Form 8-K
dated April 24, 1998).
18.2 Press Release, dated May 1, 1998, announcing that the
Company engaged BDO Seidman LLP as the principal
accountants for the Company (incorporated by reference
as Exhibit 99 to the Form 8-K dated May 5, 1998).
21 Subsidiaries of the Company (incorporated by reference
to Exhibit 21 to the Company's Post Effective Amendment
No. 1 on Form SB-1 to the Registration Statement filed
on January 11, 1994).
23.1 Consent of BDO Seidman, LLP (incorporated by reference
to Exhibit 23.1 to the Registration Statement filed
January 20, 2000).
53
<PAGE>
23.2 Consent of Wiss & Company, LLP (incorporated by
reference to Exhibit 23.2 to the Registration Statement
filed January 20, 2000).
27 Financial Data Schedule (previously filed).
* Management contract or compensatory plan or arrangement required to be
filed as an exhibit.
** Confidential treatment has been requested with respect to certain
information contained in this agreement.
+ Filed herewith.
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC.
By: /s/ Darby S. Macfarlane Date: January 20, 2000
-----------------------
Darby S. Macfarlane,
Chief Executive Officer
By: /s/ Leslie Foglesong Date: January 20, 2000
--------------------
Leslie Foglesong,
Treasurer
(Chief Financial and Accounting Officer)
In accordance with the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
By: /s/ Darby S. Macfarlane Date: January 20, 2000
-----------------------
Darby S. Macfarlane,
CEO; Chairman of the Board;
Assistant Treasurer; Director
By: /s/ David K. Macfarlane Date: January 20, 2000
-----------------------
David K. Macfarlane,
Vice President, Research & Development;
Director
By: /s/ Leslie Foglesong Date: January 20, 2000
--------------------
Leslie Foglesong,
Secretary; Treasurer; Director
By: /s/ Edmund Vimond Date: January 20, 2000
-----------------
Edmund Vimond,
Director
By: /s/ Edward Mahoney Date: January 20, 2000
------------------
Edward Mahoney,
Director
54
<PAGE>
CONSENT AND WAIVER
The undersigned, being the holder of the 14% Senior Convertible Debenture
due April 15, 2002 in the aggregate principal amount of $5,000,000 (the
"Debenture"), hereby consents to the filing of the Registration Statement (as
defined in the Subscription Agreement relating to the Debenture) not later than
the close of business on Thursday, July 1, 1999 and waives any default or event
of default under the Debenture arising as a result of the failure to file such
Registration Statement before July 1, 1999.
Dated: June 8, 1999
/s/ Gary W. Schreiner
---------------------
Gary W. Schreiner
<PAGE>
EXHIBIT 10.24
LICENSE AGREEMENT
This license agreement ("Agreement"), dated September 1, 1998, is by
and between Chromatics Color Sciences International, Inc., a New York
corporation, having its offices at 5 E. 80 St., New York, NY 10021
("Chromatics") and Nordstrom, Inc., a Washington corporation, having its offices
at 1617 6th Ave., Suite 500, Seattle, WA 98101 ("Nordstrom").
RECITALS
WHEREAS, Chromatics is the developer and owner of certain technology
and processes for skin and cosmetic product color analysis and custom color
formulation of cosmetics, whereby the color of various cosmetic products can be
coordinated to each other and to skin color;
WHEREAS, Nordstrom is a high quality specialty retailer of fashion wear
and related products including cosmetics and wishes to sell the Products defined
herein as a Nordstrom line of cosmetic products under the name C2O Color to
Order, a trademark solely owned by Nordstrom;
WHEREAS, Chromatics wishes to grant to Nordstrom and Nordstrom wishes
to accept from Chromatics, a license to use the software for the
Colormate(Registered) II System to sell the Products provided by Chromatics and
lease the Colormate(Registered) II System in the Territory for a Test Period
described in the Term of this Agreement.
NOW, THEREFORE, in consideration of the mutual covenants and
undertakings contained herein, the parties agree as follows:
ARTICLE 1
DEFINITIONS
For purpose if this Agreement, the following terms shall have the meaning stated
below:
1.1 "Bulk Materials" means the lipsticks and foundations to be provided by
Chromatics for Nordstrom to sell which are recommended by the
Colormate(Registered) II System. Nordstrom shall approve the non-color related
formulations of these lipsticks and foundations within 30 days of signing this
Agreement providing such formulations are delivered to Nordstrom at least two
(2) weeks prior to the expiration of such thirty (30) days.
1.2 "Colormate(Registered) II System" refers to the Chromatics color measurement
units which measure and analyze skin color and based on such analysis select a
cosmetic color formulation which matches or compliments the skin color or other
Products.
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1.3 "Marketing Intangibles" means Nordstrom's trademark "C2O Color to Order,"
and all trademarks, trade names, brand names, logos, trade dress, art work,
designs, service marks, packaging, marketing strategies, customer lists,
customer identification information, marketing campaigns, sales promotions and
advertising materials created, owned and/or registered to or by Nordstrom
relating to the marketing of any Products including searches concerning any such
Marketing Intangibles and any copyrights, and other rights which may exist in or
otherwise protect such Marketing Intangibles. Nordstrom does not claim, and
shall not acquire, any rights in or ownership of any Technology or Products or
other property of Chromatics by virtue of the fact that such items are
referenced or described in any Marketing Intangibles.
1.4 "Products" means all cosmetic color products produced using the Technology,
which currently include foundation, concealer, blush, eyeshadow, face powder and
lipstick.
1.5 "Technology" means all technology, relating to the Colormate(Registered) II
System, its color measurement hardware and software including without limitation
the Product Color Recommendations and the Product Color Formulations of the
Products developed by Chromatics as part of the custom color cosmetic system
embodied in the Colormate(Registered) II System.
1.6 "Territory" means the four Nordstrom full line specialty stores in the
United States to be designated by Nordstrom within 30 days of the signing of
this Agreement.
1.7 "Specialty Retail Department Stores" means retailers other than Nordstrom
that sell apparel, footwear, cosmetics and/or similar merchandise in multiple
departments within one store such as The Bon Marche, J.C. Penney, Macys, Neiman
Marcus and similar stores. This excludes specialty chain stores, such as, The
Gap, The Limited and Victoria's Secret.
1.8 "Custom Blending" means the custom mixing and blending of cosmetic pigments
by the salesperson for the Product to make a particular shade and formula of the
Product at point of sale (a physical location at the time the Product is sold to
a particular customer) based on the Product Color Formulations and Product Color
Recommendations for that particular customer. This does not include a Product
(which may be claimed to be custom blended) but which is carried in a line of
cosmetic products and recommended and sold to a particular customer based on a
Product Color Formulation and a Product Color Recommendation for that particular
customer if it is not custom blended as specified above.
1.9 "Product Color Formulations" means the color formulations of the Products
produced using the Technology.
1.10 "Product Color Recommendations" means the cosmetic Product colors
recommended for a customer's use by the Technology.
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ARTICLE 2
GRANT
2.1 License Grant. Chromatics hereby grants to Nordstrom, and Nordstrom hereby
accepts, a non-exclusive license in the Territory to use the Technology solely
to sell the Products in the Territory in order to evaluate the Technology (the
"Test") for the six month term of this Agreement.
2.2 Additional Options. Chromatics hereby grants to Nordstrom for the six month
term of this Agreement and under terms acceptable to both parties the right of
first refusal for the exclusive use of the Technology for the sale of Products
in Specialty Retail Department Stores in the Territory and the exclusive right
to do Custom Blending of the Products in the Territory during the six month term
of this Agreement. In the event Chromatics at any time during the six month term
of this Agreement offers a license to any third party (except for this
non-exclusive six month license) for the use of the Technology, or any part
thereof as defined in Section 1.5, for the sale of Products in Specialty Retail
Department Stores and/or the Custom Blending of the Products in the United
States, Chromatics shall give Nordstrom written notice thereof, including the
terms of any proposed license or agreement that Chromatics desires to enter
into, and Nordstrom may exercise its right of first refusal by written notice to
Chromatics within thirty (30) days after receipt of such notice after which date
Nordstrom's right of first refusal for such license if not exercised will
expire. In the event Nordstrom exercises its right of first refusal hereunder,
the non-exclusive license granted in Section 2.1 shall become an exclusive
license as specified above for the remainder of the six month term of this
Agreement, under terms no less favorable than the terms offered or to be offered
to such third party.
ARTICLE 3
DUTIES OF NORDSTROM
3.1 Reasonable Efforts. During the term of this Agreement, Nordstrom shall give
and devote commercially reasonable efforts to the marketing, promotion and sale
of the Products under the name C2O Color to Order in the Territory. Nordstrom
shall provide computers capable of interfacing with the Colormate(Registered) II
Systems at each of the four (4) Nordstrom store locations of the Territory.
Chromatics can take credit publicly for the Technology, the
Colormate(Registered) II System, the Product Color Formulations and the Product
Color Recommendations of the Products providing, such credit shall not make use
of the Nordstrom name other than to say the technology is used in the Nordstrom
stores in any SEC filing, or related press release for public disclosure by
Chromatics or, unless otherwise agreed in advance in writing.
3.2 Equipment and Insurance. Nordstrom shall lease one Colormate(Registered) II
System unit from Chromatics for each of the four (4) Nordstrom full-line
specialty stores of the Territory, at a cost of Two Hundred Dollars U.S. ($200)
per month for four units for a three month period
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commencing on the date of delivery of the Colormate(Registered) II System units.
In the event of theft, loss or extensive damage to any Colormate(Registered) II
System unit while in Nordstrom's possession or control, Nordstrom will be
responsible for the replacement cost of $3,500 for each such unit.
3.3 Purchase Orders. Nordstrom shall place an initial order for six hundred
(600) each of thirty-five (35) lipsticks at a cost per lipstick of $3.00 and one
thousand (1,000) each of seventeen (17) foundations at a cost per foundation of
$3.00 for delivery no later than three (3) months from the date this Agreement
is fully executed.
