UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC.
(Name of small business issuer in its charter)
NEW YORK 3826 13-3253392
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(State or jurisdiction (Primary Standard (I.R.S. Employer
of incorporation Industrial Classification Identification No.)
or organization) Code Number)
2500 Johnson Avenue
Riverdale, NY 10463
(212) 717-6544
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(Address and telephone number of principal executive offices)
2500 Johnson Avenue
Riverdale, NY 10463
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(Address of principal place of business or intended
principal place of business)
With a copy to:
Darby S. Macfarlane Jeffrey E. LaGueux, Esq.
Chairperson of the Board Patterson, Belknap, Webb & Tyler LLP
2500 Johnson Avenue 1133 Avenue of the Americas
Riverdale, NY 10463 New York, NY 10036-6710
(212) 717-6544 (212) 336-2000
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(Name, address and telephone number of agent for service)
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this registration
statement.
If this Form is filed to register additional securities for an offering pursuant
to Rule 452(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering [ ]
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If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
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If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
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If delivery of the prospectus is expected to be made pursuant to Rule 434 check
the following box. [ ]
CALCULATION OF REGISTRATION FEE
Title of each class of AMOUNT TO BE PROPOSED MAXIMUM AMOUNT OF
securities to be registered REGISTERED(1) AGGREGATE OFFERING REGISTRATION FEE
PRICE(2)
------------------------------------ ----------------- -------------------- -----------------
COMMON STOCK, PAR VALUE
$.001 PER SHARE 210,900,000 $4,218,000 $388.06
COMMON STOCK PURCHASE RIGHTS 210,900,000 -- --
==================================== ================= ==================== =================
(1) Maximum number of shares of common stock to be sold in this offering.
(2) Estimated, pursuant to rule 457(o) under the Securities Act, solely for
purposes of calculating the registration fee.
(3) Since both the shares of common stock and the rights are being registered
for distribution in this Registration Statement, pursuant to rule 457(g)
there is no separate registration fee for the rights.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
SUBJECT TO COMPLETION, DATED ____ ___, 2002
The information in this prospectus is not complete and may be changed. The fund
may not sell these securities until the registration statement filed with the
Securities and Exchange Commission is declared effective. This prospectus is not
an offer to sell these securities, and it is not soliciting an offer to buy
these securities, in any state in which the offer or sale is not permitted.
PROSPECTUS
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC.
210,900,000 SHARES OF COMMON STOCK
We are distributing, together with this prospectus, at no charge,
non-transferable subscription rights to purchase shares of our common stock to
persons who own our common stock as of the close of business on February 11,
2002, the record date. You will not be entitled to receive any rights unless you
are a shareholder of the Company at that time. You will receive 7 subscription
rights for every 1 share of our common stock, or 1 share of common stock
underlying preferred stock or options under the 1992 Employee Stock Option Plan
as amended, that you own on the record date. Each subscription right will
entitle you to purchase 1 share of our common stock at the subscription price of
$ .02 per share. The shares are being offered directly by us without the
services of an underwriter or selling agent.
The subscription rights are exercisable beginning on the date of this
prospectus and will expire at 5:00 p.m., New York City time, on March 15, 2002,
dependent on SEC review time period, which may cause an extension of the
expiration date. We, at our sole discretion, may also extend the period for
exercising the rights. Rights which are not exercised by the expiration date
will expire and will have no value. Your exercise of the rights may not be
revoked unless the expiration date is extended for more than thirty days or
there is a material change in the terms of the rights offering. You should
carefully consider whether or not to exercise your rights before the expiration
date.
If you timely exercise all of your subscription rights, you will be
entitled to exercise over-subscription privileges to purchase additional shares
of our common stock at the same subscription price.
We are undertaking this rights offering to raise proceeds from the
offering, which will be used for payables and operating capital.
The subscription rights may not be sold, transferred or assigned, and
will not be listed for trading on any stock exchange.
Our common stock is listed on the Nasdaq OTC Bulletin Board under the
symbol "CCSI." On February 1, 2002 the closing sales price of our common stock
on the Nasdaq OTC Bulletin Board was $.015.
You should read the description of risks under the caption "Risk
Factors" beginning on page 8 before purchasing any of the common stock offered
by this prospectus.
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Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed on the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
February ___, 2002
No person has been authorized by us to give any information or to make
any representation not contained in this prospectus and, if given or made, such
information or representation should not be relied upon as having been
authorized by us. This prospectus does not constitute an offer or a solicitation
of an offer to buy any securities other than the shares of our common stock to
which it relates issuable upon exercise of the rights or an offer or
solicitation to any person in any jurisdiction where such an offer or
solicitation would be unlawful. Neither the delivery of this prospectus nor any
distribution of the securities offered hereby shall, under any circumstances,
imply or create any implication that there have not been any changes in our
affairs or in the information set forth or incorporated by reference herein
subsequent to the date hereof.
TABLE OF CONTENTS
Page
Forward-Looking Statements...........................................
Questions and Answers about the Rights Offering......................
Prospectus Summary...................................................
Risk Factors.........................................................
The Rights Offering..................................................
If You Have Questions................................................
Use of Proceeds......................................................
Determination of Offering Price......................................
Market Price of Common Stock.........................................
Dividend Policy......................................................
Capitalization.......................................................
Selected Financial Data..............................................
Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................
Description of Business..............................................
Executive Compensation...............................................
Security Ownership of Certain Beneficial Owners and Management.......
Certain Relationships and Related Transactions.......................
Description of Securities............................................
Plan of Distribution.................................................
Certain Federal Income Tax Consequences..............................
Legal Matters........................................................
Experts..............................................................
Available Information................................................
Index to CCSI's Financial Statements.................................
FORWARD-LOOKING STATEMENTS
This prospectus, including Management's Discussion and Analysis of
Financial Condition, Results of Operations and Business Description, 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 8 to
16, 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 successful resolution of the
Company's current liquidity crisis, the Company's ability to obtain immediate
additional financing to continue operations, the Company's ability to implement
its business plan for various application of its technologies, including medical
and industrial applications, the Company's ability to enter into agreements with
additional 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 the 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.
1
QUESTIONS AND ANSWERS ABOUT THE RIGHTS OFFERING
WHAT IS A SUBSCRIPTION RIGHT?
We are distributing to you, at no charge, 7 subscription rights to purchase
7 shares of common stock for every share of common stock or share of common
stock underlying preferred stock or options under the 1992 Employee Stock Option
Plan as amended, that you owned on February 11, 2002. Each subscription right
entitles you to purchase 1 share of common stock for $.02 per share, subject to
the terms of this rights offering. When you "exercise" a subscription right,
that means that you choose to purchase the common stock that the subscription
right entitles you to purchase. You may exercise any number of your subscription
rights, or you may choose not to exercise any subscription rights. You cannot
give or sell your subscription rights to anybody else; only you can exercise
them.
WHAT IS A RIGHTS OFFERING?
A rights offering is an opportunity for you to purchase additional shares
of common stock at a fixed price to be determined before the rights offering
begins and in an amount proportional to your existing interest, which enables
you to maintain your current percentage ownership interest in us.
WHAT IS THE BASIC SUBSCRIPTION PRIVILEGE?
The basic subscription privilege of each subscription right entitles you to
purchase 1 share of our common stock at a subscription price of $.02 per share.
WHAT IS THE OVER-SUBSCRIPTION PRIVILEGE?
We do not expect that all of our shareholders will exercise all of their
basic subscription rights. By extending over-subscription privileges to our
shareholders, we are providing for the subscription for those shares which are
not purchased through exercise of basic subscription privileges. The
over-subscription privilege entitles you, if you fully exercise your basic
subscription privilege, to subscribe for additional shares of common stock not
acquired by other holders of rights at the same subscription price of $.02 per
share.
WHAT ARE THE LIMITATIONS ON THE OVER-SUBSCRIPTION PRIVILEGE?
We will only issue 210,900,000 shares of common stock in the rights
offering. The number of shares available for over-subscription privileges will
be 210,900,000 minus the number of shares purchased upon exercise of all basic
subscription privileges. The number of shares available under the
over-subscription privilege to any one shareholder or group of shareholders may
be reduced by the Company if any such shareholder or group of shareholders
ownership would constitute a change of control of the Company after the
offering.
If sufficient shares are available, we will seek to honor the over-
subscription requests in full. If over-subscription requests exceed the number
of shares available, we will allocate the available shares among shareholders
who over-subscribed in proportion to the number of shares purchased by those
over- subscribing shareholders through the basic subscription privilege.
However, if your pro rata allocation exceeds the number of shares you requested,
you will receive only the number of shares that you requested, and the remaining
shares from your pro rata allocation will be divided among other shareholders
exercising their over-subscription privileges who have subscribed for additional
shares in proportion to the number of shares purchased by that group of
over-subscribing shareholders through the basic subscription privilege. In
certain circumstances, however, in order to comply with applicable state or
foreign securities laws, we may not be able to honor all over-subscription
privileges even if we have shares available.
2
WHY ARE WE ENGAGING IN A RIGHTS OFFERING?
We are offering the subscription rights to our current shareholders in
order to raise additional working capital. Additional funds are required for the
Company to continue operations, protect its intellectual property and implement
its business plan. Our Board of Directors has chosen to give you the opportunity
to buy more shares and provide us with additional capital. This option provides
each shareholder the opportunity to avoid dilution of their ownership interest.
Of course, we cannot assure you that we will not need to seek additional
financing in the future.
HOW MUCH MONEY WILL CCSI RECEIVE FROM THE RIGHTS OFFERING?
Our gross proceeds from the rights offering depends on the number of shares
that are purchased. If we sell all 210,900,000 shares which may be purchased
upon exercise of the rights offered by this prospectus, then we will receive
proceeds of $4,218,000, before deducting expenses payable by us, estimated to be
$150,000.
HOW MANY SHARES MAY I PURCHASE?
You will receive 7 subscription rights for each share of common stock or
share of common stock underlying preferred stock or options under the 1992
Employee Stock Option Plan as amended, that you owned on February 11, 2002. We
will not distribute fractional subscription rights, but will round the number of
subscription rights you receive down to the nearest whole number. Each
subscription right entitles you to purchase 1 share of common stock for $.02. If
you exercise all of the subscription rights that you receive, you may have the
opportunity to purchase additional shares of common stock. On the enclosed
subscription certificate, you may request to purchase as many additional shares
as you wish for $.02 per share. Subject to the terms of the offering, we intend
to honor all of the over-subscription requests, but if not, you may not be able
to purchase as many shares as you requested on your subscription certificate.
Subject to state securities laws and regulations, we have the discretion to
issue less than the total number of shares that may be available for
over-subscription requests in order to comply with state or foreign securities
laws. In addition, the number of shares available under the over-subscription
privilege to any one shareholder or group of shareholders may be reduced by the
Company if any such shareholder or group of shareholders ownership would
constitute a change of control of the Company after the offering.
HOW DID WE ARRIVE AT THE $.02 PER SHARE PRICE?
In determining the price at which a share of common stock may be purchased
in this rights offering, we considered several factors including the historic
and current market price of the common stock, our business prospects, our recent
history of losses, general conditions in the securities market, our need for
capital, alternatives available to us for raising capital, the amount of
proceeds desired, the pricing of similar transactions, the liquidity of our
common stock, the level of risk to our investors, and the need to offer shares
at a price that would be attractive to our investors relative to the current
trading price of our common stock. We did not seek or obtain any opinion of
financial advisors or investment bankers in establishing the subscription price.
The subscription price represents approximately a 20% discount of the average
closing price of the common stock over the last 20 trading days immediately
prior to the date of filing this prospectus.
3
HOW DO I EXERCISE MY SUBSCRIPTION RIGHTS?
You must properly complete the attached subscription certificate and
deliver it to the Subscription Agent before 5 p.m., Eastern Standard Time, on
March 15, 2002. The address for the Subscription Agent is on page 22. Your
subscription certificate must be accompanied by proper payment for each share
that you wish to purchase. Please note that funds paid by uncertified personal
check may take at least ten business days to clear. Accordingly, if you wish to
pay by means of uncertified personal check, we urge you to make payment
sufficiently in advance of March 15, 2002 to ensure that payment is received and
clears before that date. If your shares are held in the name of your bank or
broker, you must contact your bank or broker if you wish to participate in this
offering.
HOW LONG WILL THE RIGHTS OFFERING LAST?
You will be able to exercise your subscription rights only during a limited
period. IF YOU DO NOT EXERCISE YOUR SUBSCRIPTION RIGHTS BEFORE 5 P.M., EASTERN
STANDARD TIME, ON MARCH 15, 2002, YOUR SUBSCRIPTION RIGHTS WILL EXPIRE. We may,
in our discretion, decide to extend the rights offering. In addition, if the
commencement of the rights offering is delayed, the expiration date will
similarly be extended.
AFTER I EXERCISE MY SUBSCRIPTION RIGHTS, CAN I CHANGE MY MIND?
No. Once you send in your subscription certificate and payment, you cannot
revoke the exercise of your subscription rights, even if you later learn
information about us that you consider to be unfavorable. You should not
exercise your subscription rights unless you are certain that you wish to
purchase additional shares of common stock at a price of $.02 per share.
IS EXERCISING MY SUBSCRIPTION RIGHTS RISKY?
The exercise of your subscription rights involves certain risks. Exercising
your subscription rights means buying additional shares of our common stock, and
should be carefully considered as you would view other equity investments. Among
other things, you should carefully consider the risks described under the
heading "Risk Factors," beginning on page 8.
WHAT HAPPENS IF I CHOOSE NOT TO EXERCISE MY SUBSCRIPTION RIGHTS?
You will retain your current number of shares of common stock or common
stock underlying preferred stock or options under the 1992 Employee Stock Option
Plan as amended, in Chromatics Color Sciences International, Inc. even if you do
not exercise your subscription rights. However, if other shareholders exercise
their subscription rights and you do not, the percentage of Chromatics Color
Sciences International, Inc. that you own will diminish, and your relative
voting rights and economic interests will be diluted.
CAN I SELL OR GIVE AWAY MY SUBSCRIPTION RIGHTS?
No.
MUST I EXERCISE ANY SUBSCRIPTION RIGHTS?
No.
4
WHAT ARE THE FEDERAL INCOME TAX CONSEQUENCES OF EXERCISING MY
SUBSCRIPTION RIGHTS?
The receipt and exercise of your subscription rights are intended to be
nontaxable. You should seek specific tax advice from your personal tax advisor.
WHEN WILL I RECEIVE MY NEW SHARES?
If you purchase shares of common stock through the rights offering, you
will receive certificates representing those shares as soon as practicable after
March 15, 2002. Subject to state or foreign securities laws and regulations, we
have the discretion to delay allocation and distribution of any shares you may
elect to purchase by exercise of your basic or over- subscription privilege in
order to comply with state securities laws.
CAN WE CANCEL THE RIGHTS OFFERING?
Yes. Our Board of Directors may cancel the rights offering at any time on
or before March 15, 2002, for any reason. If we cancel the rights offering, any
money received from shareholders will be refunded promptly, without interest.
HOW WILL WE USE THE PROCEEDS FROM THE RIGHTS OFFERING?
We will use the proceeds from the rights offering for payables, protection
of our intellectual property, regulatory fees and expenses, additional
working capital to fund operations, and implementation of our business plan.
HOW MANY SHARES WILL BE OUTSTANDING AFTER THE RIGHTS OFFERING?
The number of shares of common stock that will be outstanding after the
rights offering depends on the number of shares that are purchased. If we sell
all of the shares offered by this prospectus, then we will issue 210,900,000 new
shares of common stock during the rights offering. In that case, we will have
approximately 231,889,550 shares of common stock outstanding after the rights
offering.
5
PROSPECTUS SUMMARY
Company's Business Summary
We are engaged in the business of researching, developing and
commercializing intellectual property rights, technology and instrumentation we
have developed in the field of color science. Color science involves the
objective, standardized analysis, description and measurement by instrument to a
laboratory standard of accuracy of the colors composing the visual color
spectrum and their related physical properties in relation to each other.
We have incorporated some of these intellectual property rights, technology
and instrumentation into a proprietary color measurement system and software
marketed for various applications known as the ColorMate(R) System. We have
developed our intellectual property and the ColorMate(R) System for:
o the color measurement to a laboratory standard of accuracy and
classification of human tissue, fluid, hair and/or teeth color,
o the color coordination of these human skin, tissue, fluid, hair and/or
teeth color classifications in relation to products,
o the color measurement to a laboratory standard of accuracy,
classification and organization based on color of various
color-sensitive consumer products including chromaticity studies of
cosmetics, hair coloring, hosiery, clothing, tooth enamel, paint and
textiles,
o the color measurement to a laboratory standard of accuracy to monitor
infant jaundice,
o the color measurement in detecting and monitoring those diseases which
we believe can be diagnosed or monitored by the coloration of human
skin, tissue and fluids, and
o the color coordination of products in relation to other products.
The Company lacks funds to continue its operations and business plan. Due
to this major liquidity crisis the Company is seeking additional capital to
provide an immediate infusion of cash to continue operations. The Company plans
to raise funds through this offering to our existing stockholders, sale of the
exclusive rights to the ColorMate(R) TLc- BiliTest(R) System, and/or additional
potential financings. The Company is currently reviewing various additional
financial proposals and has significantly reduced costs. If the Company is
unable to obtain financing, and/or sell, or market its products and/or
technologies, it may have to cease operations and be forced to seek protection
from its creditors in bankruptcy.
In July 1997 we received clearance from the U.S. Food and Drug
Administration for commercial marketing of our ColorMate(R)System device for the
non-invasive monitoring of infant jaundice by healthcare professionals in the
hospital, institutional, pediatricians' office or home setting. In September
2001, we received further clearances from the U.S. Food and Drug
6
Administration for upgrades to the ColorMate(R) TLc-BiliTest(R) System. The
current procedure for the initial screening for infant jaundice is the visual
observation of the yellowing of the skin by professional care providers. This is
a subjective determination prone to errors due to different skin colors. If the
initial clinical assessment suggest the possibility of infant jaundice, the
current procedure requires that a blood sample be obtained by lancing the
infant. We believe that a non- invasive instrument that monitors infant jaundice
represents a significant improvement in patient care.
The ColorMate(R) TLc-BiliTest(R) System monitors the incremental change of
the yellow content of the skin color in infants of all races by non-invasively
measuring the color of the skin of the newborn. Color measurements are obtained
by placing the device on different physical sites of the newborn for five to ten
seconds. Accuracy of the color measurements is caused by use of the
TLc-Lensette(TM) calibration standard used prior to each baby measurement.
In June 1999 we entered into an agreement for the exclusive distribution of
this medical product in the hospital, pediatrician's office and home healthcare
markets in the United States with Datex-Ohmeda Inc. and its Ohmeda Medical
Division. As a result of the disappointing results achieved to date in pursuing
the Company's business strategy through the distribution agreement with
Datex-Ohmeda and the limited financial resources of the Company, the Company's
current objective with regard to its medical business is to either arrive at
acceptable revised terms of our existing agreement with Datex-Ohmeda or to
identify a strategic partner in the medical industry to whom the Company could
sell, for an up-front fee and ongoing royalty, the exclusive market rights to
the ColorMate(R) TLc-BiliTest(R) System. There can be no assurance that the
Company will be able to successfully renegotiate its distribution agreement with
Datex-Ohmeda or identify such a strategic partner or to negotiate and consummate
such a sale. We are also developing a business plan for establishing a new
management structure and commercializing new applications of our technology. We
will need to generate substantial revenues from equity financing and/or the sale
of our products in order to fund our continuing operations and to develop and/or
market other medical and non-medical applications for our intellectual property
rights, technology and instrumentation. If we are not successful in generating
adequate revenues, we may be forced to curtail our operations and seek
protection from our creditors under applicable bankruptcy laws.
Gordon Laboratories Sale and Repurchase Option
On June 2, 2000 we acquired the common stock and certain debt of Gordon
Laboratories, Inc. ("Gordon"), a Carson City, California based formulator and
manufacturer of cosmetics, hair care and other personal care products. We
acquired an approximately 85% equity interest in Gordon for approximately $5.5
million, principally in stock, and acquired the remaining interest in June 2001.
On July 3, 2001, Gordon was acquired by Abilene Investments Corp. and
GAC-Labs, LLC for an aggregate purchase price of $1,000,000 paid to Gordon to be
used for operating capital. Simultaneously, the shares of Gordon stock that were
outstanding immediately prior to the closing of this transaction, all of which
were owned by us, were redeemed for one dollar. In addition, we assigned to
Abilene and GAC-Labs the indebtedness of Gordon and H.B. Gordon Manufacturing
Co., Inc., its wholly-owned subsidiary, owed to the Company in the ratio of 20%
to Abilene and 80% to GAC-Labs.
7
As part of the same transaction, we were granted the option to purchase
from Abilene and GAC-Labs the shares of Gordon stock issued to them and the
indebtedness assigned to them within one year for an aggregate purchase price of
$1,000,000 plus interest thereon at the rate of 14% per annum, subject to
reduction under certain conditions.
Stockholder Rights Offering
We are now offering and selling up to 210,900,000 shares of our common
stock, which are the subject of this prospectus, to our existing stockholders.
Pursuant to this offering, each of our stockholders shall have the right to
purchase from us up to 7 shares of our common stock for every share of common
stock registered in his or her name at a price per share of $.02.
We were incorporated in New York in March 1984. Our principal executive
offices are located at 2500 Johnson Avenue, Riverdale, New York 10463 and our
telephone number is (212) 717-6544.
8
RISK FACTORS
Investing in our common stock is very risky. You should be able to bear a
complete loss of your investment. You should carefully consider the following
factors, in addition to the other information in this prospectus, before
investing in our common stock.
LIQUIDITY CRISIS
The Company is currently experiencing a liquidity crisis and requires an
immediate infusion of cash in order to continue operations. If the Company is
unable to secure an immediate infusion of cash it may be forced to seek
protection from its creditors through a voluntary bankruptcy filing.
Alternatively, creditors of the Company holding the required minimum dollar
amount of claims against the Company could commence an involuntary bankruptcy
proceeding against the Company. No assurance can be given that the Company will
obtain an immediate cash infusion.
The Independent Accountants' Report on the December 31, 2000 financial
statements indicates the Company has incurred recurring losses for the last
several years and has experienced significant problems and delays exploiting its
primary technology (medical equipment). The Independent Accountants' Report
states that these matters raise substantial doubt about the Company's ability to
continue as a going concern.
WE HAVE A LIMITED OPERATING HISTORY
We have a limited operating history and have generated insignificant
revenues. Although we have entered into agreements for the manufacturing and
distributing of our ColorMate(R) TLc- BiliTest(R) System, to date we have not
produced or sold substantial quantities of this product. We cannot assure you
that this product can be manufactured in commercial quantities or at an
acceptable cost or marketed successfully by our existing distributor and any
potential strategic partner. We also cannot assure you that we will be
successful in our efforts to commercialize our ColorMate(R) System for other
applications.
9
WE EXPECT TO CONTINUE TO OPERATE AT A LOSS AND WE MAY NEVER ACHIEVE
PROFITABILITY
We cannot be certain that we will ever achieve and sustain profitability.
To date, we have been engaged in research and development activities and have
not generated any significant revenues from sales of our ColorMate(R)
TLc-BiliTest(R) System or TLc-Lensette(R) calibration standards. We expect that
we will continue to incur operating losses for the foreseeable future.
IF WE DO NOT SECURE ADDITIONAL FINANCING WE WILL NOT BE ABLE TO DEVELOP AND
MARKET OUR PRODUCTS
We will require substantial additional funds for our research and product
development programs, for commercial obligations, to pursue regulatory approvals
and to develop and commercialize other applications of our ColorMate(R) System.
Adequate funds for these purposes, whether through the financial markets or
other sources, may not be available when needed. Additionally, under the terms
of our manufacturing agreement we must provide our manufacturing partner with a
number of key component parts to be assembled into our ColorMate(R) System and
our ColorMate(R) TLc-BiliTest(R) System. Without the funds to provide these
component parts, our products cannot be manufactured and we will be unable to
fulfill our obligations to our current distribution partner or any potential
strategic patner or third party purchaser of the exclusive rights to the
Company's bilirubin monitoring technology. If we fail to make any payment
required or if we are otherwise in default under the current manufacturing and
distribution agreements relating to our ColorMate(R) System and our ColorMate(R)
TLc-BiliTest(R) System, the other parties will have the right to terminate the
agreements. Termination of any of these agreements would have a material adverse
effect on our business by rendering us unable to manufacture and distribute our
ColorMate(R) System and ColorMate(R) TLc-BiliTest(R) System until replacement
agreements were entered into.
WE HAVE LIMITED MANUFACTURING AND MARKETING CAPABILITIES OF OUR OWN AND WILL
CONTINUE TO DEPEND ON OTHER PARTIES FOR MANUFACTURING AND MARKETING FOR THE
FORESEEABLE FUTURE.
We currently do not have the resources to manufacture or market
independently on a commercial scale the ColorMate(R) System and ColorMate(R)
TLc-BiliTest(R) System or any other products that we may develop. We rely on our
corporate partners or potential third party purchasers of the rights to the
Company's technology to manufacture and market our ColorMate(R) TLc-BiliTest(R)
System and will continue to rely on corporate partners to manufacture and to
market our ColorMate(R) System for other applications. The amount and timing of
resources to be devoted to these activities by these other parties may not be
within our control. We cannot assure you that these parties will perform their
obligations as expected or that we will derive any revenue from these
arrangements. To date our distribution partner, Datex- Ohmeda, Inc. and its
Ohmeda Medical Division, has not achieved the annual minimum market penetration
performance standards, nor has it purchased and placed the minimum quantities of
our ColorMate(R) TLc-BiliTest(R) System and TLc-Lensette(R) calibration
standards, set forth in our June 7, 1999 distribution agreement, as amended. We
have little or no experience in manufacturing or marketing any medical products.
The failure of our corporate partners or potential third party purchasers of the
rights to the Company's technology to perform their obligations relating to the
manufacturing and distributing of our ColorMate(R) System or
10
ColorMate(R) TLc-BiliTest(R) System would continue to have a material adverse
affect on our business until a replacement agreement was entered into.
WE MAY NOT BE SUCCESSFUL IN COMMERCIALIZING OUR COLORMATE(R) TLC-BILITEST(R)
SYSTEM
The Company's current ability to generate revenues in the immediate future
will depend on either the successful distribution of the bilirubin monitoring
technology or the sale of the exclusive marketing rights to a third party for an
upfront payment and ongoing royalty. Our success in commercializing our
ColorMate(R) TLc-BiliTest(R) System will be dependent upon its acceptance by
healthcare professionals and either the ability of our current distribution
partner or a potential third party strategic partner or purchaser of the
Company's bilirubin monitoring technology to penetrate the healthcare market. As
a result of the disappointing results achieved to date in pursuing the Company's
business strategy through the distribution agreement with Datex- Ohmeda and the
limited financial resources of the Company, the Company's current objective with
regard to its medical business is to either arrive at acceptable revised terms
of our existing agreement with Datex-Ohmeda or to identify a strategic partner
in the medical industry to whom the Company could sell, for an up-front fee and
ongoing royalty, the exclusive market rights to the ColorMate(R) TLc-BiliTest(R)
System. There can be no assurance that the Company will be able to successfully
renegotiate its distribution agreement with Datex-Ohmeda or identify such a
strategic partner or to negotiate and consummate such a sale or that the
purchaser would successfully market the product. The acceptance of our
ColorMate(R) TLc-BiliTest(R) System by healthcare professionals will largely
depend on our ability to show them its ability to reduce the need for heelsticks
in monitoring infant jaundice as well as its utility compared to other non-
invasive methods that currently exist or that may be developed in the future by
others with respect to:
o safety,
o effectiveness,
o ease of use and
o price.
We cannot assure you that our ColorMate(R) TLc-BiliTest(R) System will be
competitive with respect to these factors.
WE HAVE NOT YET SUCCESSFULLY COMMERCIALIZED OUR COLORMATE(R) SYSTEM FOR OTHER
POTENTIAL MEDICAL APPLICATIONS
Although we have received FDA clearance to commercially market our
ColorMate(R) TLc- BiliTest(R) System for monitoring infant jaundice, our
clinical and research and development programs for other medical applications of
our ColorMate(R) System are at a very preliminary stage. 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 or approval and produced for other medical applications. We
cannot assure you that we will be able to successfully address the problems that
may arise during the development, FDA review process and commercialization of
these other medical applications or that any of our proposed products for these
other medical applications will be successfully developed, proven safe and
effective in clinical trials, cleared or approved by the FDA for marketing or
meet applicable regulatory standards and requirements.
11
WE HAVE NOT YET SUCCESSFULLY COMMERCIALIZED NON-MEDICAL APPLICATIONS OF OUR
PRODUCTS
To date, we have not achieved commercial market penetration for our
ColorMate(R) System in any non-medical industry. In order to commercialize our
ColorMate(R) System in connection with non-medical applications we will need to
raise additional financing, to develop additional marketing skills, incur
significant expenses on sales and marketing activities, hire additional
employees and consultants and enter into arrangements with third party
distributors. We cannot assure you that we will be successful in our efforts to
commercialize any non-medical application of our ColorMate(R) System.
EXTENSIVE GOVERNMENTAL REGULATION COULD DELAY, RESTRICT OR PREVENT THE MARKETING
OF OUR PRODUCT
Governmental regulation may significantly delay the marketing of our
products, prevent marketing of products altogether or impose costly requirements
on our activities. The FDA and comparable foreign regulatory authorities
generally require rigorous pre-clinical testing, clinical trials and government
premarket review and clearance or approval for the type of human medical device
we market or contemplate marketing. Numerous regulations govern, among other
things, the manufacturing, safety, labeling, promotion, storage, record keeping,
reporting and marketing of medical devices. A delay in obtaining or failure to
obtain or maintain regulatory clearances or approvals for any of our products
would have an adverse effect on our business. We cannot predict the adverse
effects that existing or future government regulations may have on our business.
Even though our ColorMate(R) TLc-BiliTest(R) System has received FDA
marketing clearances for monitoring infant jaundice, we may still face
difficulties in manufacturing and marketing this product. A marketed product and
its manufacturer's practices are subject to regulatory review and the
manufacturer's facilities are subject to periodic establishment inspections. The
discovery of previously unknown problems with a product, manufacturer or
facility may result in restrictions on the product or manufacturer, including
withdrawal of the product from the market. The failure to comply with applicable
regulatory requirements can, among other things, result in:
o fines,
o suspended or withdrawn regulatory approvals,
o refusal to clear or approve pending applications,
o refusal to permit exports or to allow imports from the United States,
o product recalls,
o seizure of products,
o injunctions,
o operating restrictions and
o criminal prosecutions.
WE MAY BE UNABLE TO DEVELOP POTENTIAL INTERNATIONAL MARKETS AND OBTAIN FOREIGN
REGULATORY APPROVALS
Although we believe that sales of our products to customers outside of the
United States represents a significant potential source of growth we may not be
able to obtain agreeents with
12
third party distributors or purchasers of the rights to the Company's bilirubin
monitoring technology for marketing outside of the United States. We also cannot
be certain that we will be able to maintain our existing ISO 9001/EN46001
certification or that we will obtain any further regulatory approvals in other
countries. In order to market our products outside of the United States, we must
comply with numerous and varying foreign regulatory requirements implemented by
foreign authorities. The approval procedure varies among countries and can
involve additional testing. The time required to obtain further foreign
clearances or approvals may differ from that required to obtain FDA clearances
or approvals for commercial marketing. The foreign regulatory approval process
includes all of the risks associated with obtaining FDA clearances or approvals
set forth above, and clearance or approval by the FDA does not ensure clearance
or approval by the authorities of any other country.
THE MEDICAL COMMUNITY MAY BE RELUCTANT TO ACCEPT OUR TECHNOLOGY
The commercial acceptance of our ColorMate(R) TLc-BiliTest(R) System is
substantially dependent on its acceptance by the medical community for the
monitoring of infant jaundice. Because the medical community is relatively slow
to adopt new technologies we cannot assure you that the medical community will
perceive a need for, or accept, our ColorMate(R) TLc- BiliTest(R) System or be
willing to commit funds to its purchase and use. Widespread acceptance of the
ColorMate(R) TLc-BiliTest(R) System for monitoring infant jaundice will require
educating the medical community about its advantages, reliability, cost
effectiveness and utility. In addition, acceptance of the ColorMate(R)
TLc-BiliTest(R) System may be adversely affected by competing products which may
have more utility, a lower cost or be received in a better way than our
ColorMate(R) TLc-BiliTest(R) System.
OUR MAIN COMPETITORS HAVE MORE RESOURCES THAN WE HAVE
The medical device industry is characterized by rapid technological
advances, evolving industry standards and technological obsolescence. Our
inability to meet or surpass our competitors' technological advances in this
industry could have a material adverse effect on our business. We have several
competitors in this industry, none of whom we believe to be dominant. We believe
that, in addition to our ColorMate(R) TLc-BiliTest(R) System the only other
commercially available non-invasive devices for the monitoring of infant
jaundice with FDA marketing clearance in the United States are the Minolta
Jaundice Meter, manufactured by Minolta Co., Ltd. which is distributed by Air
Shields and the SpectRx Bilicheck, manufactured by SpectRx and Respironics. Both
Minolta and Respironics have financial, marketing and other resources greater
than our own. Our competitors in this industry may develop products which may
render our ColorMate(R) TLc-BiliTest(R) System obsolete or which have advantages
over our ColorMate(R) TLc-BiliTest(R) System, including greater accuracy and
precision or greater acceptance by the medical community.
To the extent that we are able to commercialize our ColorMate(R) System for
non-medical applications we will also encounter competition. We cannot assure
you that we will be able to compete successfully in these non-medical markets.
13
OUR BOARD OF DIRECTORS IS AUTHORIZED TO ISSUE PREFERRED STOCK WITHOUT
STOCKHOLDER AUTHORIZATION WHICH COULD BE USED AS AN ANTI-TAKEOVER DEFENSE
Our Board of Directors is authorized to issue from time to time without
stockholder authorization shares of preferred stock. The issuance of preferred
stock could decrease the amount of assets and earnings available for
distribution to our other stockholders. Preferred stockholders could receive
voting rights and rights to payments on liquidation or of dividends or other
rights which are greater than the rights of the holders of our common stock. In
addition, the issuance of preferred stock may make it more difficult for a third
party to acquire, or may discourage a third party from acquiring, voting control
of our stock. This provision could also discourage an unsolicited acquisition
and could make it less likely that stockholders receive a premium for their
shares as a result of any unsolicited acquisition proposal.
OUR DIRECTORS AND EXECUTIVE OFFICERS OWN A SIGNIFICANT AMOUNT OF STOCK OF
CHROMATICS AND EXERT CONSIDERABLE INFLUENCE OVER CHROMATICS
As of December 31, 2001, our directors and executive officers beneficially
owned approximately 17.56% of voting power represented by our outstanding common
and preferred stock. As a result, these stockholders are able to significantly
influence all matters requiring stockholder approval, including the election of
directors and the approval of significant corporate transactions. This
concentration of ownership could also delay or prevent a change in control that
may be favored by other stockholders.
WE WILL NEED TO RAISE FINANCES TO RETAIN EXISTING PERSONNEL AND HIRE ADDITIONAL
PERSONNEL TO MANAGE OUR TRANSITION FROM A DEVELOPMENT STAGE COMPANY TO AN
OPERATING COMPANY
In order to generate and service sales of our products we will need to
raise additional finances to retain existing personnel and attract and retain
significant additional senior and midlevel personnel experienced in financial,
administrative, marketing, sales, research, development and regulatory matters,
particularly for the medical and beauty industries. We currently have 3
full-time employees, all of which have significant compensation in arrears. Our
success will depend in part on our ability to hire, train and retain new and
existing personnel. We cannot assure you that we will be successful in raising
the necessary finances to either retain existing personnel or hiring, training
or retaining additional personnel to support our executive, operations,
marketing, sales, research and product development needs and efforts.
WE DEPEND ON THE SERVICES OF KEY PERSONNEL
Our success depends to a significant extent upon the efforts of Darby
Simpson Macfarlane, the Chairperson of our Board of Directors and Chief
Technology Officer, and David Kenneth Macfarlane, our Vice President, Research
and Development. They are co-inventors of our ColorMate(R) System and possess
unique technical knowledge required in connection with its production. Brian T.
Fitzpatrick, our President and Acting Chief Executive Officer, is also an
integral part of our organization. Although we have purchased key-man life
insurance policies in the amounts of $1,000,000 on the lives of each of Ms. and
Mr. Macfarlane, we cannot assure you that the proceeds from these policies would
enable us to retain suitable replacements for them. Additionally, significant
compensation due to these personnel is in arrears, and we can make no assurances
we will be able to raise the finances required to pay such compensation or any
monies covered under their respective employment agreements in the event of the
Company's default. The loss of the services of Ms. Macfarlane, Mr. Macfarlane or
Mr. Fitzpatrick could adversely affect our business.
WE FACE THE RISK OF PRODUCT LIABILITY CLAIMS WHICH MAY EXCEED THE SCOPE OR
AMOUNT OF OUR INSURANCE COVERAGE
The manufacture and sale of human medical devices entails significant risk
of product liability claims. In determining the amount of product liability
coverage to obtain we were advised by an insurance
14
broker with knowledge and experience regarding prevailing insurance practices in
the medical device industry. Although we believe that the amount and scope of
coverage obtained is consistent with prevailing medical device industry
practice, we cannot assure you that our product liability coverage will be
adequate to protect us from any liabilities we might incur in connection with
the use or sale of our products. In addition, we may require increased product
liability coverage if additional products are commercialized. Product liability
insurance is expensive and in the future may not be available on acceptable
terms, if at all. A successful product liability claim or series of claims
brought against us in excess of our insurance coverage could have a material
adverse effect on our business and results of operations. We must indemnify our
distribution partner against any product liability claims brought against it
arising out of products developed by us.
OUR SUCCESS IS DEPENDENT UPON OUR ABILITY TO EFFECTIVELY MAINTAIN OUR PATENTS
AND PROPRIETARY RIGHTS RELATING TO OUR COLORMATE(R)SYSTEM AND OUR
COLORMATE(R)TLC-BILITEST(R)SYSTEM, WHICH WE MAY NOT BE ABLE TO DO
Proprietary technology maintained in our trade secrets and other
proprietary information claimed by our patents is incorporated into the
proprietary software and measurement system used in our ColorMate(R) System, our
ColorMate(R) TLc-BiliTest(R) System and our TLc-Lensette(TM) calibration
standards. Because we are dependent on the commercialization of these products
our success will depend to a significant degree on our ability to preserve our
trade secrets, to raise the necessary finances to obtain and maintain our
patents and to operate without infringing the proprietary rights of others. We
cannot assure you that we will be able to raise these finances or that our
competitors will not seek to apply for and obtain patents that prevent, limit or
interfere with our ability to make, use and sell our products either in the
United States or in foreign countries. We also cannot assure you that we will
not become subject to patent infringement claims brought by third parties or to
re-examination of previously issued patents or interference proceedings to
determine the priority of inventions.
We also rely on a combination of trade secret and copyright law, employee
and third-party nondisclosure agreements and other protective measures to
protect intellectual property rights pertaining to our products and
technologies. We cannot be certain that these measures will provide protection
of our proprietary information. In addition, the laws of a small number of
foreign jurisdictions may not protect our intellectual property rights to the
same extent as the laws of the United States.
OUR ASSUMPTIONS REGARDING THE BUSINESS PLAN AND STRATEGY FOR OUR COLORMATE(R)
TLC-BILITEST(R) SYSTEM AND FOR THE COMMERCIALIZATION OF OUR TECHNOLOGY MAY PROVE
TO BE INACCURATE
Our business plan and strategy for the commercialization of our
ColorMate(R) TLc-BiliTest(R) System is based upon assumptions made by our
distribution partner in our contract regarding the size of the infant jaundice
monitoring market, our short-term and eventual share of this market, the price
at which we believe this product will be able to be sold or leased and consumer
acceptance of this product. We are currently working with our distribution
partner on revising sales and marketing strategies as well as on product
improvements recently cleared for commercial marketing by the FDA. We cannot
assure you that our initial or revised assumptions will prove to be correct. The
medical community has thus far not used a non-invasive device for monitoring
infant jaundice as a standard of care. Assumptions made by our distribution
partner about the size of the existing market were based on the current standard
of care (an invasive blood test) and, accordingly, there can be no assurance
that the market size of the ColorMate(R) TLc-BiliTest(R) System will be the
same. In addition, we are developing business plans for new applications of our
proprietary technology.
15
OUR STOCK HAS BEEN DELISTED FROM THE NASDAQ SMALLCAP MARKET
Our common stock has been delisted from the Nasdaq SmallCap Market. As a
result, the market value of our common stock has fallen and it is more difficult
for holders of our common stock to dispose of and to obtain accurate quotations
as to the market value of our common stock. In addition, our common stock has
become subject to rules adopted by the SEC regulating broker-dealer practices in
connection with transactions in "penny stocks." 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 which provides
information about penny stocks and the nature and level of risks in the penny
stock market. These disclosure requirements may have the effect of reducing the
level of trading activity in the secondary market for a stock that is subject to
these penny stock rules. As a result, you may be unable to readily sell shares
of our common stock.
OUR STOCK PRICE MAY BE VOLATILE
The market price of our common stock has historically been volatile as a
result of:
o analyst recommendations,
o announcements of technological innovations or new commercial products
by us or our competitors,
o market conditions relating to the medical device industry,
o sales of substantial amounts of our common stock by existing
stockholders, including short sales,
o adverse publicity related to accusations by short sellers and
o obtaining regulatory clearances in both the U.S. and in foreign
countries.
A short sale involves the sale of borrowed shares with the expectation that
the market price of the security will decline in the future. If the anticipated
price decline occurs the short seller replaces the borrowed securities with
shares bought in the market at the lower price and realizes a profit equal to
the difference between the price at which the borrowed shares were sold and the
price at which the replacement shares are purchased. From time to time in the
past concentrated periods of short selling of our common stock have created an
imbalance between the number of shares offered to the market for sale and the
willingness of the market to absorb these shares at prevailing price levels
which has resulted in rapid and substantial declines in the market price of our
common stock.
CONVERSION OF THE CONVERTIBLE PREFERRED STOCK AND EXERCISE OF OUTSTANDING
WARRANTS WILL DILUTE THE INTERESTS OF EXISTING STOCKHOLDERS
The conversion prices of our outstanding convertible preferred stock and
warrants may be less than the current market price of our common stock on the
date of conversion. Similarly, the exercise prices of our outstanding warrants
may be less than the current market price of our common stock on the date of
exercise. So long as these securities remain outstanding and unconverted or
unexercised, the terms under which we could obtain additional equity financing
may be adversely affected. To the extent of any conversion or exercise of these
securities, the interests of our existing stockholders will be diluted
proportionately.
COST CONTAINMENT RELATING TO HEALTHCARE REFORM COULD ADVERSELY AFFECT OUR
BUSINESS
16
Political, economic and regulatory influences are subjecting the healthcare
industry in the United States to fundamental change and are increasing
cost-containment efforts. We anticipate that Congress, state legislatures and
the private sector will continue to review and assess alternative benefits,
controls on healthcare spending through limitations on the growth of private
health insurance premiums and Medicare and Medicaid spending, the creation of
large insurance purchasing groups, price controls on pharmaceuticals and medical
devices and other fundamental changes to the healthcare delivery system. Any
changes of this nature could negatively impact our ultimate profitability. Also,
the trend toward managed healthcare in the United States and the concurrent
growth of organizations like healthcare management organizations, which could
control or significantly influence the purchase of healthcare services and
products, may result in lower prices for our medical product candidates than we
currently expect. We cannot predict what impact the adoption of any federal or
state healthcare reform measures or future private sector reforms may have on
our business.
OUR PRODUCTS MUST BE ACCEPTED FOR REIMBURSEMENT BY THIRD-PARTY PAYORS
Our ability to successfully commercialize our ColorMate(R) TLc-BiliTest(R)
System and our other medical product candidates will depend in part on the
extent to which appropriate reimbursement codes and authorized cost
reimbursement levels of our products and related treatment are obtained from
governmental authorities, private health insurers and other organizations, like
health maintenance organizations. Third- party payors are increasingly
challenging the prices charged for medical products and services. American
Medical Association 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. The AMA
has issued a new CPT Code for use with our ColorMate(R) TLc-BiliTest(R) System
which went into effect on January 1, 2001. As this is a new code, claims for
reimbursement under this new code may not be readily processed for
reimbursement.