3.4 License Fee. Nordstrom shall pay Chromatics $45,000 upon signing of this
Agreement for the six month non-exclusive license of: the software including the
Product Color Recommendations of the Colormate(Registered) II System, the
Technology, the Colormate(Registered) II System and the Product Color
Formulation of Products and Product Color Recommendations of the
Colormate(Registered) II System software program. This fee will include
Chromatics' inclusion of the pigments submitted to Chromatics by Nordstrom for
use in formulating certain eyeshadows, blush, face powder, concealer and
foundations in the Product Color Formulation of Products within three (3) months
of the date on which Chromatics receives thirty (30) unit doses of each shade of
such pigment formulations from Nordstrom.
ARTICLE 4
DUTIES OF CHROMATICS
4.1 Colormate(Registered) II Systems. Chromatics shall provide to Nordstrom no
later than three (3) months from the date this Agreement is fully executed, one
Colormate(Registered) II System unit each for the four Nordstrom full line
specialty stores of the Territory including Roosevelt Field, NY, Downtown
Seattle, WA and Dallas Galleria, TX, and one additional store in California to
be designated by Nordstrom within 30 days of the signing of this Agreement.
Chromatics shall also provide the software contained in the
Colormate(Registered) II System to Nordstrom in accordance with Section 3.4 and
4.3. During the term of this Agreement Chromatics shall repair or replace at its
own expense any Colormate(Registered) II System units that are not functioning
properly if due to defect in workmanship in the Colormate(Registered) II System,
promptly after receiving a request from Nordstrom. If such non-functioning unit
is due to damage caused by a negligent act of Nordstrom or of an employee or
agent of Nordstrom, Chromatics shall repair or replace any such
Colormate(Registered) II System unit at Nordstrom's expense.
4.2 Bulk Materials. Chromatics shall sell and deliver to Nordstrom, no later
than three (3) months from the date this Agreement is fully executed, the Bulk
Materials ordered by Nordstrom in accordance with Section 3.3 of this Agreement,
subject to the terms and conditions of 3.4.
4.3 Training and Operation. Chromatics shall provide Nordstrom with all
necessary training and operational information for the efficient use and
operation of the Colormate II System licensed, provided or purchased under this
Agreement at no additional cost, including but not
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limited to operational information for the use of the software that will collect
and store all contact information, Product Color Formulations and Product Color
Recommendations for each Nordstrom customer.
ARTICLE 5
REPRESENTATIONS AND WARRANTIES
5.1 Chromatics represents that to the best of its knowledge and belief, the
Technology and Products do not infringe any rights owned or possessed by
any third party;
5.2 Chromatics represents that it is the sole and exclusive owner of the
Technology, all of which is free and clear of any liens, charges and
encumbrances, and no other person or entity has any claim of ownership
with respect to the Technology whatsoever;
5.3 Chromatics warrants that it has the full right, power and authority to
enter into this Agreement and to grant the interest in the Technology
granted herein and that it has registered the trademark "My Colors by
Chromatics(Registered)" and "Colormate(Registered);"
5.4 Chromatics represents that there are no claims, judgements, or settlements
to be paid by Chromatics or pending claims or litigation relating to the
Technology or Products;
5.5 Chromatics represents that foundations provided to Nordstrom under this
Agreement comply with the manufacturing and product safety standards
described in the Nordstrom purchase order attached as Exhibit A;
5.6 Chromatics represents that the Colormate(Registered) II System units, are
UL and FCC approved for use pursuant to this Agreement.
5.7 Nordstrom represents that it has filed an application for registration of
the trademark "C2O Color to Order" in the United States Patent and
Trademark Office ("PTO") and will take reasonable efforts to prosecute
said application to final determination by the PTO;
5.8 Nordstrom warrants that it has the full right, power and authority to
enter into this Agreement.
ARTICLE 6
PAYMENT
6.1 Amount of Payment. As full consideration for the rights and license granted
under this Agreement, Nordstrom shall pay Chromatics the License Fee of Section
3.4 and the lease
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payments for leased Colormate(Registered) II System units and the purchase price
of the Bulk Materials ordered from Chromatics in accordance with Sections 3.2,
3.3, 3.4, 6.1 and 6.2.
6.2 Terms of Payment. Nordstrom shall pay Chromatics its License fee on the date
of signing of this Agreement. Payment for the initial order of foundations shall
be made 1/2 at the time of the order and the balance within seven (7) days of
Nordstrom's receipt of an invoice from Chromatics or the delivery of such
foundations to Nordstrom, whichever is later. Payment for the initial order of
lipsticks shall be made as the lipsticks are sold, every thirty days during the
term of this Agreement and a final payment within thirty (30) days of the
expiration of the term of this Agreement. Any remaining unsold lipsticks will be
returned to Chromatics within thirty (30) days of the expiration of the term of
this Agreement. Any lipsticks not returned to Chromatics or not paid previously
for by Nordstrom to Chromatics will be paid for by Nordstrom to Chromatics in
the final payment.
ARTICLE 7
INTELLECTUAL PROPERTY OWNERSHIP
7.1 Ownership of Technology. Nordstrom acknowledges that all Technology, the
Product Color Formulations, and the Product Color Recommendations of the
Products, the Colormate(Registered) II System and its software are the exclusive
property of Chromatics, subject to the license hereby granted.
7.2 Ownership of Marketing Intangibles. Chromatics acknowledges that Marketing
Intangibles are and shall remain the exclusive property of Nordstrom. Chromatics
is the owner of the Product Color Formulations and Product Color
Recommendations, the trademarks "Colormate(Registered)" and "My Colors by
Chromatics" and the Colormate(Registered) II System as the color analysis system
for the Products. Chromatics shall not use the name "Nordstrom", the trademark
"C2O Color to Order," or any other trademark, trade name, service mark, logo, or
other intellectual property of Nordstrom for any purpose, except as specifically
authorized by Nordstrom in writing. Nordstrom shall not use the name Chromatics,
the trademarks, "Colormate(Registered)" or "My Colors by Chromatics(Registered)"
or any other trademark, trade name, service mark, logo, Product Color
Formulations and Product Color Recommendations of the Colormate(Registered) II
System or other intellectual property of Chromatics for any purpose except as
specifically authorized by Chromatics in writing.
ARTICLE 8
TERM & TERMINATION
8.1 Term. Unless earlier terminated in accordance with Section 8.2 below, this
Agreement shall continue in effect for a period of six (6) months from the date
of the signing of this Agreement (the "Test Period") as a non-exclusive license
and lease of the Colormate(Registered) II System
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and Technology. If sales of the Products are deemed successful during the Test
Period of this Agreement, then the term of this Agreement may be renewed until
December 31, 1999 upon terms mutually agreeable to both parties. Thereafter this
Agreement may be renewed annually for a period of one year on January I of each
subsequent year, and expanded to additional Nordstrom stores by written notice
given by Nordstrom to Chromatics thirty (30) days before January 1 of the
renewal year for a total additional period of five (5) years under terms
mutually acceptable to both parties. Sale of such Products will be deemed
successful if one-third of the quantities purchased in the initial order as
specified in Section 3.3 are sold during the term of this Agreement.
8.2 Termination Events. This Agreement may be terminated upon the occurrence of
any of the following events:
8.2.1 The parties may, at any time, mutually agree to terminate this
Agreement, such termination to be effective at such time as they deem
appropriate, however, Nordstrom will be responsible to Chromatics for
all payments in Sections 3.2, 3.3, 3.4, 6.1 and 6.2. Lease payments for
the Colormate(Registered) II System will be prorated to date of
termination.
8.2.2 Upon the breach or the discovery of a breach of a warranty set
forth in Article 5, either party may terminate this Agreement by
notice, to take effect immediately upon receipt thereof by the other
party, unless otherwise specified in the notice.
8.2.3 If either party makes any transfer in violation of Section 11.2,
the non-transferring party shall have the right to terminate this
Agreement immediately by giving written notice to the transferring
party.
8.2.4 If either party fails to perform any of its obligations or
covenants contained in this Agreement and fails to cure such default
within thirty (30) days after notice from the other party, the party
giving such notice shall have the right to terminate this Agreement
immediately by giving written notice to the defaulting party. Absence
of a notice of default or of a written notice of termination under this
Section shall not constitute a waiver of any rights arising as a result
of such default. An election to terminate the Agreement under this
Section shall not constitute a waiver of any damages that may be
available to the non-breaching party as a result of the default by the
other party.
8.3 Rights and Obligations of Termination.
8.3.1 Upon the expiration of this Agreement, Nordstrom shall return the
Colormate(Registered) II System units in good and working condition to
Chromatics, or pay for repair or replacement of any damaged unit.
8.3.2 Upon the termination of this Agreement, all right, title, and
interest in any Marketing Intangibles owned by Nordstrom shall remain
exclusively with Nordstrom.
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8.3.3 During the term of this Agreement (with the exception of the
non-exclusive six month license granted herein) and upon the
termination of this Agreement, all right, title, and interest in the
Technology, Colormate(Registered) II System, Product Color
Recommendations and Product Color Formulations, all of which have been
developed or are owned by Chromatics shall remain exclusively with
Chromatics.
8.4 In the event that the six month term of this Agreement is not renewed and a
customer who purchased from Nordstrom during the six month term of this
Agreement a Product of a particular shade recommended for that customer by the
Technology in the Colormate(Registered) II System wishes to purchase a Product
of the same particular shade after termination of this Agreement, Nordstrom
shall purchase the Product of that particular shade from Chromatics at the same
or a comparable cost at which the Product of that particular shade was
originally purchased from Chromatics unless (i) Chromatics is unable or
unwilling to provide the Product of that particular shade, or (ii) Chromatics
has been acquired by another company, in either event of which Nordstrom shall
have the right to have that cosmetic product of a shade matching that particular
shade of Product made for it by any party other than Chromatics and the right to
sell that matched cosmetic product solely to the customer who purchased the
Product of that particular shade during the six month term of this Agreement so
as to continue to serve that particular customer. Nothing in this paragraph or
this Agreement shall limit or restrict Nordstrom's rights to purchase cosmetic
products from others or to sell cosmetic products which compete with the
Products licensed under this Agreement as long as the sale of such competitive
cosmetic products by Nordstrom is not a breach of this Agreement, including
Exhibit B.