WE EXPECT TO ISSUE ADDITIONAL SHARES IN THE FUTURE WHICH WOULD DILUTE THE
OUTSTANDING SHARES
In order to finance the commercialization of our ColorMate(R)
TLc-BiliTest(R) System and other applications of our ColorMate(R) System, we
expect to issue and sell additional shares of our common stock or securities
convertible into our common stock in the future. As of December 31, 2001,
approximately 400,000,000 shares of our common stock were authorized but
unissued and unreserved. These shares may be issued in the future without
stockholder approval. The prices at which we sell these securities and other
terms and provisions will depend on prevailing market conditions and other
factors in effect at that time, all of which are beyond our control. Shares may
be issued at prices which are less than the then-current market price of our
common stock and/or at prices which are less than the prices at which the shares
of common stock being offered by the selling stockholder hereby are sold.
THE TERMS OF THE CONVERTIBLE PREFERRED STOCK AND BRIDGE LOANS MAY ADVERSELY
AFFECT THE RIGHTS OF THE COMMON STOCK HOLDERS
Our convertible preferred stock and bridge loans will be entitled to
priority of payment in the event we are liquidated and dissolved in preference
to any distribution to the holders of our common stock. In addition, for as long
as the shares of convertible preferred stock are outstanding we are prohibited
from issuing any class or series of preferred stock with a priority of payment
superior or equal to the priority of payment of the convertible preferred stock
without the written consent of the holders thereof.
17
THE RIGHTS OFFERING
BEFORE EXERCISING YOUR SUBSCRIPTION RIGHTS, YOU SHOULD READ
CAREFULLY THE INFORMATION SET FORTH UNDER "RISK FACTORS"
BEGINNING ON PAGE [ ].
The Subscription Rights
We are distributing non-transferable subscription rights to shareholders
who owned shares of our common stock or shares of common stock underlying
preferred stock or options under the 1992 Employee Stock Option Plan as amended,
on February 11, 2002, at no cost to the shareholders. We will give you 7
subscription rights for each share of common stock or shares of common stock
underlying preferred stock or options under the 1992 Employee Stock Option Plan
as amended, that you owned on February 11, 2002. Each subscription right will
entitle you to purchase one share of common stock for $.02. If you wish to
exercise your subscription rights, you must do so before 5 P.M., Eastern
Standard Time, on March 15, 2002. After that date, the subscription rights will
expire and will no longer be exercisable unless the offering is extended.
Basic Subscription Privilege
Each subscription right will entitle you to receive, upon payment of $.02,
1 share of common stock. You will receive certificates representing the shares
that you purchase pursuant to your basic subscription privilege as soon as
practicable after March 15, 2002, whether you exercise your subscription rights
immediately prior to that date or earlier.
Over-Subscription Privilege
Subject to the allocation described below, each subscription right also
grants you an over- subscription privilege to purchase additional shares of
common stock that are not purchased by other shareholders. You are entitled to
exercise your over-subscription privilege only if you exercise your basic
subscription privilege in full. If you wish to exercise your over-subscription
privilege, you should indicate the number of additional shares that you would
like to purchase in the space provided on your subscription certificate. When
you send in your subscription certificate, you must also send the full purchase
price for the number of additional shares that you have requested to purchase
(in addition to the payment due for shares purchased through your basic
subscription privilege). If the number of shares remaining after the exercise of
all basic subscription privileges is not sufficient to satisfy all
over-subscription privileges, we will allocate the available shares among
shareholders who over-subscribed in proportion to the number of shares purchased
by those over-subscribing shareholders through the basic subscription privilege.
However, if your pro rata allocation exceeds the number of shares you requested,
you will receive only the number of shares that you requested, and the remaining
shares from your pro rata allocation will be divided among other shareholders
exercising their over-subscription privileges who have subscribed for additional
shares in proportion to the number of shares purchased by that group of
over-subscribing shareholders through the basic subscription privilege. In
certain circumstances, however, in order to comply with applicable state or
foreign securities laws, we may not be able to honor all over-subscription
privileges even if we have shares available. The number of shares available
under the over-subscription privilege to any one shareholder or group of
shareholders may be reduced by the Company if any such shareholder or group of
shareholders ownership would constitute a change of control of the Company after
the offering.
No Recommendation
We are not making any recommendations as to whether or not you should
exercise your subscription rights. You should make your decision based on your
own assessment of your best interests.
18
Expiration Date
The rights will expire at 5:00 p.m., Eastern Standard Time, on March 15,
2002, unless we decide to extend the rights offering. If you do not exercise
your subscription rights prior to that time, your subscription rights will be
null and void. We will not be required to issue shares of common stock to you if
the Subscription Agent receives your subscription certificate or your payment
after that time, regardless of when you sent the subscription certificate and
payment, unless you send the documents in compliance with the guaranteed
delivery procedures described below.
Withdrawal Right
Our Board of Directors may withdraw the rights offering in its sole
discretion at any time prior to or on March 15, 2002, for any reason (including,
without limitation, a change in the market price of the common stock). If we
withdraw the rights offering, any funds you paid will be promptly refunded,
without interest or penalty.
Determination of Subscription Price
Our Board of Directors chose the $.02 per share subscription price after
considering a variety of factors, including the following:
-- the historic and current market price of the common stock;
-- our business prospects;
-- our history of losses;
-- general conditions in the securities market;
-- our need for capital;
-- alternatives available to us for raising capital;
-- the amount of proceeds desired;
-- pricing of similar transactions;
-- the liquidity of our common stock;
-- the level of risk to our investors; and
-- the need to offer shares at a price that would be attractive to our
investors relative to the current trading price of our common stock.
The $.02 per share subscription price should not be considered an
indication of the actual value of CCSI or of our common stock. We cannot assure
you that the market price of the common stock will not decline during or after
the rights offering. We also cannot assure you that you will be able to sell
shares of common stock purchased during the rights offering at a price equal to
or greater than $.02 per share.
19
Non-Transferability of Subscription Rights
Both the basic subscription rights and over-subscription rights are
non-transferable and non- assignable. Only you may exercise these rights.
Exercise of Subscription Rights
You may exercise your subscription rights by delivering to the Subscription
Agent on or prior to March 15, 2002:
-- A properly completed and duly executed subscription certificate;
-- Any required signature guarantees; and
-- Payment in full of $.02 per share for the shares of common stock
subscribed for by exercising your basic subscription rights and, if
desired, your over-subscription rights.
You should deliver your subscription certificate and payment to the
Subscription Agent at the address shown under the heading "Subscription Agent."
Registered mail or overnight delivery is recommended. We will not pay you
interest on funds delivered to the Subscription Agent pursuant to the exercise
of rights. If you choose to wire transfer funds for payment, you are urged to
send your subscription certificate by overnight delivery no later than the date
of your wire transfer to assure proper matching with your payment and, in any
event, in time for delivery on or prior to March 15,2002. In addition, you are
requested to provide the name, ABA routing number of the originating bank and
the date of your wire transfer on your subscription certificate.
Method of Payment
Payment for the shares must be made by check or bank draft (cashier's
check)drawn upon a United States bank or a postal, telegraphic or express money
order payable to the order of Continental Stock Transfer & Trust Company, as
Subscription Agent. Payment for basic subscription rights and over-subscription
rights may also be effected through wire transfer, the particulars of which may
be obtained by contacting the Subscription Agent at (212)509-4000 extension 536,
or by facsimile at (212)616-7610.
Payment will be deemed to have been received by the Subscription Agent only
upon:
(A) clearance of any uncertified check;
(B) receipt by the Subscription Agent of any certified check or bank draft
drawn upon a U.S. bank or of any postal, telegraphic or express money
order;
(C) receipt by the Subscription Agent of any funds transferred by wire
transfer; or
(D) receipt of funds by the Subscription Agent through an alternative
payment method approved by Chromatics Color Sciences International,
Inc.
20
Please note that funds paid by uncertified personal check may take at least
ten business days to clear. Accordingly, if you wish to pay by means of an
uncertified personal check, we urge you to make payment sufficiently in advance
of March 15, 2002, to ensure that the payment is received and clears before that
date. We also urge you to consider payment by means of a certified or cashier's
check, money order or wire transfer.
Guaranteed Delivery Procedures
If you want to exercise your subscription rights, but time will not permit
your subscription certificate to reach the Subscription Agent on or prior to
March 15, 2002, you may exercise your subscription rights if you satisfy the
following guaranteed delivery procedures:
(1) You send, and the Subscription Agent receives, payment in full for
each share of common stock being subscribed for through the basic
subscription privilege and the over- subscription privilege, on or
prior to March 15, 2002;
(2) You send, and the Subscription Agent receives, on or prior to March
15, 2002, a notice of guaranteed delivery, substantially in the form
provided with the attached instructions, from a member firm of a
registered national securities exchange or a member of the National
Association of Securities Dealers, Inc., or a commercial bank or trust
company having an office or correspondent in the United States. The
notice of guaranteed delivery must state your name, the number of
subscription rights that you hold, the number of shares of common
stock that you wish to purchase pursuant to the basic subscription
privilege and the number of shares, if any, you wish to purchase
pursuant to the over-subscription privilege. The notice of guaranteed
delivery must guarantee the delivery of your subscription certificate
to the Subscription Agent within three business days following the
date of the notice of guaranteed delivery; and
(3) You send, and the Subscription Agent receives, your properly completed
and duly executed subscription certificate, including any required
signature guarantees, within three business days following the date of
your notice of guaranteed delivery. The notice of guaranteed delivery
may be delivered to the Subscription Agent in the same manner as your
subscription certificate at the addresses set forth under the heading
"Subscription Agent," or may be transmitted to the Subscription Agent
by facsimile transmission, to facsimile number (212)616-7610. You can
obtain additional copies of the form of notice of guaranteed delivery
by requesting them from the Subscription Agent at the address set
forth under the heading "Subscription Agent."
Signature Guarantee
Signatures on the subscription certificate do not need to be guaranteed if
either the subscription certificate provides that the shares of common stock to
be purchased are to be delivered directly to the record owner of such
subscription rights, or the subscription certificate is submitted for the
account of a member firm of a registered national securities exchange or a
member of the National Association of Securities Dealers, Inc., or a commercial
bank or trust company having an office or correspondent in the United States. If
a signature guarantee is required, signatures on the subscription certificate
must be guaranteed by an Eligible Guarantor Institution, as defined in Rule
17Ad-15 of the Securities Exchange Act of 1934, as amended, subject to the
standards and procedures adopted by the Subscription Agent. Eligible Guarantor
Institutions include banks, brokers, dealers, credit unions, national securities
exchanges and savings associations.
21
Shares Held for Others
If you are a broker, a trustee or a depository for securities, or you
otherwise hold shares of common stock for the account of a beneficial owner of
common stock, you should notify the beneficial owner of such shares as soon as
possible to obtain instructions with respect to their subscription rights. If
you are a beneficial owner of common stock held by a holder of record, such as a
broker, trustee or a depository for securities, you should contact the holder
and ask him or her to effect transactions in accordance with your instructions.
Ambiguities in Exercise of Subscription Rights
If you do not specify the number of subscription rights being exercised on
your subscription certificate, or if your payment is not sufficient to pay the
total purchase price for all of the shares that you indicated you wished to
purchase, you will be deemed to have exercised the maximum number of
subscription rights that could be exercised for the amount of the payment that
the Subscription Agent receives from you. If your payment exceeds the total
purchase price for all of the subscription rights shown on your subscription
certificate, your payment will be applied, until depleted, to subscribe for
shares of common stock in the following order:
(1) to subscribe for the number of shares, if any, that you indicated on
the subscription certificate that you wished to purchase through your
basic subscription privilege;
(2) to subscribe for shares of common stock until your basic subscription
privilege has been fully exercised;
(3) to subscribe for additional shares of common stock pursuant to the
over-subscription privilege (subject to any applicable proration).
Any excess payment remaining after the foregoing allocation will be
returned to you as soon as practicable by mail, without interest or deduction.
Regulatory Limitation
We will not be required to issue you shares of common stock pursuant to the
rights offering if, in our opinion, you would be required to obtain prior
clearance or approval from any state or federal regulatory authorities to own or
control such shares if, at the time the subscription rights expire, you have not
obtained such clearance or approval.
State and Foreign Securities Laws
The rights offering is not being made in any state or other jurisdiction in
which it is unlawful to do so, nor are we selling or accepting any offers to
purchase any shares of common stock to you if you are a resident of any such
state or other jurisdiction. We may delay the commencement of the rights
offering in certain states or other jurisdictions in order to comply with the
securities law requirements of such states or other jurisdictions. It is not
anticipated that there will be any changes in the terms of the rights offering.
In our sole discretion, we may decline to make modifications to the terms of the
rights offering requested by certain states or other jurisdictions, in which
case shareholders who live in those states or jurisdictions will not be eligible
to participate in the rights offering.
22
Our Decision Regarding Certain Matters Binding on You
All questions concerning the timeliness, validity, form and eligibility of
any exercise of subscription rights will be determined by us, and our
determinations will be final and binding. In our sole discretion, we may waive
any defect or irregularity, or permit a defect or irregularity to be corrected
within such time as we may determine, or reject the purported exercise of any
subscription right by reason of any defect or irregularity in such exercise.
Subscriptions will not be deemed to have been received or accepted until all
irregularities have been waived or cured within such time as we determine in our
sole discretion. Neither Chromatics Color Sciences International, Inc. nor the
Subscription Agent will be under any duty to notify you of any defect or
irregularity in connection with the submission of a subscription certificate or
incur any liability for failure to give such notification.
No Revocation
After you have exercised your basic subscription privilege or
over-subscription privilege, YOU MAY NOT REVOKE THAT EXERCISE. You should not
exercise your subscription rights unless you are certain that you wish to
purchase additional shares of common stock.
Shares of Common Stock Outstanding after the Rights Offering
Assuming we issue all of the shares of common stock offered in the rights
offering, approximately 231,889,550 shares of common stock will be issued and
outstanding. This would represent a 1,105% increase in the number of outstanding
shares of common stock.
IF YOU DO NOT EXERCISE YOUR BASIC SUBSCRIPTION RIGHTS, THE PERCENTAGE OF COMMON
STOCK THAT YOU HOLD WILL DECREASE IF SHARES ARE PURCHASED IN THE RIGHTS
OFFERING, OR IF CHROMATICS COLOR SCIENCES INTERNATIONAL, INC., DOES AN EQUITY
FINANCING SUBSEQUENT TO THIS RIGHTS OFFERING UNDER SIMILAR TERMS AND CONDITIONS.
Fees and Expenses
We will pay all fees charged by the Subscription Agent. You are responsible
for paying any other commissions, fees, taxes or other expenses incurred in
connection with the exercise of the subscription rights. Neither Chromatics
Color Sciences International, Inc. nor the Subscription Agent will pay such
expenses.
Subscription Agent
We have appointed our transfer agent, Continental Stock Transfer & Trust
Company as Subscription Agent for the rights offering. The Subscription Agent's
address for packages sent by mail or overnight delivery is:
Continental Stock Transfer & Trust Company
17 Battery Place
8th Floor
New York, NY 10004
The Subscription Agent's telephone number is (212)509-4000, extension 536,
and its facsimile number is (212)616-7610. You should deliver your subscription
certificate, payment of the subscription price and notice of guaranteed delivery
(if any) to the Subscription Agent. We will pay a fee of $[ ] plus certain
expenses of the
23
Subscription Agent. We have also agreed to indemnify the Subscription Agent from
certain liabilities which it may incur in connection with the rights offering.
IMPORTANT
PLEASE CAREFULLY READ THE INSTRUCTIONS ACCOMPANYING THE SUBSCRIPTION
CERTIFICATE AND FOLLOW THOSE INSTRUCTIONS IN DETAIL. DO NOT SEND SUBSCRIPTION
CERTIFICATES DIRECTLY TO US. YOU ARE RESPONSIBLE FOR CHOOSING THE PAYMENT AND
DELIVERY METHOD FOR YOUR SUBSCRIPTION CERTIFICATE, AND YOU BEAR THE RISKS
ASSOCIATED WITH SUCH DELIVERY. IF YOU CHOOSE TO DELIVER YOUR SUBSCRIPTION
CERTIFICATE AND PAYMENT BY MAIL, WE RECOMMEND THAT YOU USE REGISTERED MAIL,
PROPERLY INSURED, WITH RETURN RECEIPT REQUESTED. WE ALSO RECOMMEND THAT YOU
ALLOW A SUFFICIENT NUMBER OF DAYS TO ENSURE DELIVERY TO THE SUBSCRIPTION AGENT
AND CLEARANCE OF PAYMENT PRIOR TO MARCH 15, 2002. BECAUSE UNCERTIFIED PERSONAL
CHECKS MAY TAKE AT LEAST TEN BUSINESS DAYS TO CLEAR, WE STRONGLY URGE YOU TO
PAY, OR ARRANGE FOR PAYMENT, BY MEANS OF CERTIFIED OR CASHIER'S CHECK, MONEY
ORDER OR WIRE TRANSFER.
IF YOU HAVE QUESTIONS
If you have questions or need assistance concerning the procedure for
exercising subscription rights or if you would like additional copies of this
prospectus, the instructions, or the Notice of Guaranteed Delivery, you should
contact the Reorganization Department of Continental Stock Transfer & Trust
Company at: (212)509-4000 extension 536.
USE OF PROCEEDS
We expect to use the net proceeds of this offering as follows (in order of
priority):
Amount Assuming Amount Assuming
Subscription of Subscription of
Purpose $500,000 $4,218,000
-------------------------------------------- ---------------- -------------------
1. Fees for Intellectual Property
Maintenance and Filing Maintenance
Fees $150,000 $300,000
2. Regulatory Fees and Expenses $ 75,000 $150,000
3. Past Due Payables $ 75,000 $800,000
4. Repayment of Bridge Loans $0 $1,200,000
5. Operating Capital $50,000 $1,618,000
6. Rights Offering Expenses $150,000 $150,000
24
DETERMINATION OF OFFERING PRICE
The price of our shares of common stock in this offering was arbitrarily
determined. The factors considered in determining the offering price included
the historic and current market price of the common stock, our financial
condition, challenges facing our Company, our history of profits and losses,
general conditions in the securities market, our need for capital, alternatives
available to us for raising capital, the amount of proceeds desired, the
liquidity of our common stock, the level of risk to our investors, and the need
to offer shares at a price that would be attractive to our investors relative to
the then current trading price of our common stock. The offering price is not an
indication of and is not based upon the actual value of the Company. The
offering price bears no relationship to the book value, assets or earnings of
the Company or any other recognized criteria of value. The offering price should
not be regarded as an indicator of the future market price of the securities. On
February 1, 2002, the last reported sales price of our common stock on the
Nasdaq OTC Bulletin Board was $.015 per share.
MARKET PRICE OF COMMON STOCK
Our stock is currently quoted on the Over-the-Counter Bulletin Board. As of
February 1, 2002, we had 20,989,550 shares of common stock outstanding. As of
February 1, 2002, the number of holders of record of our common stock was 152.
From February 8, 1993 through November 30, 2001, our common stock was quoted on
the NASDAQ SmallCap Market, prior to the recent delisting from Nasdaq Small Cap
Market.
The following tables set forth the high and low bid prices of our common
stock for each of the periods indicated (after giving retroactive effect to the
February 1998 3 for 2 Stock Split):
Period High Low
------ ----- -----
January 1, 2000 to March 31, 2000 7.938 5.375
April 1, 2000 to June 30, 2000 5.375 2.875
July 1, 2000 to September 30, 2000 5.063 0.625
October 1, 2000 to December 31, 2000 2.125 0.250
January 1, 2001 to March 31, 2001 1.031 0.063
April 1, 2001 to June 30, 2001 0.310 0.100
July 1, 2001 to September 30, 2001 0.220 0.040
October 1, 2001 to December 31, 2001 0.110 0.010
January 1, 2002 to February 1, 2002 0.040 0.015
DIVIDEND POLICY
Subject to the prior rights of holders of our preferred stock, the holders
of our common stock are entitled to receive such dividends as our board of
directors may declare from time to time from any surplus that we may have.
However, we have not paid,
25
and have no present intention to declare or pay, cash dividends on the common
stock in the foreseeable future.
26
CAPITALIZATION
The following table shows out indebtedness and capitalization as of
September 30, 2001, and as adjusted for the issuance and sale of 210,900,000
shares of common stock under this rights offering, offered hereby at a purchase
price of $ .02 per share and the application of the estimated net proceeds as
shown under "Use of Proceeds" appearing on page [ ] of this prospectus
September 30, 2001
-----------------------------------------------------------------------
Actual As Adjusted Minimum As Adjusted Maximum
----------------------- -------------------- ------------------------
Notes payable $ 1,260,000 $ 1,260,000 $ 60,000
Redeemable preferred stock 13,800 13,800 13,800
Shareholders' equity (deficiency)
Preferred stock, 113,769 shares
issued and outstanding 12,344,800 12,344,800 12,344,800
Subscribed stock 500,000 500,000 500,000
Common stock 19,991,952, 20,000 45,000 231,000
44,991,952 and 230,891,952 shares
Capital in excess of par 46,718,500 47,093,500 50,575,500
Accumulated deficit (60,160,400) (60,160,400) (60,160,400)
----------------------- -------------------- ------------------------
(577,100) (177,100) 3,490,900
----------------------- -------------------- ------------------------
Total capitalization $ 696,700 $ 1,096,700 $ 3,564,700
======================= ==================== ========================
SELECTED FINANCIAL DATA
The following information has been derived from the Company's consolidated
financial statements. The selected consolidated financial data should be read in
conjunction with the Consolidated Financial statements and the notes thereto and
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations" elsewhere in this prospectus.