ARTICLE 9
REASONABLE PRECAUTIONS TO MAINTAIN SECRECY
9.1 Precautions. Nordstrom shall treat all Chromatics' Confidential Information
as provided in the "Confidential Agreement" attached as Exhibit B and shall use
the Confidential Information solely as specified in the Confidential Agreement
and in this Agreement and solely during the term of this Agreement or as
expressly provided for in Section 8.4 herein.
9.2 Survival. This Article 9 shall survive the termination of this Agreement,
regardless of the reason for such termination.
ARTICLE 10
INDEMNIFICATIONS
10.1 Indemnification. Chromatics shall defend (with counsel acceptable to
Nordstrom), indemnify, and hold Nordstrom harmless from any and all claims,
suits, liabilities, damages, losses or expenses, including attorneys' fees,
asserted against or incurred by Nordstrom by reason of, or arising out of, or
occurring in connection with any infringement or alleged infringement of
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intellectual property resulting from the use of the Technology and the
Colormate(Registered) II System or the manufacture, sale or use of the Products
(other than the Marketing Intangibles) by Nordstrom. In the event that Nordstrom
learns of any infringement or threatened infringement by the Technology and the
Colormate(Registered) II System, Nordstrom shall notify Chromatics forthwith.
Nordstrom agrees to cooperate and provide necessary information and assistance
to Chromatics at Chromatic's expense for actions that Chromatics may take to
defend Chromatics proprietary interest in the Technology and the
Colormate(Registered) II System. Chromatics agrees that Nordstrom may maintain
records of Chromatics compliance with the representations and warranties of
Chromatics made in this Agreement or otherwise, and that Nordstrom may at any
time, upon reasonable notice to Chromatics, undertake inspection of Chromatic's
manufacturing facilities for foundations, excluding lipsticks and equipment, in
order to determine such compliance with subsection 5.5 herein. The lipsticks
provided pursuant to this Agreement are ready for shipment and any inspection of
such lipsticks is limited to the finished product.
10.2 Indemnification. Nordstrom shall defend (with counsel acceptable to
Chromatics), indemnify and hold Chromatics harmless from any and all claims,
suits, liabilities, damages, losses or expenses, including attorneys' fees,
asserted against or incurred by Chromatics by reason of, or arising out of, or
occurring in connection with any infringement or alleged infringement of
intellectual properties resulting from the use of the Marketing Intangibles for
the sale of Products by Nordstrom. In the event that Chromatics learns of any
infringement or threatened infringement by Marketing Intangibles, Chromatics
shall notify Nordstrom forthwith. Chromatics agrees to cooperate and provide
necessary information and assistance to Nordstrom at Nordstrom's expense for
actions that Nordstrom may take to defend Nordstrom's proprietary interest in
the Marketing Intangibles.
10.3 Survival. This Article 10 shall survive the termination of this Agreement,
regardless of the reason for such termination.
ARTICLE I 1
GENERAL PROVISIONS
11.1 Governing Law. This Agreement, and any disputes arising out of or in
connection with this Agreement, shall be governed by and construed in accordance
with the laws of the state of Washington.
11.2 Assignment. Neither party shall have the right or the power to assign,
delegate, or otherwise transfer any or all of its rights or obligations arising
under this Agreement without the prior written consent of the other party. The
transfer, assignment, or change in the beneficial ownership of stock or voting
control of Chromatics in the aggregate in excess of 50% shall constitute an
assignment hereunder.
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11.3 Legal Expenses. The prevailing party in any legal proceeding brought by one
party against the other party to this Agreement, and arising out of or in
connection with this Agreement, shall be entitled to recover its legal expenses
including costs and reasonable attorneys' fees.
11.4 Force Majeure. Neither party shall be liable to the other party for any
delay or omission in the performance of any obligation under this Agreement,
other than the obligation to pay monies, where the delay or omission is due to
any cause or condition beyond the reasonable control of the party who is obliged
to perform.
11.5 Purchase Order. The terms and conditions of Nordstrom's purchase order,
attached hereto as Exhibit A, shall be incorporated herein by reference. To the
extent of any inconsistency, the terms and conditions of the purchase order
shall override the specific terms of this Agreement. Subsection 10 of the
purchase order attached hereto as Exhibit A is deleted from this Agreement.
11.6 Notices. All notices required by this Agreement shall be in writing and
sent by facsimile and by certified U.S. mail, postage prepaid, return receipt
requested to Chromatics or Nordstrom at their addresses as listed herein, or to
such addresses as either party may from time to time advise the other party in
writing in accordance with this notice requirement.
To Chromatics: To Nordstrom:
Chromatics Color Sciences Nordstrom, Inc.
International, Inc. 1617 6th Ave., Suite 500
5 East 80 St. Seattle, WA 98101
New York, NY 10021 Attn: Dale Crichton
Attn: Darby Macfarlane
Tel. No.: (212) 717-6544 Tel. No.: (206) 628-1118
Fax No.: (212) 717-6675 Fax. No.: (206) 628-1105
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the 1st day of September, 1998.
Chromatics Color Sciences. Nordstrom, Inc.
International, Inc.
BY: /s/ Darby Macfarlane BY: /s/ Dale C. Crichton
------------------------ ---------------------
Darby S. Macfarlane Dale C. Crichton
Chief Executive Officer Executive Vice President
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EXHIBIT A
NORDSTROM
TERMS AND CONDITIONS OF PURCHASE ORDER
The following terms and conditions, in addition to those on the front hereof,
are a part of this purchase order and are binding upon Seller.
ACCEPTANCE BY SELLER IS LIMITED TO THE TERMS OF THIS PURCHASE ORDER. PURCHASER
OBJECTS TO ANY DIFFERENT OR ADDITIONAL TERMS IN SELLER'S ACCEPTANCE OR ANY OTHER
DOCUMENT OR FORM TRANSMITTED ON BEHALF OF SELLER, UNLESS PURCHASER'S WRITTEN
CONSENT IS FIRST OBTAINED.
1. This order is not valid unless signed or otherwise authorized in writing by
the Purchaser's buyer and, when applicable, by Purchaser's Merchandise Manager.
2. Purchaser will not assume liability for any goods shipped to it or upon which
work is commenced by Seller prior to receipt by Seller of the order duty signed
or otherwise authorized.
3. In the event Seller is unable to deliver any part or all of the merchandise
called for by this order, Seller agrees to notify the Purchaser immediately.
Such notice will not limit the remedies available to Purchaser or the liability
of Seller for nonperformance.
4. Purchaser or Purchaser's agent may refuse delivery or return F.O.B.
Purchaser's dock:
a. Shipments made before the earliest ship date or after the cancel
date specified on the face of this order, time of shipment being
of the essence of this order.
b. Shipments of less than or in excess of quantities ordered.
c. Goods which are not according to sample or which are not specified
in this order.
d. Goods which are not as represented or as warranted.
e. Shipments which are not in compliance with the packing
instructions and invoicing instructions specified on the face of
this order.
f. Shipments which are not in compliance with the transportation
terms and conditions contained in this order or in the Nordstrom
Routing Guide.
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g. Goods which for any reason, except payment of applicable duties
and tariffs, will not be cleared for entry by U.S. Customs.
5. All goods furnished under this order shall be subject to inspection and
testing by representatives of Purchaser, its customers or agents. Payments for
goods prior to inspection shall not constitute acceptance and Purchaser reserves
the right to hold for Seller or return to Seller, at Seller's expense, any
rejected goods.
6. Seller warrants that the merchandise shipped under this order is fit and safe
for the use for which it was manufactured and that said merchandise or the
resale thereof by Purchaser does not and will not violate any laws, regulations,
orders or ordinances of the country of origin or of the United States or any
state or any agency or political subdivision thereof.
7. Seller warrants that it does not and will not in violation of applicable law,
custom or practice (a) discriminate in hiring on the basis of race, color,
national origin, gender, religion or sexual orientation, or (b) utilize child
labor, prison labor or indentured or force labor in the operation of its
business.
8. Seller warrants that the merchandise shipped under this order, including
packaging and labeling: (a) was produced in compliance with all applicable laws,
regulations, orders and ordinances of the country of origin and of the United
States and any state, or any agency or political subdivision thereof, including
without limitation any environmental or hazardous substance laws and
regulations, the Federal Fair Labor Standards Act and other state and local wage
and hour and wage payment laws and regulations; (b) does not and will not
infringe any patent, trademark, trade name, copyright, trade secret or other
similar right; (c) is accurately labeled and clearly identifies the country of
origin; and (d) is labeled in accordance with and complies in all respects with
any and all applicable federal, state and local laws, regulations, orders and
ordinances, including without limitation any applicable rules of the Federal
Trade Commission, the Consumer Products Safety Commission and the Department of
Health, Education and Welfare and the requirements of each of the following Acts
to which it may be subject: The Federal Food, Drug and Cosmetic Act, the Wool
Products Labeling Act of 1939, the Fair Packaging and Labeling Act, the Fur
Products Labeling Act, the Textile Fiber Products Identification Act, the
Federal Hazardous Substances Act and the Flammable Fabrics Act.
9. Seller agrees to defend (with counsel acceptable to Purchaser), indemnify and
save harmless the Purchaser from any and all claims, suits, liabilities,
damages, losses or expenses, including attorneys' fees, asserted against or
incurred by Purchaser by reason of, or arising out of or occurring in connection
with (a) any breach or alleged breach of any of the terms of conditions of this
order or any representations or warranties of Seller made in this order or
otherwise, (b) any act or omission of Seller, or the servants, agents or
subcontractors of Seller, in the furnishing of goods in the performance of work
hereunder, or (c) the use of Seller's merchandise by customers of Purchaser or
others. Seller agrees that Purchaser may maintain records of Seller's compliance
with the representations and warranties of Seller made in this order or
otherwise and that
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Purchaser may at any time, upon notice to Seller, undertake inspection of
Seller's facilities in order to determine such compliance.
10. The prices herein specified are guaranteed by Seller against manufacturer's
or Seller's own price decline and against legitimate competition until date of
shipment. In the event that prior to final shipment under this order Seller
sells or offers to sell to others goods substantially of the same kind as
ordered herein at lower prices and/or on terms more favorable to a third party
than those stated in this order, the prices and/or terms herein shall be
automatically revised to equal the lowest prices and/or most favorable terms at
which Seller shall have sold or shall have offered such goods and payment shall
be made accordingly. In the event Purchaser shall become entitled to such lower
prices, but shall have made payment at any price in excess thereof, Seller shall
promptly refund the differences in price to the Purchaser. Seller agrees to meet
the price of legitimate competition or accept cancellation of this order by
Purchaser. Unless otherwise provided in this order, prices include all charges
for packaging, boxing, crating and freight, F.O.B. destination.
11. Purchaser reserves the right to cancel all or any part of this order which
has not actually been shipped by Seller in the event Purchaser's business is
interrupted because of strikes, labor disturbances, lockout, riot, fire, act of
God, or the public enemy, or any other cause, whether like or unlike the
foregoing, if beyond the reasonable efforts of the Purchaser to control.
12. A waiver of and/or failure to perform any one or more of the conditions of
this order shall not constitute a waiver of or an excuse for nonperformance as
to any other part of this or any other order.
13. All dating except "end of month" begins at the date on which the merchandise
is received. "Eng of month" terming for shipments received after the 25th of the
month will be considered next month's business. Discount terms begin with the
receipt of invoice or goods, whichever is later.
14. In addition to any other remedies available to Purchaser, failure to comply
with any terms and conditions of this purchase order or the Nordstrom routing
Guide will result in additional handling charges and expenses being charged to
Seller. In any dispute hereunder, whether or not litigation is commenced, the
prevailing party shall be entitled to its costs and expenses incurred, including
reasonable attorneys' fees. The rights and remedies herein expressly provided
shall be in addition to any other rights and remedies given by law, including
without limitation the right to recover all incidental and consequential
damages. All warranties, representations and guaranties made by Seller herein
are in addition to any and all expenses or implied warranties provided by law.
15. In the event of any proceeding, voluntary or involuntary, in bankruptcy or
insolvency by or against the Seller, including any proceeding under the United
States bankruptcy laws, or any bankruptcy, insolvency or receivership laws of
any state or any foreign country, or any political
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subdivision thereof or in the event of the appointment with or without Seller's
consent of a receiver or an assignee for the benefit of creditors, Purchaser
may, at its option, cancel this order as to any undelivered portion of the
merchandise.
16. Seller agrees that it will not use any trademark or trade name of Purchaser,
including but not limited to "Nordstrom, "Nordstrom Rack," "Place Two," and
"Nordstrom Factory Direct" except in connection with merchandise shipped to
Purchaser in accordance with this order. Seller agrees that all trademarks and
trade names of Purchaser belong to Purchaser and Seller will make no claim of
ownership nor attempt to register any such trademark or trade name. Seller
agrees that merchandise rejected or returned for any reason pursuant to the
terms of this order, whether or not such rejection is disputed by Seller,
including but not limited to merchandise rejected or returned due to shipment
after the cancel date specified on the face of this order, will not be resold or
otherwise distributed by Seller unless all labels, tags, logos, monograms and
other items or characteristics identifying Nordstrom, Nordstrom Rack, Place Two,
Nordstrom Factory Direct, or any other trademark or trade name of Purchaser have
first been removed.
17. This order and the rights and obligations of the parties hereunder shall be
determined in accordance with the laws of the State of Washington and shall not
be subject to or governed by the U.N. Convention on Contracts for the
International Sale of Goods. If litigation arises hereunder or as a consequence
of any transaction contemplated or resulting from this or either party's
performance or breach thereof, jurisdiction and venue of such litigation shall
be in the Superior Court for the State of Washington for King County, or the
United States District Court for the Western District of Washington in Seattle,
at the option of Purchaser, and Seller hereby consents to such jurisdiction and
venue. Any award or judgment of any of said counts may be entered and enforced
in any other domestic or foreign court of competent jurisdiction, and shall be
awarded full faith and credit.
18. No claim, action or demand arising out of the transactions under this order
may be brought by Seller more than one year after the cause of action has
accrued.
19. Seller hereby assigns to Purchaser all assignable warranty rights with
respect to the merchandise in this order, including without limitation all
rights of Seller under warranties of any manufacturer of any of the merchandise
or any part or component thereof.
20. This order is enforceable by Purchaser directly against Seller, regardless
of whether the order was submitted directly to Seller by Purchaser or was
submitted to Seller by another party on behalf of Purchaser. No such other party
shall have any authority to act for Purchaser, bind Purchaser to any agreements
or modifications or otherwise act as agent for Purchaser.
Transportation Terms and Conditions
A. Routing mode specified on face of purchase order must be adhered to exactly
unless permission to deviate is given by Purchaser's Traffic Manager or Buyer,
or if there is a written
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agreement or exception signed by Purchaser on file. Authorized carrier selection
should be made from Nordstrom Routing Guide. Any questions should be directed to
the Regional Traffic Department. For questions concerning foreign shipments,
please contact the Corporate Traffic and Distribution Office.
B. Orders shipped F.O.B. city of purchase or any specific city and/or state will
be delivered free of charge to Purchaser's consolidator and will be considered
F.O.B. consolidator. Advance charges to the consolidation point will be Seller's
expense.
Orders shipped F.O.B. factory will not be free of charge to Purchaser's
consolidator and freight charges will be the responsibility of the Purchaser
from the shipper's door.
Orders shipped F.O.B. store will be delivered free of charge to Purchaser's
receiving facility and total freight charges will be at Seller's expense.
Notwithstanding any agreement to pay freight or other transportation charges,
delivery will not be deemed complete and all risk of loss shall remain with
Seller until the goods have been actually received and accepted by Purchaser.
C. All C.O.D. shipments will be refused.
D. For all domestic shipments:
(i) in addition to any other remedies available to Purchaser, any deviation
from the terms of this order or the Nordstrom routing Guide will result in
chargebacks to Seller for freight expenses and handling charges.
(ii) Merchandise must be packed, shipped and described on bills of lading in
accordance with applicable freight tariffs, and shipment must be without
declared value except when shipping Parcel Post or UPS prepaid. Any deviation
will result in a chargeback to Seller.
(iii) Enter all packages forwarded during the same day to the same final
destination on one bill of lading or airbill. If more than one page is
needed, label "1 of 2", "2 of 2," etc., and include total weight and number
of cartons only on the last page of the bill of lading or airbill. If
shipping to several final destinations, a separate bill of lading must be
filled out for each address.
(iv) Prepaid shipments: All shipments to Purchaser via motor freight must be
sent "collect," except Parcel Post and UPS shipments, which by their nature
must be sent "prepaid." Purchaser will not reimburse Seller for "prepaid"
shipments via motor and air freight.
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(v) Shipping surface: Articles not authorized for air shipment must follow
Purchaser's shipping instructions for surface. Seller is responsible for
marking "surface" on the top of general bill of lading. An air bill which is
used for surface shipment must have the special services requested box
marked.
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EXHIBIT B
CONFIDENTIALITY AGREEMENT
This Agreement made this ____ day of September 1998, is between
Chromatics Color Sciences International, Inc. ("Chromatics"), and Nordstrom,
Inc. ("Nordstrom").
WHEREAS, Chromatics owns technology and information relating to skin
and cosmetic product color analysis and custom color formulations of cosmetics
so that the color of various cosmetic products can be coordinated to each other
and to skin color, which is not disclosed in Chromatics' patents or publications
or by a Product sold to an individual customer as recommended by the
Color-Mate(Registered) II system, and which Chromatics considers to be
confidential, proprietary and secret in nature, hereinafter referred to as the
"Confidential Information."
WHEREAS, Nordstrom acknowledges and recognizes the need to preserve the
confidential nature of the Confidential Information.
WHEREAS, Chromatics desires to disclose certain portions of the
Confidential Information to Nordstrom under the following terms and conditions.
NOW, THEREFORE, in consideration of the foregoing and the mutual
covenants and agreements contained herein, the parties hereto agree as follows:
1. Chromatics shall disclose the Confidential Information to Nordstrom in
confidence solely for the purpose of permitting Nordstrom to use and evaluate
the Confidential Information in accordance with the License Agreement entered
into by the parties concurrently herewith. Nordstrom shall be under an
obligation to treat as confidential and maintain in confidence the Confidential
Information disclosed by Chromatics to Nordstrom, provided such information is
(a) disclosed in written form and marked prominently as "Confidential", or (b)
if not disclosed in written form, is identified and designated as confidential
in a written notice received by Nordstrom within ten (10) business days of the
disclosure. Nordstrom shall take all precautions reasonably necessary to prevent
any unauthorized disclosure of the Confidential Information.
2. Nordstrom may disclose the Confidential Information disclosed by Chromatics
to those of its employees or independent agents whose access to the Confidential
Information is necessary in order to carry out the purpose of the aforesaid
License Agreement; provided, however, that prior to any such disclosure (a)
Nordstrom informs the employee or independent agent that the disclosure is of
Confidential Information and is subject to the obligations of confidentiality
and non-use set forth in this agreement and (b) Nordstrom obtains from such
employee or independent agent a written undertaking, in the form annexed hereto,
to comply with those obligations with respect to all Confidential Information
that comes into the employee's or independent agent's possession.
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3. Nordstrom shall not (a) directly or indirectly disclose or otherwise make
available to any third party the Confidential Information disclosed by
Chromatics to Nordstrom, in whole or in part; (b) permit any third party access
to any portion of the Confidential Information; or (c) use the Confidential
Information for any purpose other than the purpose of the aforesaid License
Agreement, without the prior written consent of Chromatics.
4. Nordstrom shall not copy, duplicate or otherwise replicate any of the
Confidential Information disclosed by Chromatics to Nordstrom, in whole or in
part, for any purpose other than the purpose of the aforesaid License Agreement,
without the prior written consent of Chromatics.