Nine Months Ended
September 30, Years Ended December 31,
---------------------------- ---------------------------------------------------------------------------
2001 2000 2000 1999 1998 1997 1996
---- ---- ---- ---- ---- ---- ----
Total Assets $ 3,097,700 $ 13,385,300 $4,914,200 $8,110,200 $7,878,200 $10,752,600 $6,747,500
Senior Convertible
Debentures including
secured interest -- 6,020,800 -- $4,661,600 -- -- --
Redeemable Preferred
Stock 13,800 13,800 13,800 2,942,500 13,800 13,800 13,800
Stockholders' Equity
(Deficiency) (577,100) 757,800 3,386,700 (503,700) 6,569,200 9,896,300 5,942,200
Revenues 6,000 80,400 80,400 1,103,200 46,600 11,500 66,600
Net Loss (6,916,800) (10,670,100) (19,496,400) (12,808,000) (7,284,800) (5,053,100) (4,442,300)
Net Loss per share -
Basic and diluted (*) (0.35) (0.66) (1.40) (0.93) (0.49) (0.40) (0.51)
----------
(*) Loss per share was retroactively adjusted to reflect the February 1998
three for two split
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30,
2000
For the nine months ended September 30, 2001 and 2000 the Company incurred
losses from continuing operations of $5,082,800 and $9,036,700, respectively.
Loss per share from continuing operations for the nine months ended September
30, 2001 and 2000 were ($.30) and ($.63), respectively. The reduction in losses
incurred from continuing operations is primarily
27
attributable to the Company's ability to reduce its operating costs in
accordance with its business plan.
The Company incurred losses from discontinued operations of $1,000,000 or
($.05) per share for the nine months ended September 30, 2001 and $374,400 or
($.02) per share for the nine months ended September 30, 2000 due to the
decision to dispose of the Gordon operation.
Sales, marketing and trade show costs were $281,500 for the nine months
ended September 30, 2001 as compared to $1,667,100 in the prior period as the
Company has substantially reduced its medical sales force in 2001. Medical
regulatory expenses were $304,300 for the nine months ended September 30, 2001
as compared to $617,000 in the prior period due to significant reductions in the
second quarter of 2001 in FDA filing costs relating to medical products and
other regulatory requirements.
Research and development costs were $597,200 for the nine months ended
September 30, 2001 as compared to $958,300 for the nine months ended September
30, 2000. The decreased research and development costs for the nine months ended
September 30, 2001 are primarily a result of the completion of milestones in the
development of the Company's medical product.
The Company recorded a provision for estimated payments for terminated
employees of $1,000,000 at March 31, 2001.
Compensation costs - Officers, employees and consultants were $853,200 for
the nine months ended September 30, 2001 as compared to $1,258,800 for the nine
months ended September 30, 2000. The decreases were caused by significant
decreases in personnel in 2001.
Total general and administrative costs were $2,419,100 for the nine months
ended September 30, 2001 as compared to $3,673,700 in the prior period. The
decrease is primarily a result of cost reductions initiated by the Company in
2001.
Interest and non-cash financing costs were $309,900 in the nine months
ended September 30, 2001 as compared to $1,379,200 in the prior period. The
decrease is primarily due to amortization of original issue discount on senior
convertible debentures, which was fully amortized in prior periods.
Deemed dividends on preferred stock were $834,000 in the nine months ended
September 30, 2001 as compared to $1,259,000 in the prior period. The decrease
for the current period is due to an additional deemed dividend from a new
financing in the prior period, which did not occur in the current period.
Although the Company has substantially reduced personnel and ongoing
operating expenses, the Company expects that if it is successful in raising the
necessary financing to continue operations, it will continue to incur costs in
connection with the required research and development for different market
applications of its new LED instrument and technology, complete filings,
administration and maintenance for certain intellectual properties and
regulatory requirements; supply updated products and sales support to its
medical distributor; complete FDA filings for further upgrades to its medical
products, and explore the possibility of either
28
renegotiating its current distribution agreement for its medical products or
selling the exclusive rights to its medical products and technology.
The Company anticipates that it will continue to incur net losses for the
foreseeable future as expenses are incurred in implementing its long-term
business plan.
Fiscal Year 2000 Compared to Fiscal year 1999
The Company incurred net losses of $19,496,400 and $12,808,000 for the
fiscal years ended December 31, 2000 and 1999, respectively. Loss per share was
$1.40 for 2000 and $.93 for 1999.
Revenues for the fiscal year ended December 31, 2000 were $80,400 compared
to $1,103,200 in the prior fiscal year. The decrease in revenues for the fiscal
year is primarily attributable to a reduction of sales of products to
Datex-Ohmeda.
Costs of sales were $760,100 (which includes an impairment charge of
$733,100 on the Company's inventory) for the fiscal year ended December 31, 2000
as compared to $898,100 in the prior year. Cost of sales primarily relate to the
sales to Ohmeda.
In light of the serious liquidity and other problems at the Company and
because of the lack of viable levels of sales of its medical equipment the
Company recorded $1,507,700 of impairment charges.
Sales, marketing and trade show costs were $2,047,300 in 2000 as compared
to $2,511,600 in 1999. The decrease was primarily attributable to Datex-Ohmeda
assuming some of the marketing expenses in 2000.
Medical regulatory expenses were $840,100 in 2000 as compared to $1,323,300
in 1999. The decrease was primarily attributable to Datex-Ohmeda assuming some
of the regulatory expenses in 2000.
Research and development costs were $1,257,200 for the fiscal year ended
December 31, 2000 as compared to $996,300 in the prior fiscal year. The increase
in 2000 is primarily a result of the continuing implementation of the Company's
long term business plan to seek commercial applications of its intellectual
properties and technologies.
Compensation - Officers and employees were $1,194,500 for the fiscal year
ended December 31, 2000 as compared to $803,900 for the prior fiscal year. The
increase in these costs in 2000 is a result of the addition of executive and
senior level personnel to implement the Company's business plan.
Total General and administrative costs were $4,941,600 for the fiscal year
ended December 31, 2000 as compared to $3,951,200 in the prior year. The
increase primarily results from the above-mentioned increase in compensation
costs, an increase in consultants, an increase in depreciation and amortization
costs.
29
Interest and non-cash financing costs were $1,437,500 in the fiscal
year ended December 31, 2000 as compared to $3,313,000 in the prior period. The
decrease is due to a reduction in the amortization of original issue discount on
the senior convertible debentures.
Due to the sale of Gordon in 2001 the operations of Gordon, which was
acquired in June 2000, was retroactively treated as a discontinued operation.
The loss from discontinued operations in 2000 was $5,973,100 of which $696,600
represents Gordon's operating losses for the 7 months in 2000 and $5,276,500
represents the impairment of goodwill related to the acquisition of Gordon.
Deemed dividend on preferred stock was $3,900,000 in the fiscal year
ended December 31, 2000 as compared to $1,558,300 in the prior year. The
increase is due to the amortization of a new series of preferred stock which was
not issued in 1999 and the impact of a new accounting release.
Although the Company has substantially reduced personnel and ongoing
operating expenses, the Company expects that it will continue to incur costs in
connection with the required research and development on its new LED instrument
and technology, complete filings, administration and maintenance for certain
intellectual properties and regulatory requirements; supply updated products and
sales support to its medical distributor; complete FDA filings for upgrades to
its medical products, and explore the possibility of either renegotiating its
current distribution agreement for its medical products or selling the exclusive
rights to its medical products and technology.
The Company anticipates that it will continue to incur new losses for
the foreseeable future as expenses are incurred in implementing its long-germ
business plan.
Fiscal Year 1999 Compared to Fiscal Year 1998
The Company incurred a net loss of $12,808,000 and $7,284,800, for
fiscal years 1999 and 1998, respectively. In 1999 revenues of $1,103,200 were
received principally from sales of ColorMate(R) TLc-BiliTest(R) Systems and
TLc-Lensette(TM) Calibration Standards and other products under the Company's
distribution agreement with Datex-Ohmeda, Inc. and its Ohmeda Medical Division.
Of the increase in net loss from 1999 as compared to 1998, $2,740,800 represents
non-cash financing costs computed as original issue discount ("OID") on
financing transactions, $495,800 represents non-cash accrued interest on senior
convertible debentures and $140,600 represents an increase in non-cash expenses
relating to stock option grants to non- employees. The remaining $2,146,000
increase in losses from 1999 as compared to 1998 (without consideration of the
non-cash OID costs, the non-cash accrued interest on senior convertible
debentures and non-cash expenses for stock option grants to non-employees), is
primarily attributable to an increased cost of $1,552,700 relating to the
Company's medical division sales force, as the Company continued the
implementation of its long-term business plan to seek commercial applications of
its intellectual properties and technologies in the medical field. The Company
had a gross profit in 1999 from sales of ColorMate(R) TLc-BiliTest(R) Systems
and TLc- Lensette(TM) Calibration standards and other products of $205,100 which
was offset by: the increase cost of sales, marketing and trade show expense
which include the above-mentioned fully implemented sales force at its medical
division of $1,552,700; increases in amortization of patent, software and
ColorMate(R) TLc-BiliTest(R) Systems promotional expenses of $363,700 and an
increase in stock administration fees of $88,400 relating primarily to
registration costs of the 1999 financing transactions. These increased expenses
were partially offset by a decrease in legal fees of $163,000.
30
LIQUIDITY AND CAPITAL RESOURCES
Nine Months Ended September 30, 2001 Compared to nine Months Ended September 30,
2000
Current Assets were $2,002,400 at September 30, 2001 as compared to
$2,495,900 at December 31, 2000. This decrease is primarily attributable to
decrease in cash due to the operating losses.
As indicated in the Consolidated Statement of Cash Flows, the Company
continues to experience significant negative net cash flows from operating
activities. The 2001 net cash outflow from operating activities is primarily
attributed to the Company's net loss partially offset by depreciation and
amortization expense and increases in accounts payable.
The Company lacks funds to continue its operations and business plan,
including funds and necessary personnel to complete research and development on
its new LED instrument and technology recently required during its first mass
manufacturing process; complete filings, administration and maintenance for
certain intellectual properties and regulatory
31
requirements; supply upgraded products and sales support to its medical
distributor; and complete FDA regulatory filings for upgrades to its medical
products.
The Company's current objective with regard to its medical business is
to arrive at acceptable revised terms of the existing agreement with the
distributor or to identify a strategic partner in the medical industry to whom
the Company could sell, for an up-front fee and ongoing royalty, the exclusive
market rights to the ColorMate(R) TLc-BiliTest(R) System.
The Independent Accountants' Report on the December 31, 2000 financial
statements indicates the Company has incurred losses for the last several years,
including $19,464,400 in 2000 and has experienced significant problems and
delays exploiting its primary technology (medical equipment). The Independent
Accountants' Report states that these matters raise substantial doubt about the
Company's ability to continue as a going concern. Gordon was sold in 2001.
The Company is experiencing a major liquidity crisis and requires an
immediate infusion of cash to continue operations. The Company is seeking
additional capital to facilitate liquidity and is currently reviewing various
financing proposals and has taken steps to significantly reduce costs. If the
Company is unable to obtain such financing, or sell its assets to obtain a cash
infusion, it may be forced to seek protection from its creditors in bankruptcy.
Even if the Company is successful in obtaining this cash infusion, the
Company will require additional future financing to further execute its long
range business plan. If the Company is not able to attract additional future
financing, generate significant revenue from operations and/or successfully
market its products and technologies, it may have to significantly curtain
and/or cease operations and be forced to seek protection from its creditors in
bankruptcy.
In August 2001, the Company retained Janssen Partners, Inc. to serve as
its placement agent in connection with an offering of 10,333,333 shares of
common stock and warrants to raise $620,000 in proceeds. Attached to each share
is a Series A Common Stock Purchase Warrant which vests immediately, has a
five-year life and is exercisable at $0.10 per share after registration of the
underlying shares. Upon the exercise of each Series A Common Stock Purchase
Warrant, the holder will receive a Series B Common Stock Purchase Warrant which
vests immediately, has a five-year life from date of issuance and is exercisable
at $0.15 per share after registration of the underlying shares.
The Company is contemplating issuing an additional proxy to obtain
stockholder approval for an additional proposed private placement by the Company
involving potential issuance of additional shares of common stock by the Company
in an aggregate amount in excess of 20% of the Company's common stock
outstanding immediately prior to such private placement at a price per share
less than the market value of the common stock.
32
On October 31, 2001, at a special shareholder meeting an amendment to the
Company's Certificate of Incorporation to increase the number of authorized
shares of common stock, $.001 par value per share, from 50,000,000 to
550,000,000 was approved by the folowing votes: 18,110,383 for, 1,033,794
against and 71,069 abstained. Additionally, an amendment to the Company's
Certificate of Incorporation to effect a one share for up to forty shares
reverse stock split of the Company's issued and outstanding shares of common
stock, as determined by the Company's Board of Directors was approved by the
following votes: 18,078,117 for, 1,052,519 against; and 84,550 abstained. Due to
the delisting of the Company's securities from NASDAQ SmallCap market, the
Company's Board of Directors does not see the necessity to execute a reverse
split in the Company's common stock at this time, but reserves the right to
reconsider this action at a later date within time frames proposed in the Proxy
which were approved by the Company's shareholders at the October 31, 2001
Special Meeting of the Shareholders.
Some of the information presented herein constitutes "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Although the Company believes that its expectations are based on
reasonable assumptions, within the bounds of its knowledge of its business and
operations, there can be no assurance that actual results will not differ
materially from its expectations. Factors that could cause actual results to
differ from expectations including, among other things: (1) the inability of the
Company to resolve the current liquidity crisis, (ii) the inability of the
Company to secure additional financing, (iii) the failure of the Company to
implement its business plan for various applications of its technologies,
including medical and industrial technologies, (iv) government regulation and
(v) the loss of key personnel.
Fiscal Year 2000 Compared to Fiscal Year 1999
Current Assets were $2,495,900 at December 31, 2000 as compared to
$4,933,700 at December 31, 1999. This decrease is primarily attributable to a
decrease in cash due to the cash operating losses.
As indicated in the Consolidated Statement of Cash Flows, the Company
continues to experience significant negative net cash flows from operating and
investing activities.
The 2000 net cash outflow from operating activities is primarily
attributed to the Company's net loss (partially offset by depreciation and
amortization expense, non-cash compensation costs to consultants, non-cash
interest and financing costs, collections of amounts receivable and the
impairment provision.)
Cash flows from financing activities during 2000 principally represent
$9,152,400 of proceeds from the issuance of common stock, preferred stock and
warrants.
The Company lacks funds to continue its operations and business plan,
including funds and necessary personnel to complete recently required research
and development on its new LED instrument and technology discovered during its
first mass manufacturing process; complete filings, administration and
maintenance for certain intellectual properties and regulatory requirements;
supply upgraded products and sales support to its medical distributor; and
complete FDA regulatory filings for upgrades to its medical products.
33
The Company's current objective with regard to its medical business is
to arrive at acceptable revised terms of the existing agreement with the
distributor or to identify a strategic partner in the medical industry to whom
the Company could sell, for an up-front fee and ongoing royalty, the exclusive
market rights to the ColorMate(R) TLc-BiliTest(R) System.
DESCRIPTION OF BUSINESS
We are engaged in the business of researching, developing and
commercializing intellectual property rights, technology and instrumentation we
have developed in the field of color science. Color science involves the
objective, standardized analysis, description and measurement by instrument to a
laboratory standard of accuracy of the colors composing the visual color
spectrum and their related physical properties in relation to each other.
We have incorporated some of these intellectual property rights, technology
and instrumentation into a proprietary color measurement system and software
marketed for various applications known as the ColorMate(R) System. We have
developed our intellectual property and the ColorMate(R) System for:
o the color measurement to a laboratory standard of accuracy and
classification of human tissue, fluid, hair and/or teeth color,
o the color coordination of these human skin, tissue, fluid, hair and/or
teeth color classifications in relation to products,
o the color measurement to a laboratory standard of accuracy,
classification and organization based on color of various
color-sensitive consumer products including chromaticity studies of
cosmetics, hair coloring, hosiery, clothing, tooth enamel, paint and
textiles,
o the color measurement to a laboratory standard of accuracy to monitor
infant jaundice,
o the color measurement in detecting and monitoring those diseases which
we believe can be diagnosed or monitored by the coloration of human
skin, tissue and fluids, and
o the color coordination of products in relation to other products.
In July 1997 we received clearance from the U.S. Food and Drug
Administration for commercial marketing of our ColorMate(R) System device for
the non-invasive monitoring of infant jaundice by healthcare professionals in
the hospital, institutional, pediatricians' office or home setting. In September
2001, we received further clearances from the U.S. Food and Drug Administration
for upgrades to the ColorMate(R) TLc-BiliTest(R) System. The current procedure
for the initial screening for infant jaundice is the visual observation of the
yellowing of the skin by professional care providers. This is a subjective
determination prone to errors due to different skin colors. If the initial
clinical assessment suggest the possibility of infant jaundice, the current
34
procedure requires that a blood sample be obtained by lancing the infant. We
believe that a non- invasive instrument that monitors infant jaundice represents
a significant improvement in patient care.
The ColorMate(R) TLc-BiliTest(R) System monitors the incremental change
of the yellow content of the skin color in infants of all races by
non-invasively measuring the color of the skin of the newborn. Color
measurements are obtained by placing the device on different physical sites of
the newborn for five to ten seconds. Accuracy of the color measurements is
caused by use of the TLc-Lensette(TM) calibration standard used prior to each
baby measurement.
In June 1999 we entered into an agreement for the exclusive
distribution of this product in the hospital, pediatricians' office and home
healthcare markets in the United States with Datex- Ohmeda, Inc. and its Ohmeda
Medical Division.
As a result of the disappointing results achieved to date in pursuing
the Company's business strategy through the distribution agreement with
Datex-Ohmeda and the limited financial resources of the Company, the Company's
current objective with regard to its medical business is to either arrive at
acceptable revised terms of our existing agreement with Datex-Ohmeda or to
identify a strategic partner in the medical industry to whom the Company could
sell, for an up- front fee and ongoing royalty, the exclusive market rights to
the ColorMate(R) TLc-BiliTest(R) System. There can be no assurance that the
Company will be able to successfully renegotiate its distribution agreement with
Datex-Ohmeda or identify such a strategic partner or to negotiate and consummate
such a sale. We are also developing a business plan for establishing a new
management structure and commercializing new applications of our technology. We
will need to generate substantial revenues from equity financing and/or the sale
of our products in order to fund our continuing operations and to develop and/or
market other medical and non-medical applications for our intellectual property
rights, technology and instrumentation. If we are not successful in generating
adequate revenues, we may be forced to curtail our operations and seek
protection from our creditors under applicable bankruptcy laws.
In June 1999 we sold 40,000 shares of convertible preferred stock and
warrants to purchase 270,690 shares of our common stock to an affiliate of
Lehman Brothers, Inc. for aggregate proceeds of $4,000,000. In February 2000 we
sold 40,000 shares of convertible preferred stock and warrants to purchase
304,372 shares of our common stock to the same Lehman affiliate for aggregate
proceeds of $4,000,000. The shares of preferred stock issued during these
financings are convertible into shares of our common stock at a conversion price
of $4.68 per share and the warrants have an exercise price of $4.68 per share.
The shares of preferred stock and the warrants are subject to adjustment for
stock splits, combinations and similar recapitalizations affecting our common
stock and in certain circumstances involving the issuance of shares of our
common stock at prices below $4.68 per share. 575,062 of the warrants issued
during these financings are currently outstanding.
On June 2, 2000 we acquired the common stock and certain debt of Gordon
laboratories, Inc., a Carson City, California based formulator and manufacturer
of cosmetics, hair care and other personal care products. We acquired from the
shareholders of Gordon:
o approximately 85% of the outstanding shares of common stock, par value
$.001, of Gordon,
35
o options to purchase the remaining shares of Gordon, subject to
mandatory exercise by us on the first anniversary of the closing date
if not sooner exercised within one year and
o notes in the aggregate principal amount of $1,854,000 made by Gordon
in favor of its shareholders.
In exchange, we issued to the shareholders of Gordon a total of 721,233
shares of our common stock and paid them $609,000 in cash. In addition, we
agreed to register the shares of our common stock issued to the shareholders of
Gordon for resale under the Securities Act of 1933 and use our reasonable best
efforts to maintain the effectiveness of this registration statement until the
earlier of the date that all of the shares of our common stock held by such
shareholders have been sold or 360 days after the effective date of the
registration statement.
In August 2000, we sold to a private investor for gross proceeds of
$3,000,000:
o 641,026 shares of our common stock,
o a warrant to purchase 150,000 shares of our common at an exercise
price equal to $5.26 and
o an additional warrant to purchase, on two different vesting dates, at
an exercise price equal to $.001, a number of shares of our common
stock to be adjusted according to the closing bid prices of our common
stock during the forty trading days preceding each respective vesting
date.
As compensation for services rendered in connection with this private
placement, an additional warrant to purchase 30,000 shares of our common stock
was issued to our financial adviser on the same terms and conditions as the
warrant issued to the purchaser.
On October 11, 2000, we obtained commitments from three of our major
investors to restructure the terms of their respective securities. Millennium
and the Lehman affiliate agreed to eliminate provisions in their respective
purchase documents involving antidilution and provisions imposing monetary
penalties in the event that our common stock is delisted from Nasdaq. They also
agreed to delete those provisions granting them rights to require us to
repurchase shares of our common stock or preferred stock for cash, except in
certain limited circumstances within our control. The convertible debenture
holders agreed to convert the entire principal amount of their debentures, and
any accrued but unpaid interest thereon, into a newly authorized series of
convertible preferred stock, effective October 31, 2000. This new class of
convertible preferred:
o has a conversion price of $4.68 per share,
o ranks senior and prior to all existing and future classes or series of
our capital stock in the event of the distribution of our assets upon
liquidation, dissolution or winding up,
36
o is subject to involuntary conversion at our option into shares of our
common stock at a conversion price of $4.68 per share if the average
closing bid price of our common stock for ten consecutive trading days
exceeds $10.29 and
o is subject to adjustment for stock splits, combinations and similar
recapitalizations affecting our common stock.
The purpose of this restructuring was to assist us in meeting the net
tangible assets requirement for continued listing on the Nasdaq SmallCap Market.
The commitments of these investors were subject to certain conditions, including
our securing confirmation from Nasdaq of our eligibility for continued listing
on the Nasdaq SmallCap Market and the closing of the equity financing with
Crescent (described below). Each of these conditions were satisfied on or prior
to November 1, 2000. In consideration of their agreements to restructure their
respective securities, we agreed to issue to each of the Lehman affiliate and
the debenture holders 200,000 five-year warrants to purchase our common stock at
an exercise price of $1.50 per share. We also agreed with the debenture holders
not to incur or permit any future liens on any of our properties or assets, not
to grant any security interests in our future revenues and not to consummate any
future financing which involves the issuance of debentures.
On October 31, 2000, we issued to Crescent International Ltd. 200
shares of a new series of preferred stock and a five-year warrant to purchase up
to 270,000 shares of our common stock for an aggregate purchase price of
$2,000,000. The warrant has an exercise price equal to $1.00 per share and is
subject to adjustment in certain circumstances. The preferred stock is:
o convertible at any time at the option of Crescent into the number of
shares of common stock determined by dividing $10,000 by the lower of
$0.82 and 92% of the average of the lowest three consecutive closing
bid prices of our common stock during the 22 trading day period
immediately preceding the date that conversion is required;
o subject to redemption by us, at any time after October 31, 2002 and
upon the written request of Crescent, for either, at our option, (i)
$12,000 in cash per share or (ii) the number of shares of common stock
obtained by dividing $12,000 by the lower of $0.82 and 92% of the
average of the lowest three consecutive closing bid prices of our
common stock during the 22 trading day period immediately preceding
the date that redemption is requested; and
o subject to restrictions on conversion and redemption which prohibit
Crescent or its affiliates from owing more than 9.9% of our
outstanding common stock, as determined in accordance with Section
13(d) of the U.S. Securities Exchange Act of 1934, as amended.
In November 2000, Crescent converted 64 of the 200 shares of preferred
stock registered in its name into 1,391,304 shares of our common stock.
In June 2001, we exercised our option to purchase the remaining 15% of
outstanding shares of Gordon, making Gordon a wholly-owned subsidiary. In July
2001, we sold Gordon to Abilene and GAC-Labs.
37
In August 2001, we retained Janssen Partners, Inc. to serve as our
placement agent in connection with an offering of 10,333,333 shares of our
common stock and warrants to raise $620,000 in proceeds. Attached to each share
is a Series A Common Stock Purchase Warrant which vests immediately, has a
five-year term and is exercisable at $0.10 per share after registration of the
underlying shares. Upon the exercise of each Series A Common Stock Purchase
Warrant, the holder will receive a Series B Common Stock Purchase Warrant which
vests immediately, has a five-year term from date of issuance and is exercisable
at $0.15 per share after registration of the underlying shares.
In May through December, 2001 Janssen Partners, Inc. served as our agent in
financing approximately two-thirds of $1,700,000 in Bridge Loans to the Company.
These Bridge Loans were subject to 1 year promissory notes with interest.
11,875,001 Common Stock purchase Warrants exercisable at $0.06 per share, and
28,875,001 Common Stock purchase Warrants exercisable at $0.10 per share are
issuable in connection with these Bridge Loans.
On October 31, 2001, at a special shareholder meeting an amendment to
our Certificate of Incorporation to increase the number of authorized shares of
common stock, $.001 par value per share, from 50,000,000 to 550,000,000 was
approved. Additionally, an amendment to our Certificate of Incorporation to
effect a one share for up to forty shares reverse stock split of our issued and
outstanding shares of common stock, as determined by our Board of Directors was
approved.
On May 29, 2001, we received notification from NASDAQ that our common
stock failed to comply with the $2,000,000 minimum net tangible assets condition
required for continued listing of the common stock on the NASDAQ SmallCap
market. A hearing on the proposed delisting of the Company's common stock was
held on August 16, 2001. At that hearing the NASDAQ Hearing Committee requested
additional information regarding the Company's plans to achieve compliance with
the minimum net tangible asset requirement. On October 30, 2001, NASDAQ granted
a temporary exception to us to remain listed until November 30, 2001, pending
our ability to be in compliance with the terms of the exception, including the
net tangible assets requirement. We were not able to be in compliance by
November 30, 2001, and as a result our common stock was delisted from NASDAQ
SmallCap Market. However, our common stock continues to be listed on the OTC
Bulletin Board.
On September 13, 2001, the Company received Food and Drug Administration
(FDA) clearance of its 510(k) premarket application to commercially market its
upgraded ColorMate(R) TLc-BiliTest(R) System for non-invasive monitoring of
infant jaundice. The TLc-BiliTest(R) System upgrade includes faster, more user
friendly test programs with many new or improved features requested by
healthcare providers, such as test result transfer capability to a central
server via the internet. This most recent FDA clearance also confirmed the
safety and effectiveness of the TLc-BiliTest(R) System for infants of all races
and gestational ages before, during and after phototherapy, other than infants
with discoloration at a required measurement site. The Company believes these
features will provide a state-of-the art monitoring system for aiding physicians
and healthcare providers in monitoring bilirubin for newborn infants.
The Company has begun discussions with potential investors and
placement agents including certain principal shareholders of the Company,
including Janssen Partners, Inc., for issuance of up to 400,000,000 shares of
common stock pursuant to one or more additional financings, including a possible
additional private placement, this rights offering, and/or other potential
offerings but as of yet has not reached definitive terms agreed upon by the
parties. The details of principal shareholders holdings are provided in the
table under the section titled, "Security Ownership of Certain Beneficial owners
and Management." The material proposals entail an approximately $3.5 million
private placement whereby the Company's stock would be sold at a discount to
market price to be determined, in addition to certain placement agent
compensation and registration rights subject to negotiation. The potential
private placement
38
would be preceded by this rights offering by the Company to shareholders of
record prior to such a private placement offering, at the same discount to
market as the private placement, under terms yet to be finalized.
Description of Property
The Company occupies approximately 2,000 sq. ft. of space located in
Riverdale, New York and is occupied pursuant to a month to month lease. Rentals
under such lease currently are being paid at the rate of $2,260 per month, plus
occupancy costs. The Company also maintains approximately 1,000 sq. ft. of space
at 10 Old Jackson Avenue, Hastings-on-Hudson, New York, at the residence of Mrs.
Macfarlane which is used for research and development activities and
administrative offices for extensive overtime hours spent on management and
research and development. The Company paid approximately $10,980 for such space
in 2001. The Company has recently moved its principal executive offices from 5
East 80th Street, NY, NY as part of its business plan to reduce operating costs.
Legal Proceedings
On January 16, 2001, a lawsuit was commenced against the Company and Darby
Macfarlane in the federal district court for the Sourthern District of New York
entitled Richard Sommers and Linda Sommers v. Chromatics Color Sciences
International, Inc. and Darby S. Macfarlane. The plaintiffs alleged that certain
statements purportedly made by or on behalf of the Company concerning the
Company's success, the extent of use of the ColorMate(R) System and the
Company's cash flow constituted violations of Section 10(b) of the Securities
Exchange Act of 1934 and SEC Rule 10b-5 promulgated thereunder and Section
12(a)(2) of the Securities Act of 1933 as well as common law claims alleging
fraudulent misrepresentation, concealment and nondisclosure and seek unspecified
charges in an amount to be proven at trial. On March 1, 2001, the defendants
moved to dismiss the complaint for failure to make a claim upon which relief can
be granted, for failure to plead fraud with requisite particularity and for
failure to comply with the statutory requirements for federal securities fraud
claims. Oral argument was held before the court (Grisea, J.) on January 17,
2002, and the court entered an order granting the defendants' motion and
dismissing the case without prejudice, but with leave for the plaintiffs to
refile. Defendants believe that the claims asserted against them are without
merit and intend to vigorously defend this action, assuming that the complaint
is refiled.
MANAGEMENT
Directors, Executive Officers, Promoters and Control Persons
Name Age Position(s)
---- --- -----------
Darby Simpson Macfarlane 57 Director, Chairperson of the
Board of Directors, Chief
Technology Officer, Treasurer
Brian T. Fitzpatrick 48 Director, Acting Chief Executive
Officer, President
David Kenneth Macfarlane 55 Director, Vice President Research
and Development
Leslie Foglesong 46 Director, Secretary,
Assistant Treasurer
Edmund Vimond*++ 65 Director
Ed Mahoney*++ 50 Director
----------
* Member of the Audit Committee of the Board of Directors.
++ Member of the Compensation Committee of the Board of Directors.
39
Directors are elected annually by the shareholders and hold office until
the next annual meeting and until their respective successors are elected and
qualified. Executive officers are elected by the Board of Directors, serve at
the direction of the Board of Directors and hold office until their respective
successors are elected and qualified. There is no current arrangement or
understanding between any director or executive office and any other person
pursuant to which such person was or is to be selected as a director or
executive officer of the Company.
Mrs. Macfarlane and Mr. Macfarlane were formerly married to one another.
There are no other family relationships among the directors or executive
officers of the Company.
Set forth below is certain additional information with respect to the
directors, executive officers and certain consultants of the Company.
Mrs. Macfarlane co-founded the Company in March 1984. She has been
Chairperson of the Board, Chief Executive Officer, chief Technology Officer,
Treasurer or Assistant Treasurer and a director of the Company since formation
and also served in the capacity of President until April 9, 1995. Prior to such
time, Mrs. Macfarlane was the co-founder in 1974 of Personalized Colors, Inc.
Commencing in 1978, Mrs. Macfarlane and Mr. Macfarlane led and directed the
Company's research and development and mass-manufacturing efforts of the color
science technology, instrumentation and cosmetic and related products now
offered by the Company.
Mr. Macfarlane co-founded the Company and is also one of the primary
inventors of the patented technologies used in the ColorMate(R)System. In
addition, Mr. Macfarlane developed the manufacturing, technical and engineering
specifications necessary to have miniaturized and mass manufactured the
ColorMate(R)System. Mr. Macfarlane has been Vice President - Research and
Development, and a director of the Company since formation. Prior to 1984, Mr.
Macfarlane held a variety of executive positions with finance, sales, marketing,
research and development and manufacturing companies in Europe, South Africa and
the United States, including International Technical Research and Development,
Ltd., and Trumach, Inc.
Leslie Foglesong has been the Secretary, Treasurer or Assistant Treasurer
and a director of the Company since its formation.
Mr. Edmund G. Vimond has previously provided consulting services to the
Company. On December 1, 1997, Mr. Vimond was appointed to the Company's Board of
Directors and currently acts as Chairman of the Company's compensation
Committee. From 1991 to 1997, Mr. Vimond was the President and Chief Executive
Officer of Ocurest Laboratories, Inc. Mr. Vimond was responsible for managing
all functions of the business, including marketing, sales, contract
manufacturing, personnel and finance and systems. Prior to 1991, Mr. Vimond held
positions in various executive capacities with RJR Nabisco, Inc., American
Cyanaruld Co., Johnson & Johnson and Warner-Lambert Company. Since January 1998,
Mr. Vimond has beent he principal of Edmund Vimond Associates, a business
development consulting practice. Mr. Vimond received BSBA and MBA degrees from
Northwestern University.
Edward Mahoney, a certified public accountant, was appointed to the Board
of Directors on January 26, 1998, and currently acts as Chairman of the
Company's Audit Committee. Since January 1998, Mr. Mahoney has owned and
operated a certified public accounting firm and was a tax partner with the
accounting firm of BDO Seidman LLP from 1994 to 1997 and Price
40
Waterhouse from 1973 to 1994. Mr. Mahoney received a Bachelor of Science in
Accounting degree from Brooklyn College of the City University of new York.
Brian T. Fitzpatrick was appointed Acting Chief Executive Officer and a
director of the Company on August 14, 2000. He previously served in the capacity
of President and Chief Operating Officer of the Company, which role he assumed
upon the Company's June 2000 acquisition of Gordon laboratories, Inc., a Carson
City, California based formulator and manufacturer of cosmetics, hair care and
other personal care products. Mr. Fitzpatrick had been the President, Chief
Executive Officer and Chairman of Gordon since April 1995. Prior to Gordon, Mr.
Fitzpatrick served as President of several electronic manufacturing companies
and worked for the Polaroid Corporation in its industrial marketing division.
Mr. Fitzpatrick earned an M.B.A. in Finance and marketing from Adelphi
University in 1986 and a B.S. in marketing from Seton Hall University in 1975.
Darby S. Macfarlane and David Kenneth Macfarlane are the founders of the
Company and, as such, may be deemed "promoters" of the Company as those terms
are defined in the rules and regulations promulgated under the Securities Act of
1933, as amended.
Medical Advisory Board
The Company established a Medical Advisory Board consisting of Dr. Fred W.
Billmeyer, Dr. Ian Holzman and Dr. Jeffrey Maisels, independent
consultants/advisors to the Company.
Dr. Fred Billmeyer, Jr., Professor Emeritus at Rensselaer Polytechnic
Institute, a color scientist and recognized expert in the color science field
for more than 40 years, has been a consultant to the Company since 1984 and is a
member of the Company's Medical Advisory Board. Dr. Billmeyer has published
numerous books and articles in the field of color science. The consulting
agreement with Dr. Billmeyer provides that he will provide color consulting
services to the Company at a fee of $125 per hour. Such services include
providing advice and supervisory assistance in connection with any further
research and development, modification, enhancement or marketing activity
relating to the ColorMate(R) System and Intellectual Properties in specific
applications and assisting in obtaining patent protection for the unpatented
Intellectual Properties. In addition, Dr. Billmeyer is entitled to receive a
royalty in the amount of 2% of the selling price less the cost of manufacture of
any device sold by the Company. In 2000 and 1999, the Company paid Dr. Billmeyer
$2,800 and $4,827 respectively.
Dr. Ian Holzman, a physician with the Department of Pediatrics, Division of
Newborn Medicine, Mt. Sinai Medical Center, is a member of the Medical Advisory
Board. Dr. Holzman is presently the Chief of the Division of Newborn Medicine at
Mt. Sinai Medical Center and a member of the Attending Staff at each of Mt.
Sinai Medical Center and City Hospital Center at Elmhurst. In addition, Dr.
Holzman is a Professor of Pediatrics, Obstetrics and Gynecology and Reproductive
Medicine at Mt. Sinai School of Medicine. Dr. Holzman has published numerous
journal articles, book chapters and medical abstracts in the field of pediatric
treatment and medicine including publications relating to bilirubin infant
jaundice and phototherapy.
41
Consultants
The Company relies on the services of certain other consultants and
advisors. The consultants are not executive officers of the Company but make or
are expected to make significant contributions to the business of the Company.
Mr. Frederick Frank, Vice Chairman of Lehman Brothers, an investment
banking firm, has been an advisor to the Company since December 1, 1997,
providing financial, strategic and business advisory services. The consulting
agreement with Mr. Frank expired December 1, 1998 but was renewed by mutual
agreement of the Company and Mr. Frank until July 1, 2002.
The Company also employs certain other consultants and temporary personnel
for various purposes such as FDA and regulatory matters, the Bilirubin Project
and marketing, engineering, research and development associated with the
Intellectual properties, Beauty-Aid Products, the ColorMate(R) Bilirubin Device
and ColorMate(R) units. The Company has also retained consultants to provide
public relations, shareholder relations, financial, administrative, licensing
and investment banking services. In 2001, these consultants and temporary
personnel were paid an aggregate of $874,700. All consultants may be reimbursed
by the Company for reasonable out-of-pocket expenses incurred by them in
connection with the services each consultant provides the Company.
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table summarizes all plan and non-plan compensation awarded
to, earned by or paid to the Company's Chief Executive Office and its three
other executive officers who were serving as such during and at the end of
fiscal 2001 for services rendered in all capacities to the Company in the last
three fiscal years.
Long-Term Compensation
----------------------------------------
Annual Compensation Awards Payouts
-------------------------------- ---------------- ---------------------
All Other
Name and Principal Position Year Salary ($) Bonus ($) Options (#) (1) Compensation ($)
--------------------------------- -------- --------------- ------------ ---------------- ---------------------
Darby S. Macfarlane, 2001 $225,000
Chairperson 2000 $224,000 $20,000
1999 $175,000
David Kenneth Macfarlane, 2001 $125,000
Vice President 2000 $125,000
1999 $125,000
Leslie Foglesong, 2001 $135,000
Secretary 2000 $134,000
1999 $100,000 $10,000
Brian T. Fitzpatrick, 2001 $150,000
Acting Chief Executive Officer 2000 $115,000 (2) 250,000
1999
----------
(1) In February 1998, the Company effected a three-for-two forward stock split.
The number of share issuable upon the exercise of stock options granted
under the 1992 Plan presented above give effect to the stock split.
(2) For 6 months.
42
The following table sets forth information with respect to stock
options exercised during the fiscal year ended December 31, 2001 and the value
at December 31, 2001 of unexercised stock options held by the Chief Executive
Officer and the other executive offers of the Company. The number of shares
presented gives effect to the Stock Split:
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options at
Options at Fiscal Year-End Fiscal Year-End (1)
Shares acquired Value ----------------------------- -----------------------------
Name on Exercise (#) Realized Exercisable/Unexercisable (#) Exercisable/Unexercisable (#)
---------------------------- ------------------ ------------ ----------------------------- -----------------------------
Darby S. Macfarlane 450,000 / 0
Brian T. Fitzpatrick 83,334 / 166,666
David Kenneth Macfarlane 300,000 / 0
Leslie Foglesong 250,000 / 0
----------
(1) Options were not in-the-money at year end
Compensation of Directors
Directors who are officers of the Company do not receive additional
compensation for serving on the Board of Directors or for their attendance at
Board of Directors' meetings.
Employment Agreements
The Company has entered into separate employment agreements with each
of Darby Simpson Macfarlane and David Kenneth Macfarlane, providing for Mrs.
Macfarlane's employment as Chairperson and Chief Executive Officer and for Mr.
Macfarlane's employment as Vice President, Research and Development, each
extendable at the employee's option until February 1, 2003. These Agreements
were amended in August 2000 to provide for conforming severance benefits in
accordance with the terms of these employment agreements when Brian T.
Fitzpatrick was appoint Acting Chief Executive Officer and Ms. Macfarlane was
appointed as Chief Technology Officer and continued as Chairperson of the
Company. Payments due under these agreements are currently in arrears. The
agreements with Mrs. and Mr. Macfarlane provide for annual base salaries in 2000
of $225,000 and $150,000, respectively, subject to annual increases as provided
for in their agreements. In addition, Mrs. Macfarlane's agreement provides for a
bonus payment of 33% of the first million of the Company's net recovery in
excess of $2,000,000 from the Avon Litigation. Accordingly, Mrs. Macfarlane was
to receive $361,200, all of which has been paid. In connection with Mrs.
Macfarlane's agreement to defer full repayment until January 1, 1999, Mrs.
Macfarlane also agreed to forego any discretionary performance bonus under her
employment agreement in 1999. Under the employment agreements, the Company is
obligated to provide Mr. Macfarlane with a $300,000 and Mrs. Macfarlane with a
$1,000,000 term life insurance policy and disability insurance. The Company
maintains key-man life insurance of each of Mrs. and Mr. Macfarlane in the
amount of $1,000,000.
43
The employment agreements also provide for the payment of termination
benefits by the Company if employment thereunder is terminated (i) by the
Company for any reason other than death or disability as set forth therein or
(ii) by reason of death or disability. If Mr. or Mrs. Macfarlane's employment is
terminated by the Company or the employee for any reason the Company is required
by each agreement to pay to the terminated employee an amount equal to (a) the
aggregate base salary payable for the remainder of the employment period fo the
agreement and (b) the aggregate base salary payable thereunder for three years,
plus, in each case, and for each year, an amount not less than any bonus granted
by the Board of Directors of the Company to the employee in the year immediately
preceding the year in which termination occurred. If the employee's employment
is terminated by reason of death or disability, the Company is required to pay
to Mrs. Macfarlane and Mr. Macfarlane, as application, an amount equal to three
years aggregate base salary in the case of Mrs. Macfarlane, and two year's base
salary in the case of Mr. Macfarlane, plus in each case and for each year, an
amount not less than the pro rata portion of any bonus granted to the employee
in the year immediately preceding the year in which such termination occurs.
In addition, the Company entered into a five-year employment agreement
with Brian T. Fitzpatrick, commencing on April 17, 2000, pursuant to which he
serves as the Chief Operating Officer, President and Acting Chief Executive
Officer of the Company. As compensation, Mr. Fitzpatrick is entitled under the
agreement to an annual base salary of $200,000, plus options under the 1992
Stock Option Plan to purchase an aggregate of 170,636 shares of Common Stock.
The exercise price (i) for the first 99,364 options exercised is twice the
closing bid price of the Common Stock on June 2, 2000 and (ii) for the remaining
options is equal to such closing bid price. The options vest in equal
installments upon each of the first, second and third anniversaries of the start
date. In addition, Mr. Fitzpatrick is to receive with respect to each fiscal
year a bonus to be determined by the Compensation Committee of the Company. The
Company may terminate the agreement by reason of physical or mental disability,
but in such case Mr. Fitzpatrick would remain entitled to full compensation and
benefits during the period prior to such termination. If Mr. Fitzpatrick's
employment were terminated by reason of his death, the Company would have no
further obligations under the agreement other than his stock options. If his
employment were terminated for any reason other than death, disability, "cause,"
voluntary resignation or a "change of control," then the Company would pay Mr.
Fitzpatrick his base salary for the 24 months following such termination.
Additionally, the Company entered into a four-year employment agreement
with Leslie Foglesong commencing on December 15, 1997, pursuant to which she
serves as Secretary and Treasurer (or Assistant Treasurer) of the Company. The
term of the agreement have been extended for an additional year at Ms.
Foglesong's option. The agreement provides for an annual base salary of
$100,000, subject to an increase as of January 1, 2000 to $135,000, plus a bonus
with respect to each fiscal year to be determined by the Board of Directors, as
well as options under the 1992 Stock Option Plan. The Company may terminate the
agreement by reason of physical or mental disability, but in such case Ms.
Foglesong would remain entitled to full compensation and benefits during the
period prior to such termination. If Ms. Foglesong's employment were terminated
by reason of her death, the Company would have no further obligations under the
agreement other than allowing her stock options to be exercised by her estate
for a period of five years after such termination. If her employment were
terminated for any reason other than death, disability or "cause," then Ms.
Foglesong would be entitled to her
44
base salary for the 24-month period following such termination or the remaining
term of the agreement, whichever is greater; in addition, her stock options
would continue to be exercisable for a period of five years after such
termination.
The agreements described above prohibit disclosure of proprietary and
confidential information regarding the Company and its business to anyone
outside the Company both during and subsequent to employment and provide certain
non-competition and non-solicitation restrictions on the employee for the
duration of employment with the Company, and for one year thereafter. Payments
due under these agreements are currently in arrears.