5. Upon the request of Chromatics, Nordstrom shall return to Chromatics all
tangible materials provided by Chromatics to Nordstrom, and shall certify to the
destruction of any writings, data, reports, records, plans, correspondence,
notes or memoranda of conversations, discussions, considerations or evaluations
which contain or summarize Confidential Information, including all copies and
all electronic, magnetic or other records thereof, within thirty (30) days after
Chromatics' request for their return and/or destruction.
6. The obligations of confidentiality and non-use set forth in this agreement
shall not apply to information which (a) was known to Nordstrom prior to
disclosure by Chromatics to Nordstrom, as evidenced by written records dated
prior to such disclosure, and was not acquired directly or indirectly from
Chromatics; (b) was publicly available or generally known in the trade at the
time of disclosure by Chromatics to Nordstrom, or becomes publicly available or
generally known in the trade after the disclosure by Chromatics to Nordstrom
through no act or fault of Nordstrom; (c) was rightfully received by Nordstrom
from a third party whose disclosure to Nordstrom did not violate any obligation
of confidentiality owed directly or indirectly to Chromatics; or (d) is
independently developed by or for Nordstrom and such independent development can
be shown by clear and convincing evidence. The fact that Nordstrom may be
relieved of its obligations of confidence under subparagraphs (a), (c) or (d)
above shall not prevent Chromatics from continuing to claim in its dealings with
third parties unrelated to Nordstrom or Nordstrom's suppliers or customers, in
appropriate situations, that the effected information remains confidential or
proprietary to Chromatics.
7. In the event that Nordstrom is requested or becomes legally compelled (by
oral questions, interrogatories, requests for information or documents,
subpoena, criminal or civil investigative demand or similar process) to disclose
any Confidential Information (including disclosures to regulatory agencies such
as the FDA), Nordstrom will, to the extent it is aware of such fact, provide
Chromatics with prompt written notice of such requirement and use reasonable
efforts to obtain a protective order or other appropriate remedy. Nordstrom also
agrees to cooperate with and assist Chromatics in any efforts it may make to
seek a protective order or other appropriate remedy. In the event that such
protective order or other remedy is not obtained, Nordstrom shall furnish only
that portion of the Confidential Information which it is advised in writing by
counsel of its choice it is legally required to furnish.
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IN WITNESS WHEREOF, the parties have caused this agreement to be
executed as of the date first written above.
Chromatics Color Sciences
International, Inc. Nordstrom, Inc.
BY: /s/ Darby S. Macfarlane BY: /s/ Dale C. Crichton
------------------------ -------------------------
Darby S. Macfarlane Dale C. Crichton
TITLE: Chief Executive Officer TITLE: Executive Vice President
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UNDERTAKING
OF _______________________________
I, ________________________________________________ , state that:
1. My residence address is ________________________________________________.
My present employer is _________________________________ and the address
of my present employer is ___________________________________. My present
occupation is _____________________________________.
2. I have received a copy of the Confidentiality Agreement between Chromatics
Color Sciences International, Inc. ("Chromatics") and Nordstrom, Inc.
("Nordstrom"), dated September __, 1998 ("the Confidentiality Agreement").
I have carefully read and understand the provisions of the Confidentiality
Agreement.
3. I will comply with all of the obligations set forth in the Confidentiality
Agreement, including those relating to confidentiality and non-use with
respect to the Confidential Information that comes into my possession.
----------------------------------------
Signature
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EXHIBIT 10.25
AGREEMENT
This Agreement effective as of December ___, 1996 is by and between
Gordon Laboratories, Inc. ("Gordon"), and Chromatics Color Sciences
International, Inc. ("Chromatics).
WHEREAS, Chromatics has designed and developed a device which analyzes
a consumer's skin tone and may be programmed to recommend the foundation
cosmetic shades best suited for each particular skin tone (the "Colormate
System");
WHEREAS, Gordon and Chromatics desire to utilize Chromatics's technical
expertise in the programming and operation of Colormate Systems for custom
blended cosmetic foundations, all of which shall remain the property of
Chromatics.
WHEREAS, the parties intend to set forth the terms and conditions under
which Chromatics will make available pursuant to the terms hereof the Colormate
System for use in a field test retail program as described herein.
Capitalized terms used herein and not otherwise defined shall have the
meaning ascribed thereto in Schedule 1 hereto.
NOW, THEREFORE, in consideration of the mutual covenants and terms
herein set forth, the parties agree as follows:
I. Colormate System Lease; Technology License
1. Unless sooner terminated pursuant to the terms hereof, the term of
this Agreement will be from the date hereof until six months after the later of
the date (i) Chromatics first notifies Gordon in writing that twenty (20)
Colormate Systems are immediately available for shipment for use in the Field
Test (the "Ship Notice"), (ii) that Gordon provides the "Final Samples" (as
defined in Article II), and (iii) that Gordon provides the twenty (20) Custom
Blended Foundation Cosmetic Product Dispensing Systems. During the term of this
Agreement, Chromatics shall lease for a term not to exceed the earlier of (i)
six months from the date of the lease and (ii) the date of termination of this
Agreement or the Field Test to Gordon's customers approved in writing by
Chromatics ("Gordon Approved Customers"), pursuant to lease documentation
satisfactory to Chromatics, a total of twenty (20) portable briefcase Colormate
Systems. In consideration of providing such Colormate Systems, Chromatics shall
receive from the "Budget Account" and pursuant to the "Budget" six equal
payments of $1,667 each on the first day of each month during the term hereof
commencing with the first day of the month following the month in which
Chromatics delivers the Ship Notice. Gordon Approved Customers will not be
charged any lease or rental fee under such leases for the use of the Colormate
Systems during the Term of the Field Test. The Colormate Systems will be
available for use by the date of the Ship Notice and will be shipped from
Chromatics directly to the Customer Location. One Colormate System shall be
provided by Chromatics for each Customer Location and shall be used pursuant
<PAGE>
to the lease solely at such Customer Location and shall not be used at any other
location without prior written consent of Chromatics. The leases shall expressly
provide that the Colormate Systems shall be returned directly to Chromatics at
the earlier of conclusion of the Field Test, the expiration of the Lease or the
termination of this Agreement.
2. Beginning on the date of the signing of this Agreement and
continuing until six months after the later of the date (i) of the Ship Notice,
(ii) Gordon provides the Final Samples, and (iii) Gordon provides the twenty
(20) Custom Blended Foundation Cosmetic Product Dispensing Systems, unless
sooner terminated pursuant hereto, Chromatics agrees to grant to Gordon a
non-exclusive license solely in the contiguous states of the United States of
America for the Colormate Systems, "Software" (as defined in Article II
paragraph 1 below) and "Foundation Products Color Formulations" solely for use
in the marketing, distribution and sale to Gordon Approved Customers in the
"Specialty Store Market" at Customer Locations of Foundation Cosmetic Products
manufactured directly by Gordon for Chromatics under the terms specified in this
Agreement for a Field Test as described herein.
The Colormate Systems, Software and Foundation Product Color
Forumlations shall remain the property of Chromatics. Gordon acknowledges and
agrees that the Colormate Systems, Software, and Foundation Products Color
Formulations may not be used in any manner whatsoever by Gordon or by Gordon
Approved Customers other than in the Field Test, and may not be used
independently of each other. In this regard, and by way of example but without
limitation, the Foundation Products Color Formulations may not be used in any
manner whatsoever other than in conjunction with formulation and manufacture of
the Foundation Cosmetics Products for distribution in the Field Test, the
Software may not be used in any manner whatsoever other than in conjunction with
the Colormate System for marketing efforts in the Field Test, and the Colormate
System and Software may not be used in any manner whatsoever other than in
conjunction with making analyses and recommendations in the sale of the
Foundation Cosmetic Products in the Field Test. Under no circumstances may the
Colormate System, Software or Foundation Product Color Formulations be used to
develop, distribute, manufacture, market or sell any cosmetic product other than
the Foundation Cosmetic Product for sale in the Field Test. Gordon shall have no
right to subcontract, submanufacture, or otherwise retain any third party to
manufacture the Foundation Cosmetic Products, and shall not sublicense, assign,
pledge, transfer or dispose of in any manner whatsoever the license or any
portion thereof granted by Chromatics hereunder.
3. Beginning on the latest of the date of the Ship Notice, the date
Gordon provides the Final Samples, and the date Gordon provides the twenty (20)
Custom Blended Foundation Cosmetic Product Dispensing Systems, and continuing
for six months thereafter (the "Field Test"), Chromatics shall have available
for lease twenty (20) Colormate Systems, appropriately programmed with the
Software to recommend Foundation Cosmetic Products manufactured solely by Gordon
for Chromatics as required by paragraph 1 of Article II hereof, to Gordon
Approved Customers at the Customer Locations based on mutually agreed on
criteria. Gordon shall arrange for the schedules and on-site training in the
operation of the Colormate Systems of
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the Gordon Approved Customers personnel at the Customer Locations at Gordon's
sole cost and expense (but reimbursable as set forth in the Budget), utilizing
up to two (2) Gordon personnel so trained by Chromatics in the operation of the
Colormate Systems. Chromatics shall use its best efforts to so train such Gordon
personnel prior to the date of the Ship Notice. Chromatics shall not be paid any
additional compensation for training up to two (2) such Gordon personnel
(provided, however, that the Budget will provide for travel and expenses
incurred by Chromatics in training such Gordon personnel); any additional
training requirements or the training of additional personnel shall be at rates
to be agreed upon by the parties. Prior to any disclosure of any confidential
information of Chromatics, including, without limitation, any confidential
information contemplated by Article IV hereof, Gordon shall cause those of its
personnel and those of the Gordon Approved Customers receiving such training, to
enter into confidentiality agreements with Chromatics in the form annexed as
Schedule 2 hereto, and the lease agreement between Chromatics and Gordon
Approved Customers.