Disclosure of Commission Position on Indemnification for Securities Act
Liabilities
We have been advised that in the opinion of the SEC, indemnification for
liabilities arising under the Securities Act is against public policy as
expressed in the Securities Act, and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities is asserted by one of
our directors, officers or controlling persons in connection with the securities
being registered, we will, unless in the opinion of our counsel the matter has
been settled by controlling precedent, submit the question of whether such
indemnification is against public policy to a court of appropriate jurisdiction.
We will then be governed by the court's decision.
Chromatics has directors' and officers' liability insurance. This
insurance may cover liabilities asserted against any present or past director or
officer incurred in the capacity of director or officer arising out of his or
her status, whether or not Chromatics would have the power to indemnify this
person.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The following tables sets forth, as of December 31, 2001, the beneficial
ownership of the common stock: (i) by each shareholder 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 (iv) by all
executive officers and directors of the Company as a group. Except as otherwise
indicated below, each named beneficial owner has sole voting and investment
power with respect to the shares of common stock listed.
common stock Percent of
Name and Address of Beneficial Owner Number of Shares Class
------------------------------------ ---------------- -------------
Darby Simpson Macfarlane 3,611,895 (1) 15.21%
2500 Johnson Ave.
Riverdale, NY 10463
David Kenneth Macfarlane 3,611,895 (2) 15.21%
2500 Johnson Ave.
Riverdale, NY 10463
Brian T. Fitzpatrick 199,033 (3) *
c/o Gordon Laboratories, Inc.
751 East Artesia Boulevard
Carson, CA 90746
45
Leslie Foglesong 265,000 (4) 1.25%
c/o Chromatics Color
Sciences International, Inc.
2500 Johnson Ave.
Riverdale, NY 10463
Edmund Vimond 57,500 (5) *
6967 Country Lakes Circle
Sarasota, FL 34243
Edward Mahoney 57,500 (6) *
140 Jones Creek Drive
Jupiter, FL 33458
Gary W. Schreiner 1,241,633 (7) 5.65%
2126 Melvin Drive
Rock Falls, IL 61071
LB I Group, Inc. 2,163,951 (8) 9.35%
745 Seventh Ave.
New York, NY 10019
Peter Janssen 636,250 (9) 3.03%
c/o Janssen Partners, Inc.
1345 Old Northern Blvd.
Roslyn, NY 11576
Janssen Partners, Inc. 636,250 (10) 3.03%
1345 Old Northern Blvd.
Roslyn, NY 11576
Crescent International, Ltd. 4,195,800 (11) 17.57%
c/o The Robinson-Humphrey
Company LLC
3333 Peachtree Road, N.E.
Atlanta, GA 30326
GAC-LABS, LLC 1,600,000 (12) 7.08%
1936 Lee Road
Winter Park, FL 32789
Millennium Partners, LP 4,195,800 (13) 17.30%
666 5th Avenue
New York, NY 10103
All directors and executive 4,247,928 (14) 17.56%
officers as a group (3 persons)
----------
* indicates less than 1%
(1) Includes 861,895 issued and outstanding shares of the common stock
beneficially owned by Mrs. Macfarlane, 2,000,000 warrants which are
exercisable upon registration of the underlying securities, 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. 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.
46
(2) Includes 861,895 issued and outstanding shares of common stock and
2,000,000 warrants which are exercisable upon the registration of the
underlying securities 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.
(3) Includes 83,333 shares of common stock issuable upon the exercise of
options which are currently exercisable.
(4) Includes 250,000 shares of common stock issuable upon the exercise of
options which are currently exercisable.
(5) Represents 57,500 shares of common stock issuable upon the exercise of
options which are currently exercisable.
(6) Represents 57,500 shares of common stock issuable upon the exercise of
options which are currently exercisable.
(7) Includes 781,846 shares of common stock issuable upon the conversion of
Class B Series 5 Convertible Preferred Stock and 200,000 shares of common
stock issuable upon the exercise of warrants which are currently
exercisable.
(8) Represents 1,388,889 shares of common stock issuable upon the conversion of
Class B Series 2 and Class B Series 3 Convertible Preferred Stock and
775,062 shares of common stock issuable upon the exercise of currently
exercisable warrants. Frederick Appel is the investment manager for these
shares.
(9) Represents 636,250 shares of common stock owned by Peter Janssen. Mr.
Janssen is the principal shareholder of Janssen Partners, Inc.
(10) Represents 636,250 shares of common stock owned by Peter Janssen. Mr.
Janssen is the principal shareholder of Janssen Partners, Inc.
(11) Includes 1,311,304 shares of common stock, 270,000 warrants which are
currently exercisable, and 2,614,496 issuable upon the conversion of Class
B Series 4 Preferred Stock totaling shares not in excess of 20% of the
current outstanding shares of the Company's common stock. Mel Craw is the
investment manager of these shares.
(12) Represents 1,600,000 warrants, which are currently exercisable. John
Schmool and Thomas Little are managers for GAC-Labs.
(13) Includes 3,048,202 shares issuable to Millennium that are not in excess of
20% of the current outstanding shares of the Company's common stock. Daniel
Cardella is the investment manager for these shares.
(14) Includes 3,198,333 options and warrants which are currently exercisable.
47
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since August 1990, the Company has occupied office space leased under
Darby Simpson Macfarlane's name. The Company pays $2,260 per month under the
lease (representing the actual lease cost for such premises), which rent
increased from $1,965 in August 2001. For the year ended December 31, 2000 the
Company paid $21,000 in connection with such lease and $26,320 for the year
2001. In addition, the Company also paid approximately $10,980 for the year
ended December 31, 2000 and approximately $10,980 for the year ended December
31, 2001 under a lease for the use of her residence as offices of the Company,
which operates after normal business hours and on weekends.
Management believes that each of the transactions described above were
obtained on terms at least as favorable as could have been obtained from
unaffiliated third parties.
On July 3, 2001, Gordon issued 200 shares of its common stock, par value
$.001 per share, to Abilene Investments Corp. and 800 shares to GAC-Labs, LLC
for an aggregate purchase price of $1,000,000 paid to Gordon to be used for
operating capital. Simultaneously, the share of Gordon stock that were
outstanding immediately prior to the closing of this transaction, all of which
were owned by us, were redeemed for one dollar. In addition, we assigned to
Abilene and GAC-Labs the indebtedness of Gordon and H.B. Gordon Manufacturing
Co., Inc., its wholly-owned subsidiary, owed to the Company in the ratio of 20%
to Abilene and 80% to GAC-Labs.
As part of the same transaction, we were granted the option to purchase
from Abilene and GAC-Labs the shares of Gordon stock issued to them and the
indebtedness assigned to them within one year for an aggregate purchase price of
$1,000,000 plus interest thereon at the rate of 14% per annum, subject to
reduction under certain conditions, as described below.
Furthermore, we granted to Abilene and GAC-labs one-year warrants to
purchase (i) an aggregate of 2,000,000 shares of our common stock at the
exercise price of $.50 per share, if we do not consummate a rights offering
prior to the expiration of such warrants, or (ii) an aggregate of 11,200,000
shares of our common stock at the exercise price of $.10 per share, if we
consummate a rights offering prior to the expiration of such warrants and obtain
shareholder approval for the increase in warrants.
If (i) we exercise our option to purchase the shares of Gordon stock
issued to Abilene and GAC-Labs and the indebtedness assigned to them, (ii) we
have not effected a reverse stock split of our common stock in a ratio greater
than ten to one, (iii) we have consummated a rights offering and (iv) the market
price of our common stock exceeds $1.00 per share for at least ten consecutive
trading days from the date of exercise, the warrants will be subject to
mandatory exercise. In the event of such a mandatory exercise, we will accept as
payment of the aggregate exercise price the shares of Gordon stock that the
Abilene and GAC-Labs acquired last year, and the purchase price under the
repurchase option agreement will be reduced to one dollar. The warrants are also
subject to mandatory exercise if (i) a registration statement, filed by us with
respect to the shares of our common stock issuable upon exercise of the warrants
has been declared effective by the Securities and Exchange Commission, (ii) we
have not effected a reverse stock split of our common stock in a ratio greater
than ten to one, (iii) we have consummated a
48
rights offering and (iv) the market price of our common stock exceeds $1.00 per
share for at least ten consecutive trading days from and after the effective
date of such registration statement. In the event of such a mandatory exercise,
we will accept payment of the aggregate exercise price through the terms of a
broker's cashless exercise transaction.
Brian T. Fitzpatrick, the President and Secretary of Gordon and the
President, Acting Chief Executive Officer and a director of the Company, is also
the President of GAC-Labs.
DESCRIPTION OF SECURITIES
As of February 1, 2002 there are 20,989,550 shares of common stock
outstanding, 113,769 shares of preferred stock, and 3,476,666 options under the
1992 Employee Stock Option Plan as amended.
The following description of CCSI's capital stock and selected
provisions of its Articles of Incorporation and By-laws, as amended is a summary
and is qualified in its entirety by the CCSI's Articles of Incorporation and
By-laws, as amended, copies of which have been filed with the Securities and
Exchange Commission.
Common Stock
The Company has 550,000,000 authorized shares of common stock and 20,989,550
are outstanding.
Preferred Stock
Class A
The Company's shares of Class A convertible preferred stock are
entitled to noncumulative 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.
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.
Class B
The Company also has authorized 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.
49
At December 31, 2000 the Company has outstanding the following series
of Class B preferred stock:
Amount
--------------------------------
Shares Value
------------------- ------------ ----------------
Series 2 25,000 $ 2,262,700
Series 3 40,000 3,155,000
Series 4 136 1,229,800
Series 5 48,633 4,863,300
------------------- ------------ ----------------
113,769 $ 11,510,800
------------ ----------------
Class B Series 1 Preferred Stock
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 $0.001each 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.
Class B Series 2 Convertible Preferred Stock
On June 15, 1999, the Company completed a private placement of 40,000
shares of convertible preferred stock and warrants to purchase 220,690
shares of common stock to
50
a private investor for aggregate proceeds of $4 million. The shares of
Class B Series 2 convertible preferred stock issued on that date (the
"Series 2 Shares") are convertible into shares of the Company's common
stock at a price of $4.68 per share, subject to adjustment for stock
splits, combinations and similar recapitalizations affecting the
Company's common stock and in certain circumstances including the
issuance of shares of the Company's common stock. The Series 2 Shares
were previously redeemable in cash for an amount equal to $115 per
Series 2 Share on the third anniversary of the date of initial
issuance if not sooner converted unless the Company elects in the
Company's discretion to extend the redemption date to the fifth
anniversary of the date of initial issuance. As a result of a capital
restructuring program completed on October 31, 2000, the Series 2
Shares are no longer redeemable in cash. Accordingly, the amount was
classified within equity in the fourth quarter of 2000. The Series 2
Shares are subject to mandatory conversion into shares of the
Company's common stock at the Company's option at any time after
December 15, 1999 if the average closing bid price of the Company's
common stock for ten consecutive trading days equals or exceeds $7.02
per share. The Series 2 Shares are not entitled to any voting rights
except as otherwise required by applicable law and are not entitled to
any dividend rights unless the Company elects to extend the redemption
date of the fifth anniversary of the date of initial issuance, in
which case noncash dividends (which increase the number of shares
issuable upon redemption ) would accrue at the rate of 8% from and
after the third anniversary of the date of initial issuance which can
only be paid in shares of the Company's common stock.
In addition to the Series 2 Shares, on June 15, 1999, the Company also
issued an aggregate of 220,690 warrants to purchase shares of the
Company's common stock to the same private investor. An additional
50,000 warrants were issued to such investor as compensation for
services rendered in connection with the placement of the Series 2
Shares. The warrants issued on that date have a five-year term unless
sooner exercised. The warrants are exercisable for shares of the
Company's common stock at a price of $4.68 per share, subject to
adjustment in the same circumstances as the Series 2 Shares described
above and are subject to mandatory exercise into shares of the
Company's common stock at the Company's option at any time after
December 15, 1999 if the average closing bid price of the Company's
common stock measured over twenty consecutive trading days equals or
exceeds $9.36.
The private placement resulted in a deemed dividend charge of
approximately $4.5 million, resulting from a below market conversion
price of preferred stock ($2,400,000), a $15 per share redemption
premium and other costs ($800,000) and the fair value (using the Black-
Scholes method) of warrants issued in connection with the private
placement ($1,275,000). Of this amount, approximately $1.6 million had
been charged through December 1999, $1.8 million has been charged in
2000 and $500,000 will be charged over the remaining redemption period.
Of the original deemed dividend charge, $.6 million has been eliminated
as a result of the conversion of preferred stock into common stock.
In 2000, 15,000 Series 2 Shares were converted into 238,473 shares of
the Company's common stock.
51
Class B Series 3 Convertible Preferred Stock
On February 11, 2000, the Company completed a private placement of
40,000 shares of convertible preferred stock to the above private
investor for aggregate proceeds of $4 million. The shares of Class B
Series 3 convertible preferred stock issued on that date (the "Series 3
Shares") are convertible into shares of the Company's common stock at a
price of $4.68 per share, subject to adjustment for stock splits,
combinations and similar recapitalizations affecting the Company's
common stock and in certain circumstances including the issuance of
shares of the Company's common stock. The Series 3 Shares were
previously redeemable in cash for an amount equal to $115 per Series 3
Share on the third anniversary of the date of initial issuance if not
sooner converted unless the Company elects in the Company's discretion
to extend the redemption date to the fifth anniversary of the date of
initial issuance. As a result of the capital restructuring program
completed on October 31, 2000, the Series 3 Shares are no
longer redeemable in cash. Accordingly, the amount was classified
within equity in the fourth quarter of 2000.The Series 3 Shares are
subject to mandatory conversion into shares of the Company's common
stock at the Company's option at any time after August 11, 2000 if the
average closing bid price of the Company's common stock for ten
consecutive trading days equals or exceeds $7.02 per share. The Series
3 Shares are not entitled to any voting rights except as otherwise
required by applicable law and are not entitled to any dividend rights
unless the Company elects to extend the redemption date to the fifth
anniversary of the date of initial issuance, in which case noncash
dividends (which increase the number of shares issuable upon
redemption) would accrue at the rate of 8% from and after the third
anniversary of the date of initial issuance which can only be paid in
shares of the Company's common stock.
In addition to the Series 3 Shares, on February 11, 2000, the Company
also issued an aggregate of 254,372 warrants to purchase shares of the
Company's common stock to the same private investor. An additional
50,000 warrants were issued to such investor as compensation for
services rendered in connection with the placement of the Series 3
Shares. The warrants issued on that date have a five-year term unless
sooner exercised. The warrants are exercisable for shares of the
Company's common stock at a price of $4.68 per share, subject to
adjustment in the same circumstances as the Series 3 Shares described
above and are subject to mandatory exercise into shares of the
Company's common stock at the Company's option at any time after August
11, 2000 if the average closing bid price of the Company's common stock
measured over twenty consecutive trading days equals or exceeds $9.36.
The private placement resulted in a deemed dividend charge of
approximately $3.5 million, resulting from a below market conversion
price of preferred stock ($1,495,000), a $15 per share redemption
premium and other costs ($990,000) and the fair value (using the
Black-Scholes method) of warrants issued in connection with the private
placement ($1,050,000). Of this amount, approximately $2.1 million has
been charged in 2000 and $1.4 million will be charged over the
remaining redemption period.
Class B Series 4 Convertible Preferred Stock
On October 31, 2000, the Company consummated a private placement of 200
shares of a new series of preferred stock, designated Class B Series 4
convertible preferred stock, par value $.01 per share ("Series 4
Preferred Stock") for an aggregate purchase price of
52
$2,000,000. Pursuant to the Stock Purchase Agreement between the
Company and Crescent International Ltd. (the "Purchaser"), the Company
also issued to the Purchaser a warrant (the "Incentive Warrant"), the
terms of which provide that the Purchaser has the right to acquire up
to 270,000 shares of the Company's common stock at an exercise price
equal to $1.00 per share, subject to adjustment in certain
circumstances, for a five-year period.
The Series 4 Preferred Stock will, with respect to the distribution of
assets on liquidation, dissolution or winding up of the Company, rank
(i) senior and prior to the common stock of the Company and any other
class or series of capital stock of the Company hereafter issued, the
terms of which specifically provide that shares of such class or series
shall rank junior to shares of the Series 4 Preferred Stock (ii) on
parity with any other class or series of capital stock of the Company
hereafter issued, the terms of which specifically provide that shares
of such class or series shall rank on parity with shares of the Series
4 Preferred Stock, and (iii) junior to the Class A preferred stock and
any other class or series of capital stock of the Company hereafter
issued, the terms of which specifically provide that shares of such
class or series shall rank senior to shares of the Series 4 Preferred
Stock
At any time after October 31, 2002, any or all of the outstanding
shares of Series 4 Preferred Stock will, upon written request of the
holders of a majority of the issued and outstanding shares thereof, be
subject to redemption by the Company for either, at the option of the
Company, (i) $12,000 in cash per share or (ii) the number of shares of
common stock obtained by dividing $12,000 by the lower of $.82 and 92%
of the average of the lowest three consecutive closing bid prices of
the common stock during the 22 trading day period immediately preceding
the date that redemption is requested. In addition, subject to certain
adjustments, each share of the Series 4 Preferred Stock will be
convertible at any time at the option of the holder thereof into the
number of shares of common stock determined by dividing $10,000 by the
lower of $.82 and 92% of the average of the lowest three consecutive
closing bid prices of the common stock during the 22 trading day period
immediately preceding the date that conversion is requested. The holder
of shares of Series 4 Preferred Stock will have no voting rights and,
if the Company fails to deliver certificates of shares of common stock
upon redemption or conversion of the Series 4 Preferred Stock, will
receive dividends at a rate of 8.0% per annum, payable in cash in
quarterly installments.
In December 2000, 64 of these shares were converted into 1,391,304
shares of common stock.
Class B Series 5 Convertible Preferred Stock
Pursuant to a letter agreement, the Company and the holders agreed to
convert the entire principal amount of the Debentures, and any accrued
but unpaid interest thereon, into a newly-authorized series of
convertible preferred stock of the Company (the "New Preferred"),
effective October 31, 2000. Prior to their conversion, the Debentures
had a principal face amount of $5,000,000, accrued but unpaid interest
in the amount of $1,079,167 and were due on April 15, 2002. The
Company and the holders further agree that (i) the New Preferred would
be convertible into shares of common stock at a conversion price of
$4.68 per share, subject to adjustment for stock splits, combinations
53
and similar recapitalizations affecting the common stock, (ii) with
respect to the distribution of assets on the liquidation, dissolution
or winding up of the Company, the New Preferred shall rank senior and
prior to all classes or series of capital stock of the Company issued
prior thereto or thereafter issued, (iii) cumulative dividends would
accrue on the New Preferred beginning on April 15, 2002 at a rate of 8%
per annum (subject to increase to 11% per annum during any period in
which such cumulative dividends are not currently paid), and (iv) the
New Preferred would be subject to involuntary conversion into shares of
common stock at the option of the Company at a conversion price of
$4.68 per share if the average closing bid price of the Company's
common stock for ten consecutive trading days exceeds $10.29. The
Company also agreed with the holders (i) not to incur or permit any
future liens on any of its properties or assets, (ii) not to grant any
security interests in its future revenues and (iii) not to consummate
any future financings which contemplate the issuance of debentures by
the Company.
In December 2000, 12,158 of these shares were converted into 259,786
shares of common stock.
Shareholder Action
Pursuant to the Company's Certificate of Incorporation, as amended,
with respect to any action required of or by the holders of the Company's common
stock, the affirmative vote of the holders of a majority of the issued and
outstanding shares of common stock entitled to vote thereon is sufficient to
authorize, affirm, ratify or consent to such act or action, except as otherwise
provided by law.
Under the New York General Corporation Law, shareholders may take
certain actions without the holding of a meeting by a written consent or
consents signed by the holders of a majority of the outstanding shares of the
capital stock of the Company entitled to vote thereon. Prompt notice of the
taking of any action without a meeting by less than unanimous consent of the
shareholders is required to be given to those shareholders who do not consent in
writing to the action. The purposes of this provision are to facilitate action
by shareholders and to reduce the corporate expense associated with annual and
special meetings of shareholders. Pursuant to the rules and regulations of the
Securities and Exchange Commission, if shareholder action is taken by written
consent, the Company will be required to send each shareholder entitled to vote
on the applicable matter, but whose consent was not solicited, an information
statement containing information substantially similar to that which would have
been contained in a proxy statement.
Transfer Agent and Registrar
The transfer agent and registrar for CCSI's common stock is Continental
Stock Transfer & Trust, Co..
Shares Eligible for Future Sale
Upon completion of this offering, the Company will have a maximum of
231,889,550 shares of Common stock outstanding. All of the shares sold by the
Company in this offering will be freely transferable without further restriction
or registration under the Securities Act, except for any shares purchased by an
"affiliate" of the Company (as defined under the Securities Act). Of these
54
231,889,550 shares of common stock, certain shares may be "restricted
securities" under applicable securities laws. Additional shares of common stock
may become eligible for sale in the public market from time to time upon
exercise of warrants and stock options.
Holders of restricted securities must comply with the requirements of
Rule 144 in order to sell their shares in the open market. In general, under
Rule 144 as currently in effect, any affiliate of the Company and any person (or
persons whose sales are aggregated) who has beneficially owned his or her
restricted shares for at least two years, would be entitled to sell in the open
market within any three-month period a number of shares that does not exceed the
greater of: (i) 1% of the then outstanding shares of the Company's Common Stock;
or (ii) the average weekly trading volume reported on the Nasdaq OTC Bulletin
Board during the four calendar weeks preceding such sale. Sales under Rule 144
are also subject to certain limitations on manner of sale, notice requirements,
and availability of current public information about the Company. Nonaffiliates
who have held their restricted shares for two years are entitled to sell their
shares under Rule 144 without regard to any of the above limitations, provided
they have not been affiliates of the Company for the three months preceding such
sale. As of December 31, 2001, options to acquire 3,476,000 shares were
outstanding under the 1992 Employees Stock Option Plan as amended ("the Plan").
As of December 31, 2001 an additional 1,775,916 shares are available for future
grants under the Plan.
The Company can make no prediction as to the effect, if any, that sales
of shares of common stock or the availability of shares for sale will have on
the market price of common stock. Nevertheless, sales of significant amounts of
common stock could adversely affect the prevailing market price of common stock,
as well as impair the ability of the Company to raise capital through the
issuance of additional equity securities.
Dividends
Subject to the prior rights of holders of our preferred stock, the
holders of our common stock are entitled to receive such dividends as our board
of directors may declare from time to time from any surplus that we may have.
However, we have not paid, and have no present intention to declare or pay, cash
dividends on the common stock in the foreseeable future.
Voting Rights
Each share of our common stock entitles the holder to one vote on any
matter submitted to the vote of our stockholders.
Preemptive Rights
None of the holders of our common stock are entitled to any preemptive
rights.
PLAN OF DISTRIBUTION
The stock offered by CCSI is being offered through the issuance of rights
directly to its shareholders of record on February 11, 2002. Certain employees,
officers or directors of CCSI may solicit responses from you, but such
individuals will not receive any commissions or compensation for such services
other than their normal employment compensation.
55
We intend to distribute rights and copies of this prospectus to
shareholders of record on February 11, 2002, as soon as the Registration
Statement, of which this prospectus is a part, becomes effective with the
Securities and Exchange Commission ("SEC").
FEDERAL INCOME TAX CONSIDERATIONS
The following summarizes the material federal income tax considerations
of the rights offering to you and CCSI. This summary is based on the Internal
Revenue Code of 1986, as amended, the Treasury regulations thereunder, judicial
authority and administrative rulings and practice, all of which are subject to
change at any time, possibly with retroactive effect. This summary is not a
complete discussion of all federal income tax consequences of the rights
offering, and, in particular, may not address federal income tax consequences
applicable to stockholders subject to special treatment under federal income tax
law, such as financial institutions, broker-dealers, life insurance companies or
traders in securities that elect to mark to market. Also, this discussion does
not address applicable tax consequences if you hold our common stock as part of
a hedging, straddle, constructive sale, conversion or other risk reduction
transaction. In addition, this summary does not address the tax consequences of
the rights offering under applicable state, local or foreign tax laws. This
discussion assumes that your shares of common stock and the subscription rights
and shares issued to you during the rights offering constitute capital assets
(generally, property held for investment) for federal income tax purposes.
Receipt and exercise of the subscription rights distributed pursuant to the
rights offering is intended to be nontaxable to shareholders, and assumes you
will qualify for such nontaxable treatment. If, however, the rights offering
does not qualify as nontaxable, you would be treated as receiving a taxable
distribution equal to the fair market value of the subscription rights on their
distribution date. The distribution would be taxed as a dividend to the extent
made out of CCSI's current or accumulated earnings and profits; any excess would
be treated first as a return of your basis (investment) in your CCSI stock and
then as a capital gain. Expiration of the subscription rights would result in a
capital loss.
This discussion is included for your general information only. You
should consult your tax advisor to determine the tax consequences to you of the
rights offering in light of your particular circumstances, including any state,
local and foreign tax consequences.
Taxation of Shareholders
Receipt of a Subscription Right. You will not recognize any gain or other
income upon receipt of a subscription right.
Tax Basis and Holding Period of Subscription Rights. Your tax basis in
each subscription right will effectively depend on whether you exercise the
subscription right or allow the subscription right to expire. If you exercise a
subscription right, your tax basis in the subscription right will be determined
by allocating the tax basis of your common stock on which the subscription right
is distributed between the common stock and the subscription right, in
proportion to their relative fair market values on the date of distribution of
the subscription right. However, if the fair market value of your subscription
rights is less than 15% of the fair market value of your existing shares of
common stock, then the tax basis of each subscription right will be deemed to be
zero, unless you
56
elect, by attaching an election statement to your federal income tax return for
the taxable year in which you receive the subscription rights, to allocate tax
basis to your subscription rights.
If you allow a subscription right to expire, it will be treated as
having no tax basis.
Your holding period for a subscription right will include your holding
period for the shares of common stock upon which the subscription right is
issued.
Expiration of Subscription Rights. You will not recognize any loss upon
the expiration of a subscription right.
Exercise of Subscription Rights. You generally will not recognize a
gain or loss on the exercise of a subscription right. The tax basis of any share
of common stock that you purchase through the rights offering will be equal to
the sum of your tax basis (if any) in the subscription right exercised and the
price paid for the share. The holding period of the shares of common stock
purchased through the rights offering will begin on the date that you exercise
your subscription rights.
Sale or Exchange of Shares Acquired Upon Exercise of Subscription
Rights. If you sell or exchange shares of CCSI common stock, you will generally
recognize gain or loss on the transaction. The gain or loss you recognize is
equal to the difference between the amount you realize on the transaction and
your basis in the shares you sold. Such gain or loss generally will be capital
gain or loss so long as you held the shares as a capital asset at the time of
the sale or exchange. Gain or loss from an asset held for more than one year
will generally be taxable as long-term capital gain or loss. If you are an
individual, any long-term capital gain is generally taxed at a maximum federal
income tax rate of 20%.
Taxation of CCSI
We will not recognize any gain, other income or loss upon the issuance
of the subscription rights, the lapse of the subscription rights, or the receipt
of payment for shares of common stock upon exercise of the subscription rights.
LEGAL MATTERS
The validity of the shares of common stock offered hereby will be
passed upon for us by Patterson, Belknap, Webb & Tyler LLP.
EXPERTS
Our financial statements included in this prospectus and registration
statement have been audited by BDO Seidman, LLP, independent auditors, as set
forth in their report dated April 13, 2001, except for note 3, which is July 3,
2001, and are included in reliance upon the authority of BDO Seidman, LLP as
experts in accounting and auditing.
57
AVAILABLE INFORMATION
We have filed with the SEC a registration statement on Form SB-2, which
registers the securities that we are offering under this prospectus. The
registration statement, including the attached exhibits, contains additional
relevant information about us and the securities offered. The rules and
regulations of the SEC allow us to omit certain information included in the
registration statement from this prospectus.
We file annual, quarterly and special reports, proxy statements and
other information with the SEC under the Securities Exchange Act of 1934. You
may read and copy this information at the following locations of the SEC:
Judiciary Plaza
450 Fifth Street, N.W.
Washington, D.C. 20549
Citicorp Center
500 West Madison Street
Suite 1400
Chicago, Illinois 60661
You may also obtain copies of this information by mail from the Public
Reference Room of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. You may obtain information on the operation of the Public
Reference Room by calling the SEC at (800) SEC-0330.
The SEC also maintains an Internet World Wide Web site that contains
reports, proxy statements and other information about issuers, like us, who file
electronically with the SEC. The Internet address of that site is
http://www.sec.gov.
The SEC allows us to incorporate by reference information into this
prospectus. This means that we can disclose important information to you by
referring you to another document filed separately with the SEC. The information
incorporated by reference is considered to be part of this prospectus, except
for any information that is superseded by subsequent incorporated documents or
by information that is included directly in this prospectus. Our descriptions in
this prospectus concerning the contents of any contract, agreement or document
are not necessarily complete. For those contracts, agreements or documents that
we filed as exhibits to the registration statement, you should read the exhibit
for a more complete understanding of the document or subject matter involved.
58
FINANCIAL INFORMATION
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
--------
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Independent Accountants' Reports ...................................... 60
Audited Consolidated Balance Sheets as
of December 31, 2000 and 1999 ........................................ 61
Audited Consolidated Statements of Operations for
the years ended December 31, 2000, 1999 and 1998 ..................... 62
Audited Consolidated Statements of Changes in
Shareholders' Equity for the years ended
December 31, 2000, 1999 and 1998 ..................................... 63
Audited Consolidated Statements of Cash Flows for
the years ended December 31, 2000, 1999 and 1998 ..................... 64
Notes to Audited Consolidated Financial Statements .................... 65
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited Consolidated Balance Sheets
as of September 30, 2001 ............................................ 85
Unaudited Consolidated Statements of Operations for
the nine months ended September 30, 2001 and 2000 ................... 86
Unaudited Consolidated Statements of Changes in
Shareholders' Equity for the nine months ended
September 30, 2001 ................................................... 87
Unaudited Consolidated Statements of Cash Flows for
the nine months ended September 30, 2001 and 2000 ................... 88
Notes to Unaudited Consolidated Financial Statements .................. 89
59
Independent Accountants' Report
To the Board of Directors and Stockholders of
Chromatics Color Sciences International, Inc.
We have audited the consolidated balance sheets of Chromatics Color Sciences
International, Inc. and subsidiaries as of December 31, 2000 and 1999, and the
related consolidated statements of operations, changes in stockholders' equity
(deficit) and cash flows for each of the three years in the period ended
December 31, 2000. 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 auditing standards generally accepted
in the United States of America. 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 subsidiaries as of December 31, 2000 and 1999,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2000 in conformity with accounting
principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has incurred recurring losses for
the last several years, including $19,496,400 in 2000, and has experienced
significant problems and delays exploiting its primary technology (medical
equipment). These matters raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 2. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
BDO Seidman, LLP
New York, New York
April 13, 2001, except for Note 3,
which is July 3, 2001
60
CHROMATIC COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31,
-------------------------------
2000 1999
-------------- --------------
ASSETS
Current:
Cash and cash equivalents $ 1,379,000 $ 2,790,400
Accounts receivable - net allowance of $131,000 in 2000 72,900 842,300
Inventories 747,100 1,171,800
Prepaid expenses and other current assets 296,900 129,200
-------------- --------------
Total current assets 2,495,900 4,933,700
Property and equipment - net 244,100 612,200
Software development costs - net 261,400 470,500
Patent costs - net 581,100 984,000
Net assets of discontinued operations 1,000,000 -
Other assets 331,700 654,400
-------------- --------------
$ 4,914,200 $ 8,110,200
============== ==============
Liabilities and Stockholders' Equity (Deficit)
Current Liabilities:
Amounts payable to related party $ - $ 256,100
Accounts payable and accrued expenses:
Attorneys and accountants 458,900 394,600
Consultants 141,700 119,100
Trade 260,100 240,000
-------------- --------------
Total current liabilities $ 860,700 $ 1,009,800
-------------- --------------
Long-term debt:
Senior convertible debentures - 4,165,800
Accrued interest on senior convertible debentures - 495,800
Amount payable for purchase of Gordon 653,000 -
-------------- --------------
653,000 4,661,600
-------------- --------------
Commitments and contingencies
Redeemable preferred stock: Class A, 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
Class B, Series 2 convertible preferred stock, no par value:
Authorized - 10,000,000 shares; issued and outstanding 40,000
shares in 1999 - $115 redemption value - 2,928,700
-------------- --------------
13,800 2,942,500
-------------- --------------
Stockholders' equity (deficit):
Preferred stock 11,510,800 -
Common stock, par value $.001 per share:
Authorized - 50,000,000 shares; issued and outstanding -
19,033,308 (2000) and 15,539,117 (1999) shares 19,100 15,500
Capital in excess of par value 45,934,400 34,062,000
Accumulated deficit (54,077,600) (34,581,200)
-------------- --------------
Total stockholders' equity (deficit) 3,386,700 (503,700)
-------------- --------------
$ 4,914,200 $ 8,110,200
============== ==============
See accompanying notes to consolidated financial statements
61
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
-------------------------------------------------
2000 1999 1998
--------------- -------------- --------------
REVENUES :
Sales $ 80,400 $ 1,103,200 $ 46,000
--------------- -------------- --------------
COSTS AND EXPENSES :
Cost of sales 760,100 898,100 -
Sales, marketing and trade show costs 2,047,300 2,511,600 958,900
Medical regulatory expenses 840,100 1,323,300 1,341,500
Research and development 1,257,200 996,300 705,000
Patent application costs 255,600 134,400 221,700
Compensation costs relating to options granted
to consultants 690,000 984,000 843,400
Impairment charges 1,507,700 - -
General and administrative :
Compensation - officers and employees 1,194,500 803,900 772,200
Consultants 505,600 301,000 265,600
Legal fees 702,200 793,900 956,900
Accounting fees 158,300 79,100 51,000
Rent and storage 339,100 296,800 266,000
Insurance 315,300 222,600 194,700
Travel and entertainment 142,800 120,000 98,200
Repairs and maintenance 158,400 118,100 87,500
Depreciation and amortization 728,900 494,600 130,900
Payroll taxes 73,600 55,200 56,700
Stock administrative fees 130,500 171,700 83,300
Public relations 212,100 299,400
Amortization of goodwill - - -
Other 280,300 301,600 343,400
--------------- -------------- --------------
12,229,600 10,798,900 7,676,300
--------------- -------------- --------------
OPERATING LOSS (12,219,200) (9,695,700) (7,629,700)
--------------- -------------- --------------
INTEREST INCOME ( EXPENSE)
Interest income 133,400 200,700 372,000
Interest expense and non - cash financing costs (1,437,500) (3,313,000) (27,100)
--------------- -------------- --------------
(1,304,100) (3,112,300) 344,900
--------------- -------------- --------------
Loss from Continuing Operations (13,523,300) (12,808,000) (7,284,800)
Loss from Discontinued Operations (5,973,100) - -
--------------- -------------- --------------
Net Loss $ (19,496,400) $ (12,808,000) $ (7,284,800)
=============== ============== ==============
Net loss to common stockholders :
Loss from Continuing Operations $ (13,523,300) $ (12,808,000) $ (7,284,800)
Deemed dividend for class B, Series 2 and 3
convertible preferred stock (3,900,000) (1,558,300) -
Loss from Continuing Operations to Common Shareholders (17,423,300) (14,366,300) (7,284,800)
Loss from Discontinued Operations (5,973,100)
--------------- -------------- --------------
Net loss to common stockholders $ (23,396,400) $ (14,366,300) $ (7,284,800)
=============== ============== ==============
Weighted average number of common shares outstanding 16,746,354 15,498,300 14,968,019
=============== ============== ==============
Basic and diluted loss per share:
Loss from Continuing Operations $ (1.04) $ (0.93) $ (0.49)
Loss from Discontinued Operations (0.36) -- -
--------------- -------------- --------------
Net loss to common stockholders (1.40) (0.93) (0.49)
=============== ============== ==============
See accompanying notes to consolidated financial statements
62
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
Common Stock
-------------------------
Preferred Number of Additional
Stock Shares Paid in Accumulated
Amount Outstanding Par Value Capital Deficit
------------- ------------- ---------- ------------- -------------
Balances, January 1, 1998 $ - 13,814,859 $ 13,800 $ 24,370,900 $ (14,488,400)
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)
Net loss - - - - (12,808,000)
Exercise of Stock options and warrants - 86,675 100 377,300 -
Original issue discount on senior
convertible debentures (below market
conversion price) - - - 3,575,000 -
Original issue discount on Class B,
Convertible preferred stock (warrants and
below market conversion price) - - - 2,357,000 -
Deemed dividend on Class B,
convertible preferred stock - - - (1,558,300) -
Compensation cost relating to options
granted to consultants - - - 984,000 -
------------- ------------- ---------- ------------ -------------
Balances, December 31, 1999 - 15,539,117 $ 15,500 $ 34,062,000 $ (34,581,200)
Net loss - - - - (19,496,400)
Conversion of debentures to preferred
stock 6,079,100 - - - -
Issuance of preferred stock for cash 5,024,800 - - - -
Reclassification of redeemable preferred
stock 2,262,700 - - - -
Exercise of stock options and warrants - 162,880 200 377,500 -
Conversion of convertible preferred stock
into common shares (1,855,800) 1,889,563 1,900 3,016,900 -
Original issue discount on convertible
preferred stock (warrants and below
market conversion price) - - - 3,858,000 -
Deemed dividend on Class B convertible
preferred stock - - - (3,900,000) -
Issuance of common stock - Gordon - 721,231 700 4,535,800 -
Issuance of common stock - other - 720,517 800 3,294,200 -
Compensation cost relating to options
granted to consultants - - - 690,000 -
------------- ------------- ---------- ------------ -------------
Balances, December 31, 2000 $ 11,510,800 19,033,308 $ 19,100 $ 45,934,400 $ (54,077,600)
============= ============= ========== ============ =============
See accompanying notes to consolidated financial statements
63
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
------------------------------------------------
2000 1999 1998
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (19,496,400) $ (12,808,000) $ (7,284,800)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 728,900 494,600 130,900
Compensation cost relating to options
granted to consultants 690,000 984,000 843,400
Noncash interest and financing costs 851,200 2,740,800 --
Impairment provision, including discontinued operations 7,517,300 -- --
Changes in operating assets and liabilities
(net of effect of acquisition in 2000):
Accounts receivable 769,400 (750,000) 100
Inventories (308,400) (293,400) 800
Prepaid expenses and other assets (230,700) (47,400) (5,400)
Accrued interest on senior convertible debentures 583,300 495,800 --
Accounts payable and accrued expenses (107,000) (222,600) 431,700
-------------- -------------- --------------
Net cash flows from operating activities (8,788,400) (9,455,900) (5,876,700)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Software development costs -- (81,300) (421,800)
Capitalized patent costs (337,100) (553,000) (540,300)
Purchase of property and equipment (78,300) (91,200) (87,700)
-------------- -------------- --------------
Net cash used in investing activities (415,400) (725,500) (2,554,200)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net of
related costs 3,672,600 377,400 3,114,300
Proceeds (payments) of amounts payable to related party (1,360,000) (62,800) 25,700
Proceeds from senior convertible debentures -- 5,000,000 --
Payments of notes payable -- -- (4,700)
Net proceeds from the issuance of preferred stock and
warrants, net of costs 5,479,800 3,727,400 --
-------------- -------------- --------------
Net cash provided by financing activities 7,792,400 9,042,000 3,135,300
-------------- -------------- --------------
NET DECREASE IN CASH AND EQUIVALENTS (1,411,400) (1,139,400) (5,295,600)
CASH AND EQUIVALENTS, BEGINNING OF YEAR 2,790,400 3,929,800 9,225,400
-------------- -------------- --------------
CASH AND EQUIVALENTS, END OF YEAR $ 1,379,000 $ 2,790,400 $ 3,929,800
============== ============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest Paid $ -- $ 88,900 $ 1,400
============== ============== ==============
Reclassification of ColorMate(R)Units $ -- $ 1,820,100 1,504,400
============== ============== ==============
Issuance of common stock and amount payable
for purchase of Gordon stock $ 5,189,500 $ -- $ --
============== ============== ==============
Conversion of preferred stock into common stock $ 3,018,800 $ -- $ --
============== ============== ==============
See accompanying notes to consolidated financial statements
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Business and Summary of Significant Accounting Policies
Since its formation in 1984, Chromatics Color Sciences International,
Inc. (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.
(a) 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. Significant
estimates relate primarily to inventory valuation and recoverability of
the Company's tangible and intangible assets.
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All intercompany balances
and transactions have been eliminated in consolidation.
(c) Patent Application Costs
The Company began capitalizing certain patent application costs,
commencing January 1, 1998, and is amortizing such costs over the
remaining patent lives, generally 10 to 15 years. Accumulated patent
amortization costs as of December 31, 2000 and 1999 are $268,200 and
$109,300, respectively. The Company assesses the continuing carrying
value of these assets when events and circumstances warrant and, in
2000, recorded an impairment charge totaling $581,000.
(d) Revenue Recognition
The Company records revenue from the sale of ColorMate TLc-BiliTest
Systems and TLc- Lensette(R) Calibration Standards at the time of
shipment at the minimum transfer price provided in the distribution
agreement. The agreement provides for additional amounts from the
distributor equal to a defined percentage of the distributor's sales
price of these products. The Company records revenue from the
additional amounts upon receipt from the distributor. Sales of cosmetic
products are recorded when the products are shipped.
Shipping charges are included in sales. Shipping and handling costs are
included in cost of sales.
(e) Inventories
Inventories are stated at the lower of first-in, first-out cost or
market.
(f) Property and Equipment and Depreciation
65
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 and,
in 2000, wrote off the net book value of certain equipment totaling
$257,600.
(g) Software Development Costs
Once technological feasibility was established, the costs of developing
software to be marketed as part of a product was capitalized.
Capitalization ceased in 1999 when the products became available for
sale. The costs are 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 (three years).
Accumulated amortization of software development costs at December 31,
2000 and 1999 was $366,000 and $157,000, respectively.
(h) 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. In 2000, the Company
recorded impairment losses relating to these assets.
(i) 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.
(j) Financial Instruments
Financial instruments include cash and equivalents, accounts
receivable, accounts payable and long-term debt. 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, 2000.
(k) 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 all of its revenues from one customer in 1999 and
2000.
The Company is dependent upon one supplier for a major part of its
ColorMate(R) TLc-BiliTest System(R) and one company to manufacture the
ColorMate(R) TLc-BiliTest(R) System. The loss of these companies would
materially adversely affect the Company.
(l) Loss Per Share
66
The Company follows Statement of Financial Accounting Standards
("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 earnings available to common stockholders
by the weighted-average number of common shares outstanding for the
period. Diluted EPS assumes conversion of convertible debt, preferred
stock and the issuance of common stock for all other potentially
dilutive equivalent shares outstanding. All of these equivalents were
anti-dilutive for all periods presented.
(m) Stock-Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation," ("SFAS No.
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 for employees 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.
(n) 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.
(o) Research and Development
These costs are expensed as they are incurred.
(p) Recent Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") 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 balance sheet and
measure those instruments at fair value. This statement will be adopted
in the Company's 2001 fiscal year. The Company does not have any
derivative instruments; accordingly, the adoption of this statement is
not expected to have a material effect on the Company's consolidated
financial position, results of operations or cash flows.
In December 1999 the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in
Financial Statements". SAB No. 101 summarizes certain of the SEC's
views in applying accounting principles to revenue recognition in
financial statements. SAB No. 101 was adopted in 2000 and had no
material impact on the Company's revenue recognition policy.
67
In November 2000, the Emerging Issues Task Force ("EITF") issued
consensus number 00-27 which requires the remeasurement of the original
issue discount on preferred stock with characteristics similar to the
convertible preferred stock issued by the Company earlier in 2000 and
in 1999. The adoption of this EITF resulted in an additional imputed
dividend of $2,325,000 which was recorded in the fourth quarter of
2000.
2. Basis of Presentation
The Company's consolidated financial statements have been presented on
the basis that it is a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal
course of business. The Company has suffered recurring losses for the
past several years, including $19,496,400 in 2000, and has experienced
significant problems and delays exploiting its primary technology
(medical equipment). In 2001, the Company has significantly reduced its
workforce and other costs. The Company is attempting to obtain
additional financing. With additional funds, the Company plans to
continue exploiting its color sciences technology and possibly sell its
medical technology to a third party. There can be no assurances that
additional financing will be obtained or that the Company's other plans
will be achievable. The financial statements do not include any
adjustments relating to the recoverability and classification of asset
amounts or the amounts and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern.