II. Field Test
1. On or before 30 days from the date hereof, Gordon shall provide
Chromatics with samples and specifications of basic Foundation Product
Formulations to be included in the Field Test, which Foundation Product
Formulations must be approved by Chromatics. Chromatics shall be entitled to
unilaterally terminate this agreement without penalty pursuant to Article VI
hereof by written notice to Gordon if such basic Foundation Product Formulations
have not been delivered by Gordon and approved by Chromatics within 60 days of
the date hereof. Upon approval, Chromatics shall perform chromaticity studies at
Chromatics' expense on the sample to determine the appropriate color
compatibilities ("Chromaticity Studies"). Upon completion of the Chromaticity
Studies (approximately three (3) months), Chromatics shall provide to Gordon a
written report of Foundation Product Color Formulations which report and
Foundation Product Color Formulations shall remain the property of Chromatics.
Promptly following receipt of such written report (but in no event later than 30
days from such receipt, plus an additional 30 days grace period), Gordon shall
provide to Chromatics, for review and approval by Chromatics, such number of
samples and reformulation of each Foundation Product Formulation as Chromatics
may request, until such samples shall meet Chromatics' specifications for the
Foundation Product Color Formulations (the "Final Samples"). Gordon shall not
manufacture quantities of any Foundation Cosmetic Products unless and until it
has received written notice from Chromatics that, based on the Final Samples,
all Foundation Product Formulations meet Chromatics, specifications. Chromatics
shall give, Gordon the Ship Notice within 30 days (plus an additional 15 days
grace period) of Chromatics receipt of the Final Samples. If Gordon fails to
deliver and have available twenty (20) Custom Blended Foundation Cosmetic
Product Dispensing Systems by the date of the Ship Notice, or fails to provide
Chromatics within thirty (30) days (plus an additional 30 days grace period)
following delivery to Gordon of the written report regarding the Chromaticity
Studies (but in no event later than the date of the Ship Notice) with Final
Samples for all Foundation Product Formulations that meet Chromatic's
specifications, Chromatics shall have the right, to unilaterally terminate this
Agreement pursuant to Article VI hereof without penalty or liability to either
party by written notice to Gordon. In the event that Chromatics has
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not completed the Chromaticity Studies by April 1, 1997 (plus an additional 15
(days grace period), or delivered the Ship Notice within 30 days (plus an
additional 15 days grace period) of receipt of the Final Samples, either
Chromatics or Gordon may unilaterally terminate this Agreement without penalty
or liability to either party pursuant to Article VI hereof on written notice to
the other. All Foundation Cosmetic Product manufactured by Gordon under the
terms of this Agreement will bear the label of Chromatics and will remain the
property of Chromatics. Gordon shall manufacture the initial inventory of
Foundation Cosmetic Product to implement the Field Test, together with, at no
additional cost, the bottle, cap, label and packaging, at a price of $1.25 per
ounce of Foundation Cosmetic Products, payable solely from the Budget Account
(but in an amount not to exceed $8,650) except as set forth in the last sentence
of the next paragraph. Gordon shall manufacture additional quantities of such
inventory and such related materials as agreed upon by both parties to be needed
to implement the Field Test at the same per ounce cost, payable from the Budget
Account.
The suggested wholesale price and retail resale price and other terms
of sales of the Foundation Cosmetic Products to be offered to Gordon Approved
Customers and their customers, respectively, to the extent not specifically set
forth herein, shall be mutually agreed upon by Gordon and Chromatics, including
without limitation providing written instructions directing such Gordon Approved
Customers to direct payment for Foundation Cosmetic Products invoiced by Gordon
to the Budget Account. At the end of the Field Test Chromatics will purchase
from Gordon all remaining inventory of Foundation Cosmetic Products manufactured
by Gordon under the Budget at a cost of $.625 per ounce of Foundation Cosmetic
Products, together with at no additional cost the bottle, cap, label and
packaging, dispenser and customer support/sales materials used in connection
with the Field Test, but only to the extent that (i) the foregoing have not been
invoiced to Gordon Approved Customers, (ii) any such purchase by Chromatics does
not exceed $4,325 in the aggregate, (iii) that the funds remaining in the Budget
Account are not sufficient therefor, and (iv) any such amount to be paid to
Gordon by Chromatics is in excess of amounts otherwise to be paid to Chromatics
pursuant hereto as contemplated by the Budget.
Chromatics shall develop software proprietary to Chromatics
recommending appropriate shades of the Foundation Cosmetic Products based on
skin tone (the "Software") for distribution and installation in the Colormate
Systems. The Software will provide a custom color formulation for each skin tone
that may be custom blended (pigments mixed with the basic Foundation Product
Formulation colors). At the conclusion of the Field Test, Chromatics shall
receive from the Budget Account and pursuant to the Budget in consideration of
developing and programming such Software the sum of $10,000.
2. During the Field Test, Chromatics' at its cost and expense shall
maintain and keep in good working order all Colormate Systems used in this test,
providing such maintenance is required as a result of normal wear and tear. Each
Gordon Approved Customer will insure, pursuant to the terms of the Chromatics
lease, the Colormate System for damage or replacement under their existing
policies and Chromatics will be named the beneficiary and loss payee under
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these policies for this purpose. Each Colormate System also will be insured
while shipping for its replacement cost of $3,500.00 per System; payable to
Chromatics, and the cost of all such shipping and insurance will be paid from
the Budget Account in conformity with the Budget. In the event any Colormate
System is damaged for reasons other than normal wear and tear then Chromatics
shall be reimbursed from the insurance carrier.
3. During the term of this Agreement, Gordon shall provide the
following promotional, marketing, distribution, formulations, research and
merchandising functions for the consideration indicated below, payable solely
from the Budget Account and as set forth in the Budget as being payable to
Gordon:
a) Design, develop and provide prior to the date of the Ship
Notice in quantities necessary, (but in no event fewer than
twenty (20)), point of sale packaging and custom blending
dispensing system as approved in writing by Chromatics (the
"Custom Blended Foundation Cosmetic Product Dispensing
System") for Foundation Cosmetic Products to be used at
Customer Locations, for consideration as set forth in the
Budget (Item #10) (and not in excess of $4,375 in the
aggregate).
b) Provide twenty (20) Customer Locations which will utilize the
Chromatics Colormate System and the Foundation Product Color
Formulations solely in connection with the sale, utilizing the
Custom Blended Foundation Cosmetic Product Dispensing System,
of Foundation Cosmetic Products as described herein solely at
each such Customer Location for the term of the Field Test,
without additional compensation.
c) Design and supply any supporting promotional literature, to be
approved by Chromatics, not to be unreasonably withheld for
consideration as set forth in the Budget (Item #2); provided,
however, that Chromatics shall in all events have final legal
approval.
d) Supply and distribute the Foundation Cosmetic Product, the
supporting promotional literature and the printer paper rolls
supplied by Chromatics for computer print-outs in quantities
as needed for each Customer Location during the Field Test,
without additional compensation. Gordon Approved Customers
shall pay to Chromatics $2.00 per roll for each additional
roll beyond the first such roll provided by Chromatics
e) Compile and tabulate research/sales data relating to the Field
Test as specified in Exhibit A, without additional
compensation other than that approved for personnel in the
Budget (Item #1).
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f) Provide in-store training for each Customer Location during
the Field Test, at Gordon's cost and expense (but reimbursed
as set forth in the Budget) (Items #1 and 6) and utilizing
Gordon personnel trained by Chromatics as described above.
g) Provide a name, logo and mechanical art work for the Colormate
Systems to be used at Customer Locations. Cost of producing
and installing this into the Colormate Systems will be paid to
Chromatics as provided in the Budget (Item #3).
h) Provide Foundation Cosmetic Product tester kits for each of
twenty (20) Customer Locations for consideration as provided
in the Budget (Item #11).
i) Provide two (2) Foundation Product Formulations in 10 basic
color formulations specified by Chromatics and up to 3 pigment
formulations specified by Chromatics (all of which are to be
approved by Chromatics and which remain the property of and
proprietary to Chromatics and for use only in this Field Test
and under the terms of this Agreement) for aggregate
consideration of $10,000 payable at the conclusion of the
Field Test (Item #13).
j) Coordinate distribution and sales support and overall customer
support during the term of the Field Test, without additional
compensation other than as provided in the Budget (Items #1,
2, 4, 6).
k) Manage overall activities of the Field Test as approved by
Chromatics, without additional compensation other than as
provided in the Budget (Items #1, 5). Disbursement of Budget
items requires joint signatures by Chromatics and Gordon.
4. If The Field Test has met the requirements set forth in Exhibit A
hereto, Chromatics and Gordon intend to enter into good faith negotiations to
establish a joint venture under terms acceptable to both parties and which shall
include the terms referenced in Exhibit C hereto, it being expressly
acknowledged that there are no other obligations or agreements of the parties
with respect to the formation of any joint venture or other business
arrangement.
III. Budget Matters
1. Chromatics and Gordon will each contribute $37,500.00 (the "Initial
Payment") to the Budget on the date which is 30 days prior to the date
Chromatics reasonably anticipates delivering the Ship Notice (as notified in
writing to Gordon by Chromatics), to jointly finance this Field Test. The Budget
for the use of these funds including use of any sales income received from the
Field Test is attached hereto as Exhibit B. Any sales income generated by the
Field Test in excess of Field Test expenses in the Budget and reimbursement to
be provided to the parties as set forth herein and pursuant to the Budget shall
be shared equally by Chromatics and Gordon. It
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is agreed by the parties that should there be less sales income than projected
in the Budget or no sales income received from the Field Test to contribute to
the Budget, then each of Gordon and Chromatics will pay, in equal amounts, up to
$5,234 each (the "Additional Payment").
2. In no event will either Gordon or Chromatics be responsible to pay
an amount in excess of the sum of the Initial Payment and the Additional Payment
unless mutually agreed upon in writing by both parties. Gordon shall be entitled
to make payments from the Budget Account to third parties in the amounts
specified as set forth in Exhibit D hereto ("Approved Payments"). Any payments
from the Budget Account other than Approved Payments (including, without
limitation, any payments to either Gordon, Chromatics or their respective
affiliates, other than (i) $8,650 to Gordon for initial inventory, (ii) $4,375
to Gordon for the Custom Blended Foundation Cosmetic Product Dispensing Systems,
(iii) $10,000 in 6 monthly installments of $1,667 to Chromatics for the
Colormate II Systems, and (iv) $2,500 to Chromatics for repackaging the
Colormate II Systems, which amounts shall be paid by Gordon without additional
consent of Chromatics) shall require the consent of both parties.
IV. Additional Limitations and Confidentiality
1. a) Gordon may not grant any rights in any Software, Colormate System
or any custom blended foundation (including without limitation any Foundation
Product Color Formulation) or any Foundation Cosmetic Product or system
utilizing any color formulations or systems of color formulations or pigments
provided or disclosed to Gordon by Chromatics or permit anyone else to take
credit for the invention, development or design of such Colormate Systems or
formulations or pigments without the prior written approval of Chromatics.
Gordon acknowledges that the Colormate System and the Software, including,
without limitation, the processes, Foundation Product Color Formulations,
pigments, custom blended foundation colors, Foundation Cosmetic Product, color
formulations or systems of color formulations or pigments, techniques, programs,
parts, methods, color chart and swatch pack colors, designs and ideas embodied
therein are the proprietary products of Chromatics (and any licensor to
Chromatics), shall remain the property of Chromatics (and any such licensor) and
are furnished on a strictly confidential basis, for use exclusively in the Field
Test provided herein and agrees that no other use shall be made thereof. No
title to or ownership of any of the same or any rights therein, including all
rights to patents, trade names and copyrights applicable thereto, or any copies
thereof, in whole or in part, shall be transferred to Gordon. In addition,
Gordon shall keep confidential and use only for the Field Test and under the
terms of this Agreement all of the kinds of following information;
1) Hardware design, parts, and integration.
2) All aspects of software for systems.
3) Foundation Product Color Formulation, Foundation
Color Pigments, Chromaticity Studies, including the
results of the Chromaticity Studies.
7
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4) Color Consultant Training Techniques.
2. a) Nothing in this Agreement will restrict Gordon in the use or
treatment of any of Chromatics' confidential information:
(a) which is freely available to the public on a
unrestricted basis and without violation of any
confidentiality obligations prior to the disclosure
of same by Chromatics to Gordon; or
(b) which can be shown by written contemporaneous records
to have been known to Gordon prior to the date of
disclosure by Chromatics to Gordon of the same; or
(c) after such Chromatics confidential information
becomes freely available to the public on an
unrestricted basis through no fault of Gordon.
This paragraph shall not limit any patent protection Chromatics may have.
V. Indemnity
1. Chromatics shall indemnify and hold Gordon harmless from and against
any and all actions, causes of action, claims, demands, liabilities, losses,
judgments, damages or expenses and charges which Gordon shall or may at any time
incur, sustain, or become subject to by reason of any claim or claims against
Gordon arising out of any act or omissions of Chromatics related to this
Agreement, or the performance thereof (provided that Chromatics will not be
responsible for any of the foregoing attributable to failure to use the
Colormate System strictly in accordance with the training and instructions
provided by Chromatics) ; provided that Chromatics is given prompt notice of
such claims and has the right to manage and control all such claims with
attorneys of its own selection.
2. Gordon shall indemnify and hold Chromatics harmless from and against
any and all actions, causes of actions, claims, demands, liabilities, losses,
judgments, damages or expenses and charges which Chromatics shall or may at any
time incur, sustain, or become subject to by reason of any claim or claims
against Chromatics arising out of any act of omission of Gordon related to this
Agreement, or the performance thereof, including but not limited to claims
regarding: advertising or product claims or promises made by Gordon; consumer
use or purchase of Gordon manufactured products, including without limitation
Foundation Cosmetics Products; loss of business due to damage to the Colormate
Systems in transport and any act which is the responsibility of Gordon as
provided in this Agreement; provided, that Gordon is given prompt notice of such
claims and has the right to manage and control all such claims with attorneys of
its own selection.
VI. Miscellaneous
8
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1. This Agreement will be governed by the laws of the State of New York
without giving effect to the conflict of laws principles thereof. The parties
hereto hereby irrevocably submit to the jurisdiction of any New York State or
Federal court sitting in the County of New York, State of New York, in any
action or proceeding arising out of or relating to this Agreement, and the
parties hereby irrevocably agree that all claims in respect of such action or
proceeding shall be heard and determined in such New York State or Federal
court. The parties hereto irrevocably waive, to the fullest extent permitted by
law, any objection which they or any of them may now or hereafter have to the
laying of the venue of any such action or proceeding brought in any such court,
and any claim that any such action or proceeding brought in any such court has
been brought in an inconvenient forum. The parties hereto agree that a final
judgment in any such action or proceeding shall be conclusive and binding on the
parties hereto.
2. This Agreement will continue in effect until six months after the
latest of the date (i) of the Ship Notice, (ii) Gordon delivers the Final
Samples, and (iii) Gordon delivers twenty (20) Custom Blended Foundation
Cosmetic Product Dispensing Systems, unless earlier terminated pursuant to
Article II hereof by Chromatics or Gordon, as applicable, provided the
provisions of Articles IV, V and VI, shall survive the termination of this
Agreement. In the event of such termination, all funds in the Budget Account
after any required payments to third party suppliers, shall be disbursed to
Gordon and Chromatics, in their capacity as creditors in accordance with the
Budget, and all other funds in the Budget Account shall be disbursed Fifty
Percent (50%) to Chromatics and Fifty Percent (50%) to Gordon. Upon the
termination of this Agreement, Gordon will immediately return to Chromatics all
documents and materials of Chromatics referred to in Article IV hereof and/or
otherwise provided to Gordon or its customers by Chromatics, including, without
limitation, the Colormate Systems provided by Chromatics and all documents,
including copies, extracts, or derivations thereof prepared by Gordon or such
customers, including without limitation any marketing material relating to the
Field Test whether or not provided by Chromatics.
3. Nothing contained herein shall place the parties in the relationship
of partners, joint venturers, principal-agent, or employer-employee and neither
party shall have any power to obligate or bind the other whatsoever.
4. None of the terms of this Agreement may be waived or modified, nor
may this Agreement be renewed or extended except by express agreement in writing
signed by both parties.
5. All notices which must or may be given pursuant to this Agreement
shall be delivered by hand or sent by certified or registered mail in the case
of Gordon to-
with a copy to:
9
<PAGE>
Lawrence Braun, Esq.
Sheppard, Mullin, Richter & Hampton LLP
333 South Hope Street, 48th Floor
Los Angeles, California 90071
and in the case of Chromatics to:
Mrs. Darby Macfarlane
Chromatics Color Sciences International, Inc.
5 East 80th St.
New York, New York 10021
with a copy to:
Eric M. Lerner, Esq.
Rosenman & Colin LLP
575 Madison Avenue
New York, New York 10022
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first above written.
- --------------------------------------------------------------------------------
AGREED: |
- ------------------------------|-------------------------------------------------
CHROMATICS COLOR SCIENCES |
INTERNATIONAL, INC. | GORDON LABORATORIES, INC.
- ------------------------------|
By:___________________________ By:____________________________
Title:________________________ Title:_________________________
- --------------------------------------------------------------------------------
10
<PAGE>
EXHIBIT A
FIELD TEST REQUIREMENTS
1) Chromatics delivers 20 Colormate Systems for use at 20 Customer
Locations with Software as defined within.
2) Gordon provides 20 Customer Locations which utilize the Colormate
System and Custom Blended Foundation Cosmetic Product Dispensing Systems.
3) Gordon Delivers 20 Custom Blended Foundation Cosmetic Product
Dispensing Systems to the Customer Locations.
4) The Foundation Cosmetic Product manufactured by Gordon for this
Field Test is acceptable to Chromatics.
5) Minimum monthly store sales over a 6-month period (such period
commencing on the date of the Ship Notice) of 45 1 oz. units per Customer
Location.
6) The Custom Blended Foundation Cosmetic Product Dispensing System
dispenses accurately the Foundation Cosmetic Product correctly reflecting the
Foundation Product Color Formulation provided by Chromatics as recommended by
the Software of the Colormate System provided by Chromatics at each Customer
Location.
7) CCSI's Colormate System identifies the customers' skin tones and
produces a color compatible custom blending formulation to be mixed by the
Custom Blended Foundation Cosmetic Product Dispensing System at each Gordon
Customer Location.
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EXHIBIT B, Part 1
Budget (Without Additional Field Test Income)
1. Salaries - $36,000 (includes training cost of Gordon and Chromatics)
2. Marketing - $9,900 (includes printing of support and promotional
materials costs)
3. CMII(Trademark) Case Logo - $2,500 to CCSI for printing and installation
4. Auto - $000
5. Office - $1,100
6. Travel - $15,000 (includes travel expenses for Chromatics, or Gordon
for Gordon training by Chromatics)
7. Misc. - $3,400
8. Freight (Shipping CMII(Trademark)s and Insurance) - $2,500
9. Use of CMII(Trademark)s (to CCSI). $10,000 (6 x $1,667; 6 monthly
installments beginning 30 days after
Ship Notice)
10. Dispensing Systems - $4,375 (for dispensing systems when bought)
11. Original Cosmetic inventory Cost - $8,650 to Gordon
Operating Cost
Sub-Total: $94,025
-75,000 - Originally contributed by CCSI and Gordon
------- ($37,500 each)
$19,025
-10,468 - the Additional Payment committed to by Gordon
------- and Chromatics if revenue insufficient from
$ 8,557 Field Test ($5,234 each)
$8,557
-4,325
------
$4,232 - up to $4,325 to be paid by Chromatics to Gordon at
End of field test for receiving remaining inventory
product not sold during Field Test at $0.625 per
ounce together with other items described in Article
II.
$4,232 remaining indebtedness for total Budget if no additional revenue received
during Field Test.
12. Software Programming - to CCSI for programming cost for
CMII(Trademark)s (will only be paid out
of Budget if additional revenue received
to pay this amount from Field Test
otherwise CCSI absorbs this cost).
13. Cosmetic Product Formulation - to Gordon for formulating Foundation
Cosmetic Product (will only be paid out
of Budget if additional revenue received
to pay this amount from Field Test,
otherwise Gordon absorbs this cost.)
1
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EXHIBIT B, Part 2
Chromatic Color Sciences/Gordon Laboratories Field Test Budget with
Protected Field Test Income.
<TABLE>
<CAPTION>
Profit & Loss Start Up Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Totals
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sales 0 3,240 6,600 15,760 16,900 18,900 18,900 80,300
Cost of Goods 0 875 1,800 3,080 3,935 3,935 3,935 17,560
Gross Profit 0 2,365 4,800 12,680 12,965 14,965 14,965 62,740
Expenses
Salaries 6,000 6,000 6,000 6,000 6,000 6,000 36,000
Marketing 6,200 2,500 750 750 750 750 750 12,450
Auto 100 100 100 100 100 100 600
Office Expense 500 100 100 100 100 100 100 1,100
Travel & Entertainment 3,000 3,000 3,000 2,000 2,000 2,000 15,000
Miscellaneous 500 665 456 458 448 448 448 3,423
Freight 420 420 420 1,200 2,460
Total Operating Expenses 7,620 12,785 10,826 10,408 9,398 9,398 10,598 71,033
(7,620) (10,420) (6,026) 2,272 3,567 5,567 4,367 (8,293)
Net Income
Balance Sheet
Assets:
Cash 62,380 42,959 31,686 25,111 25,860 29,750 32,404
Accounts Receivable 0 3,240 8,820 15,750 18,900 18,900 18,900
Inventory 8,660 8,660 8,660 8,660 8,660 8,660 8,660
Total Current Assets 71,040 54,859 49,166 49,521 53,420 57,310 59,964
Fixed Assets
Equipment Dispensing 4,375 4,375 4,375 4,375 4,375 4,375 4,375
Colormate Systems 10,000 10,000 10,000 10,000 10,000 10,000 10,000
Colormate Software 10,000 10,000 10,000 10,000 10,000 10,000 10,000
Gordon Foundation Formula 10,000 10,000 10,000 10,000 10,000 10,000 10,000
Total Assets 105,415 89,234 83,541 83,896 87,795 81,094 94,028
Liabilities & Equity
Accounts Payable 43,035 36,994 35,328 33,062 31,990 30,330 28,000
Paid-In Capital 70,000 70,000 70,000 70,000 70,000 70,000 70,000
Retained Earnings (7,620) (10,766) (21,700) (18,000) (14,200) (8,645) (4,331)
Total Liabilities & Equity 105,415 89,234 85,531 83,896 87,795 91,685 94,339
Cash Flow
Cash Flows from Operating
Activities
Net Income (7,620) (10,420) (6,026) 2,272 3,567 5,567 4,367 (39,839)
(Revenue) Decrease from
Changes
Accounts Receivable 0 (5420) (3,400) (7,100) (3,750) 0 0 (19,670)
Inventory (8,660) 0 0 0 0 0 0 (8,660)
Accounts Payable 43,085 (6,041) (1,055) (1,600) (1,600) (1,000) (1,000) 30,789
Cash Listed In Operating
Activities 26,735 (19,421) (11,094) (6,750) 749 3,599 2,635 (3,547)
Cash Flows from Inventory
Activities
Equipment Dispensing (4,375) 0 0 0 0 0 0 (4,375)
Colormate Systems (10,000) 0 0 0 0 0 0 (10,000)
Colormate Software (10,000) 0 0 0 0 0 0 (10,000)
Gordon Equipment
Foundation (10,000) 0 0 0 0 0 0 (10,000)
Cash Used in Investing
Activities (34,375) 0 0 0 0 0 0 (34,375)
Cash Flows From Financing
Activities
Net Proceeds from CCSNGL 70,000 0 0 0 0 0 0 70,000
Cash provided by Financing
Activities 70,000 0 0 0 0 0 0 70,000
Net Increase of Cash 62,300 (79,221) (1,094) (6,755) 749 3,899 2,035 32,394
Cash Beginning 0 62,300 42,950 31,856 25,111 25,850 29,750 0
Cash Ending 62,300 42,950 31,856 25,111 25,850 29,750 32,394 32,394
</TABLE>
<PAGE>
EXHIBIT C
The following terms are to be reflected in any joint venture the parties
may enter into:
CCSI agrees to grant the Joint Venture exclusive distribution
rights in respect of the Foundation Cosmetic Products in the Specialty Retail
market (as defined in Exhibit A). In order to maintain the exclusivity
agreements, CCSI will receive preferred returns from the "free cash flows" (to
be defined) generated by the Joint Venture in each of the first 5 years of the
agreement or until CCSI receives a total of $2.5 million within the first 5
years of the agreement. In year 1, CCSI will receive the first $60,000 of free
cash flow. In year 2, CCSI will receive the first $690,000 of free cash flow. In
year 3, CCSI will receive the first $750,000 of free cash flow. In year 4, CCSI
will receive the first $500,000 of free cash flow. In year 5, CCSI will receive
the first $500,000 of free cash flow. In the event CCSI does not receive the
preferred returns from free cash flow as listed above during any of the first 5
years, both parties agree that (i) the exclusivity agreement with the Joint
Venture will be terminated and will be replaced with non-exclusive distribution
rights, (ii) CCSI and GAC will subsequently divide equally all future free cash
flow, and, (iii) CCSI will not directly sell to the following accounts already
established by the Joint Venture: Garden Botanika, Bare Essentials, Crabtree &
Evelyn, Bath & Body Works, Ulta 3, Beauty Mart, CEDA, the Body Shop, and H20
Plus.
For their part, in year 1, GAC will receive the second $60,000
of free cash flow. In year 2, GAC will receive the second $690,000 of free cash
flow, but not less than a minimum total payment of $250,000. In year 3, GAC will
receive the second $750,000 of free cash flow, but not less than a minimum total
payment of $375,000. In year 4, GAC will receive the second $500,000 of free
cash flow, butnot less than a minimum total payment of $500,000. In year 5, GAC
will receive the second $500,000 of free cash flow, but not less than a minimum
total payment of $500,000. In the event the Joint Venture fails to generate
sufficient free cash flow in any of the first 5 years to make its preferred
payment to CCSI and its secondary payment to GAC, provided the Joint Venture has
made its minimum total payments to GAC, the deficit will roll over into the
following year and be added to the secondary payment due to GAC in that year,
and so on for each of the subsequent years in the first 5 years. In each of the
first 5 years of the agreement, after CCSI has received its preferred payment
and GAC has received its secondary payment (plus any appropriate deficit
payments), CCSI and GAC will equally divide any remaining free cash flow. In
the event GAC does not receive their minimum total payments from free cash flow
as listed above during any of the first 5 years, both parties agree that (i) the
exclusivity agreement with the Joint Venture may be terminated at GAC's option
and will be replaced with non-exclusive distribution rights, (ii) CCSI and GAC
will subsequently divide all future free cash flow, and (iii) CCSI will not
directly sell to the following accounts already established by the Joint
Venture: Garden Botanika, Bare Essentials, Crabtree & Evelyn, Bath & Body Works,
Ulta 3, Beauty Mart, CEDA, the Body Shop, and H20 Plus.
In consideration of the preferred payments, at the time CCSI
receives a total of $2.5 million within the first 5 years of the agreement, CCSI
agrees to (i) pay GAC $300,000 from
1
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their portion of future payments that exceed $500,000 in any one year until the
entire $300,000 is paid and, (ii) equally divide the free cash flows generated
by the Joint Venture after CCSI and GAC have each received a total of $2.5
million within the first 5 years of the agreement.
2
<PAGE>
EXHIBIT D
APPROVED PAYMENTS
1. Salaries - not to exceed $36,000 - payable at Gordon's discretion to
third parties.
2. Marketing - not to exceed $9,900 - payable at Gordon's discretion to
third parties.
3. CMII Case Logo - not to exceed $2,500 - to CCSI.
4. Auto - not to exceed $600 - payable at Gordon's discretion to third
parties.
5. office - not to exceed $1,100.
6. Travel - not to exceed $15,000 - payable at Gordon's discretion to third
parties (includes CCSI travel costs for training Gordon).
7. Miscellaneous - not to exceed $3,400.
8. Freight (shipping CMII's and Insurance) - not to exceed $2,500 - payable
at Gordon's discretion to third parties.
9. Dispensing Systems - not to exceed $4,375 - payable at Gordon's
discretion.
10. Cosmetic Product Inventory - not to exceed $8,650 - payable at Gordon's
discretion.
11. CMII Equipment - not to exceed $10,000 to CCSI @ $1,667 per month from
Ship Date for six months.
*12. Software Programming - not to exceed $10,000 to CCSI at end of six months
test, but payable only from additional income from Field Test.
*13. Formulation of Cosmetic Products - not to exceed $10,000 to Gordon at end
of six months test, but payable only from additional income from Field
Test.
- ---------------------------
* Additional Income to be applied pro rata to items 12 and 13.
3
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Schedule 1
Glossary
"Customer Location" shall mean those retail establishments selected by Gordon
and approved in writing by Chromatics and which are owned and/or operated by
Gordon Approved Customers.
"Foundation Products Formulations" shall mean that aspect and portion of the
Foundation Cosmetic Product which has been developed by Gordon with respect to
the chemical and ingredient composition and the consistency of the Foundation
Cosmetic Product.
"Foundation Cosmetic Products" shall mean the final foundation cosmetic product
to be manufactured, marketed and distributed by Gordon in the Field Test as
approved in writing by the parties hereto and reflecting the Foundation Products
Formulations and the colors and specifications of the Foundation Product Color
Formulations.
"Foundation Product Color Formulation" shall mean the recommendations and
specifications developed and licensed by Chromatics hereunder with respect to
the pigmentation, color and color compatibility aspects of the Foundation
Cosmetic Products.
"Budget" shall mean the approved Budget attached as Exhibit B hereto for the
Field Test described in Exhibit A hereto, as it may from time to time be
modified by the express written agreement of the parties.
"Budget Account" shall mean the Gordon/Chromatics Joint Special Account at a
bank to be mutually agreed upon.
"Specialty Retail Market" shall mean any retail store chain that commits 80% of
its total retail selling space to personal care or cosmetic products such as
creams, lotions, makeups, or bath and body products such as shampoos,
conditioners, or gels, e.g., Garden Botanika, H20 Plus.
4