3. Gordon Laboratories
On June 2, 2000, the Company acquired the common stock and certain debt
of Gordon Laboratories ("Gordon")a privately held formulator an
manufacturer of cosmetics, hair care and other personal care products.
The acquisition was for a purchase price of $609,000 in cash used to
repay Gordon debt and approximately 721,000 shares of the Company's
common stock, valued for financial reporting purposes at $6.29 per
share, which approximated the market value of the Company's common
stock at the acquisition date. The Company owes a balance of $653,000
to the former shareholders of Gordon to complete the purchase. The
amount is payable in shares of the Company's common stock, valued at
$6.29 per share or 96,820 shares. This amount has been classified as a
long-term liability at December 31, 2000. The acquisition has been
accounted for under the purchase method of accounting for business
combinations.
Due to the Company's deteriorating financial condition and inability to
continue to support Gordon's operations, the Company decided in early
2001 to sell Gordon.
On July 3, 2001, pursuant to the Share Subscription and Redemption
Agreement, dated as of June 19, 2001 (the "Purchase Agreement"), among
the Company, Abilene Investments Corp. ("Abilene"), GAC-Labs, LLC
("GAC- Labs" and collectively with Abilene, the "Purchasers") and
Gordon Acquisition Corp., a wholly-owned subsidiary of the Company
("Gordon"), Gordon issued 200 shares of common stock, par value $.001
per share, of Gordon ("Gordon Stock") to Abilene and 800 shares of
Gordon Stock to GAC-Labs for an aggregate purchase price of $1,000,000.
Simultaneously, the shares of Gordon Stock that were outstanding
immediately prior to the closing of this transaction, all of which were
owned by the Company, were redeemed for one dollar. In addition, the
Company assigned to the Purchasers its right, title and interest in the
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indebtedness of Gordon and/or H.B. Gordon Manufacturing Co., Inc., its
wholly-owned subsidiary, owed to the Company in the ratio of 20% to
Abilene and 80% to GAC-Labs.
As part of the same transaction, pursuant to the Purchase Option
Agreement, dated as of July 3, 2001 (the "Option Agreement"), among the
Company, Abilene and GAC-Labs, the Company was granted the option to
purchase from the Purchasers the shares of Gordon Stock issued to them
and the indebtedness assigned to them under the Purchase Agreement
within one year for an aggregate purchase price of $1,000,000 plus
interest thereon at the rate of 14% per annum, subject to reduction
under certain conditions, as described below.
Furthermore, the Company granted to the Purchasers one-year warrants
(the "Warrants") to purchase (i) an aggregate of 2,000,000 shares of
common stock, par value $.001 per share, of the Company ("CCSI Stock")
at the exercise price of $.50 per share, if the Company does not
consummate a rights offering/ private placement by the Company of its
securities prior to the one year expiration of such warrants, or
alternatively (ii) an aggregate of 11,200,000 shares of CCSI Stock at
the exercise price of $.10 per share and 4.8 million shares at $0.001
per share, subject to price adjustment, if the Company consummates a
rights offering/private placement by the Company of its securities
prior to the one year expiration of such warrants and obtains
shareholder approval with respect to such rights offering/private
placement by the Company of its securities and such increase in
warrants. The fair market value of the 2 million warrants was
immaterial. If the alternative additional warrants are issued at a
later date, the fair market value of such warrants will be recorded as
a further loss on the disposal of Gordon.
If (i) pursuant to the Option Agreement the Company exercises its
option to purchase from the Purchasers the shares of Gordon Stock
issued to them and the indebtedness assigned to them under the Purchase
Agreement, (ii) the Company has not effected a reverse stock split of
the CCSI Stock in a ratio greater than ten to one, (iii) the Company
has consummated a rights offering/private placement by the Company of
its securities and (iv) the market price of CCSI Stock exceeds $1.00
per share for at least ten consecutive trading days from and after the
date of exercise under the Option Agreement, the Warrants will be
subject to mandatory exercise. In the event of such a mandatory
exercise, the Company will accept as payment of the aggregate exercise
price the shares of Gordon Stock that the Purchasers acquired under the
Purchase Agreement, and the exercise price under the Option Agreement
will be reduced to one dollar. The Warrants are also subject to
mandatory exercise if (i) a registration statement filed by the Company
with respect to the shares of CCSI Stock issuable upon exercise of the
Warrants has been declared effective by the Securities and Exchange
Commission, (ii) the Company has not effected a reverse stock split of
the CCSI Stock in a ratio greater than ten to one, (iii) the Company
has consummated a rights offering/private placement by the Company of
its securities and (iv) the market price of CCSI Stock exceeds $1.00
per share for at least ten consecutive trading days from and after the
effective date of such registration statement. In the event of such a
mandatory exercise, the Company will accept payment of the aggregate
exercise price through the means of a broker's cashless exercise
transaction.
The Company recorded the sale of Gordon in 2001 as a discontinued
operation. The financial statements for 2000 have been retroactively
changed to reflect Gordon's net assets and operations as discontinued
operations.
The loss from discontinued operations for the year ended December 31,
2000 were:
69
Net sales $ 3,761,600
Loss from operations (696,600)
Impairment loss - relating to goodwill (5,276,500)
----------------
Net loss from discontinued operations (5,973,100)
Net assets of Gordon at December 31, 2000 were:
Cash $ 78,800
Accounts receivable 887,600
Inventory 896,200
Property and equipment 813,800
Other assets 2,650,700
5,381,300
----------------
Accounts payable and accrued expenses 1,233,800
Debt 3,147,500
----------------
4,381,300
----------------
Net assets $ 1,000,000
================
4. Inventories
Inventories consist of the following:
December 31, 2000 1999
------------------------ ----------------- ----------------
Raw materials $ 1,480,200 $ 521,550
Work-in-process -- --
Finished goods -- 650,300
------------------------ ---------------- ----------------
1,480,200 1,171,800
Valuation reserve (733,100) --
------------------------ ---------------- ----------------
$ 747,100 $ 1,171,800
------------------------ ---------------- ----------------
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5. Property and Equipment
Property and equipment consist of the following:
December 31, 2000 1999
----------------------------------- ---------------- ----------------
Machinery and equipment $ 998,000 $ 928,200
Furniture and fixtures 139,400 144,600
---------------- ----------------
1,137,400 1,072,800
Less: Accumulated depreciation
and amortization (635,700) 460,600
Impairment reserves (257,600) --
----------------------------------- ---------------- ----------------
$ 244,100 $ 612,200
----------------------------------- ---------------- ----------------
Depreciation and amortization expense for property and equipment for
the years ended December 31, 2000, 1999 and 1998 is $175,100, $148,200
and $95,800, respectively.
6. ColorMate(R) Units
ColorMate(R) TLc-BiliTest(R) Systems
On June 7, 1999, the Company executed a renewable, five-year agreement
with Datex-Ohmeda, Inc. and its Ohmeda Medical Division ("DO") pursuant
to which the Company appointed DO as the exclusive distributor in the
United States of the Company's ColorMate(R) TLc-BiliTest(R) System
("Systems") for non-invasive monitoring of bilirubin infant jaundice in
the hospital market, the nonconsumer home healthcare market (in which
the test is administered solely by a healthcare professional), the
pediatrician office market and clinics within all such markets. The
agreement also applies to the Company's disposable calibration standard
(TLc-Lensette(TM)) that is used to calibrate each measurement taken by
the ColorMate(R) TLc-BiliTest(R) System and provides that the Company
will share in the sales revenues for both products. Terms of the
agreement include annual minimum market penetration performance
standards and purchasing and placement of quantities for both the
ColorMate(R) TLc-BiliTest(R) System and the TLc-Lensette(TM)
Calibration Standard. Sales under the agreement commenced in July 1999.
To date, the distribution partner has not achieved the annual minimum
market penetration performance standards, nor has it purchased and
placed the minimum quantities of the ColorMate(R) TLc-BiliTest(R)
System and the TLc-Lensette(TM) Calibration Standards as set forth in
the June 7, 1999 distribution agreement, as amended. Other than the
original sales to DO in 1999 of $1,075,300, there have been minimal
sales in 2000 and 2001 to date. The Company is currently working with
DO on revising the sales and marketing strategies, as well as product
improvements based on the results of the initial launch of the products
by DO. The parties are also exploring renegotiating the terms and
conditions of the distribution agreement. However, there can be no
assurances that any significant sales will be generated from the
agreement.
The agreement called for the Company to provide a certain number of
Systems to DO at no cost until sold to serve as demo units or
promotional units to assist in the sales and marketing of the Systems.
The Company maintains title of certain of these Systems, while DO
obtained ownership of the other Systems. The Company had classified
$329,000 in property and equipment, representing the cost of the
Systems for which it maintains title, and had classified $506,000 in
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other amortizable assets, representing the cost of the remaining
Systems (intangible asset associated with obtaining the agreement with
DO). The amount classified in other amortizable assets was being
amortized over the life of the DO Agreement, 5 years. Given the poor
level of sales to date, the Company wrote off the balance of these
capitalized costs ($611,700) in the fourth quarter of 2000.
In 1999, the Company recorded sales from both the ColorMate(R)
TLc-BiliTest(R) System and the TLc-Lensette(TM) Calibration Standards.
The sales were recorded at the initial minimum transfer price as
defined in the distribution agreement. The Company incurred a small
loss on the initial sales of the Systems. The Company expected to
receive additional amounts from the distributor equal to a defined
percentage of the distributor's sale of the above products ("profit
sharing payments"). However, that has not incurred to date and the
Company cannot predict when, or if, such additional amounts will be
received.
ColorMate(R) Systems
In connection with a prior 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 license on June 24,
1991, with the principal effect that the Company received 1,947 units,
of which 1,400 were useable and not in need of significant repair. For
accounting purposes, the $700,000 estimated fair value of the
nonproprietary equipment (based upon an independent appraisal of the
complete units with allowances for the lack of a verifiable used
equipment market, varying usage, the need for refurbishment and similar
factors) was recorded as an asset. The 1,700 useable units of
nonproprietary equipment were received in the form of (i) 1,400
complete units valued at $500 per unit and (ii) 300 complete units in
need of significant repair that were assigned zero value. No valuation
of the proprietary portion of the units or of the additional 247
unusable units returned by Avon was performed.
Following the Food and Drug Administration ("FDA") marketing clearance
in 1997, the Company had decided to use certain components (consisting
of sensors, miniature printers, cables, power supplies and certain
other items) from the existing ColorMate(R) units for use in the
ColorMate(R) TLc-BiliTest(R) System. The costs (which were not expected
to be material) incurred in extracting the components from the existing
ColorMate(R) units for use in the ColorMate(R) TLc-BiliTest(R) System
would have been expensed as incurred.
The cost of the above units has been classified as other assets in the
accompanying consolidated balance sheets and amounted to $614,900 in
December 31, 1999. Due to the problems arising in 2000 with the sale of
the ColorMate(R) TLc-BiliTest(R) Systems, these Avon units have not
been utilized to date. The Company is in negotiations to sell all the
units to a third party. If consummated, the arrangement will provide no
funds in advance. Rather, the third party will pay a fee to the Company
per usage of the System. Based upon estimates of future cash flows from
this proposed arrangement, the Company took an impairment charge in the
fourth quarter of 2000 of $314,900. The net amount capitalized at
December 31, 2000 totaled $300,000.
7. Income Taxes
72
The Company has a deferred tax asset at December 31, 2000 and 1999 of
approximately $19,500,000 and $15,000,000, respectively. These amounts
relate primarily to net erating loss and tax credit carryforwards.
These assets have been offset by valuation allowances since their
realizability cannot be determined. At December 31, 2000, the Company
had net operating loss carryforwards of approximately $48,700,000 for
Federal income tax purposes which expire through December 31, 2020. In
addition, the Company had research and development tax credit
carryforwards of approximately $75,000 at December 31, 2000 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
$5,700,000 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.
8. Senior Convertible Debentures
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 were 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) was not convertible until after the first
anniversary of the closing (except for 20%, which was immediately
convertible). At that time, the Debentures were convertible into shares
of common stock, at the option of the holder or holders thereof, at the
conversion price of $5.00. At any time after the18-month anniversary of
the closing, the Company could have prepaid 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 the18-month anniversary of the closing and
prior to the maturity date, in the event the average closing bid price
(as reported on the NASDAQ Small Cap Market or such other principal
market or exchange on which the common stock is then traded) of the
Company's common stock for any10 consecutive trading days equals or
exceeds $10.29, the Company could have required 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.
The Debentures resulted in an original issue discount charge of
approximately $3.6 million (representing the intrinsic value of the
below- market conversion price) which was amortized over one year.
In1999, the Company amortized $2.7 million and, in 2000, the balance of
$900,000 was amortized This debt was converted to preferred stock in
2000.
9. Preferred Stock
Class A
The Company's shares of Class A convertible preferred stock are
entitled to noncumulative 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
73
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.
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.
Class B
The Company also has authorized 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.
At December 31, 2000 the Company has outstanding the following series
of Class B preferred stock:
Amount
----------------------------------
Shares Value
------------------- ------------ ---------------
Series 2 25,000 $ 2,262,700
Series 3 40,000 3,155,000
Series 4 136 1,229,800
Series 5 48,633 4,863,300
------------------- ------------ ---------------
113,769 $ 11,510,800
------------ ---------------
Class B Series 1 Preferred Stock
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
74
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 $0.001each 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.
Class B Series 2 Convertible Preferred Stock
On June 15, 1999, the Company completed a private placement of 40,000
shares of convertible preferred stock and warrants to purchase 220,690
shares of common stock to a private investor for aggregate proceeds of
$4 million. The shares of Class B Series 2 convertible preferred stock
issued on that date (the "Series 2 Shares") are convertible into shares
of the Company's common stock at a price of $4.68 per share, subject to
adjustment for stock splits, combinations and similar recapitalizations
affecting the Company's common stock and in certain circumstances
including the issuance of shares of the Company's common stock. The
Series 2 Shares were previously redeemable in cash for an amount equal
to $115 per Series 2 Share on the third anniversary of the date of
initial issuance if not sooner converted unless the Company elects in
the Company's discretion to extend the redemption date to the fifth
anniversary of the date of initial issuance. As a result of a capital
restructuring program completed on October 31, 2000 (see Note 12), the
Series 2 Shares are no longer redeemable in cash. Accordingly, the
amount was classified within equity in the fourth quarter of 2000. The
Series 2 Shares are subject to mandatory conversion into shares of the
Company's common stock at the Company's option at any time after
December 15, 1999 if the average closing bid price of the Company's
common stock for ten consecutive trading days equals or exceeds $7.02
per share. The Series 2 Shares are not entitled to any voting rights
except as otherwise required by applicable law and are not entitled to
any dividend rights unless the Company elects to extend the redemption
date of the fifth anniversary of the date of initial issuance, in which
case noncash dividends (which increase the number of shares issuable
upon redemption ) would accrue at the rate of 8% from and after the
third anniversary of the date of initial issuance which can only be
paid in shares of the Company's common stock.
In addition to the Series 2 Shares, on June 15, 1999, the Company also
issued an aggregate of 220,690 warrants to purchase shares of the
Company's common stock to the same private investor. An additional
50,000 warrants were issued to such investor as compensation for
services rendered in connection with the placement of the Series 2
Shares. The warrants issued on that date have a five-year term unless
sooner exercised. The warrants are exercisable for shares of the
Company's common stock at a price of $4.68 per share, subject to
adjustment in the same circumstances as the Series 2 Shares described
above and are subject to mandatory exercise into shares of the
Company's common stock at the Company's option at any time after
December 15, 1999 if the average closing bid price of the Company's
common stock measured over twenty consecutive trading days equals or
exceeds $9.36.
75
The private placement resulted in a deemed dividend charge of
approximately $4.5 million, resulting from a below market conversion
price of preferred stock ($2,400,000), a $15 per share redemption
premium and other costs ($800,000) and the fair value (using the
Black-Scholes method) of warrants issued in connection with the private
placement ($1,275,000). Of this amount, approximately $1.6 million had
been charged through December 1999, $1.8 million has been charged in
2000 and $500,000 will be charged over the remaining redemption period.
Of the original deemed dividend charge, $.6 million has been eliminated
as a result of the conversion of preferred stock into common stock.
In 2000, 15,000 Series 2 Shares were converted into 238,473 shares of
the Company's common stock.
Class B Series 3 Convertible Preferred Stock
On February 11, 2000, the Company completed a private placement of
40,000 shares of convertible preferred stock to the above private
investor for aggregate proceeds of $4 million. The shares of Class B
Series 3 convertible preferred stock issued on that date (the "Series 3
Shares") are convertible into shares of the Company's common stock at a
price of $4.68 per share, subject to adjustment for stock splits,
combinations and similar recapitalizations affecting the Company's
common stock and in certain circumstances including the issuance of
shares of the Company's common stock. The Series 3 Shares were
previously redeemable in cash for an amount equal to $115 per Series 3
Share on the third anniversary of the date of initial issuance if not
sooner converted unless the Company elects in the Company's discretion
to extend the redemption date to the fifth anniversary of the date of
initial issuance. As a result of the capital restructuring program
completed on October 31, 2000 (see Note 12), the Series 3 Shares are no
longer redeemable in cash. Accordingly, the amount was classified
within equity in the fourth quarter of 2000.The Series 3 Shares are
subject to mandatory conversion into shares of the Company's common
stock at the Company's option at any time after August 11, 2000 if the
average closing bid price of the Company's common stock for ten
consecutive trading days equals or exceeds $7.02 per share. The Series
3 Shares are not entitled to any voting rights except as otherwise
required by applicable law and are not entitled to any dividend rights
unless the Company elects to extend the redemption date to the fifth
anniversary of the date of initial issuance, in which case noncash
dividends (which increase the number of shares issuable upon
redemption) would accrue at the rate of 8% from and after the third
anniversary of the date of initial issuance which can only be paid in
shares of the Company's common stock.
In addition to the Series 3 Shares, on February 11, 2000, the Company
also issued an aggregate of 254,372 warrants to purchase shares of the
Company's common stock to the same private investor. An additional
50,000 warrants were issued to such investor as compensation for
services rendered in connection with the placement of the Series 3
Shares. The warrants issued on that date have a five-year term unless
sooner exercised. The warrants are exercisable for shares of the
Company's common stock at a price of $4.68 per share, subject to
adjustment in the same circumstances as the Series 3 Shares described
above and are subject to mandatory exercise into shares of the
Company's common stock at the Company's option at any time after August
11, 2000 if the average closing bid price of the Company's common stock
measured over twenty consecutive trading days equals or exceeds $9.36.
76
The private placement resulted in a deemed dividend charge of
approximately $3.5 million, resulting from a below market conversion
price of preferred stock ($1,495,000), a $15 per share redemption
premium and other costs ($990,000) and the fair value (using the
Black-Scholes method) of warrants issued in connection with the private
placement ($1,050,000). Of this amount, approximately $2.1 million has
been charged in 2000 and $1.4 million will be charged over the
remaining redemption period.
Class B Series 4 Convertible Preferred Stock
On October 31, 2000, the Company consummated a private placement of 200
shares of a new series of preferred stock, designated Class B Series 4
convertible preferred stock, par value $.01 per share ("Series 4
Preferred Stock") for an aggregate purchase price of $2,000,000.
Pursuant to the Stock Purchase Agreement between the Company and
Crescent International Ltd. (the "Purchaser"), the Company also issued
to the Purchaser a warrant (the "Incentive Warrant"), the terms of
which provide that the Purchaser has the right to acquire up to 270,000
shares of the Company's common stock at an exercise price equal to
$1.00 per share, subject to adjustment in certain circumstances, for a
five-year period.
The Series 4 Preferred Stock will, with respect to the distribution of
assets on liquidation, dissolution or winding up of the Company, rank
(i) senior and prior to the common stock of the Company and any other
class or series of capital stock of the Company hereafter issued, the
terms of which specifically provide that shares of such class or series
shall rank junior to shares of the Series 4 Preferred Stock (ii) on
parity with any other class or series of capital stock of the Company
hereafter issued, the terms of which specifically provide that shares
of such class or series shall rank on parity with shares of the Series
4 Preferred Stock, and (iii) junior to the Class A preferred stock and
any other class or series of capital stock of the Company hereafter
issued, the terms of which specifically provide that shares of such
class or series shall rank senior to shares of the Series 4 Preferred
Stock
At any time after October 31, 2002, any or all of the outstanding
shares of Series 4 Preferred Stock will, upon written request of the
holders of a majority of the issued and outstanding shares thereof, be
subject to redemption by the Company for either, at the option of the
Company, (i) $12,000 in cash per share or (ii) the number of shares of
common stock obtained by dividing $12,000 by the lower of $.82 and 92%
of the average of the lowest three consecutive closing bid prices of
the common stock during the 22 trading day period immediately preceding
the date that redemption is requested. In addition, subject to certain
adjustments, each share of the Series 4 Preferred Stock will be
convertible at any time at the option of the holder thereof into the
number of shares of common stock determined by dividing $10,000 by the
lower of $.82 and 92% of the average of the lowest three consecutive
closing bid prices of the common stock during the 22 trading day period
immediately preceding the date that conversion is requested. The holder
of shares of Series 4 Preferred Stock will have no voting rights and,
if the Company fails to deliver certificates of shares of common stock
upon redemption or conversion of the Series 4 Preferred Stock, will
receive dividends at a rate of 8.0% per annum, payable in cash in
quarterly installments.
In December 2000, 64 of these shares were converted into 1,391,304
shares of common stock.
Class B Series 5 Convertible Preferred Stock
77
Pursuant to a letter agreement, the Company and the holders agreed to
convert the entire principal amount of the Debentures (see Note 10),
and any accrued but unpaid interest thereon, into a newly-authorized
series of convertible preferred stock of the Company (the "New
Preferred"), effective October 31, 2000. Prior to their conversion, the
Debentures had a principal face amount of $5,000,000, accrued but
unpaid interest in the amount of $1,079,167 and were due on April 15,
2002. The Company and the holders further agree that (i) the New
Preferred would be convertible into shares of common stock at a
conversion price of $4.68 per share, subject to adjustment for stock
splits, combinations and similar recapitalizations affecting the common
stock, (ii) with respect to the distribution of assets on the
liquidation, dissolution or winding up of the Company, the New
Preferred shall rank senior and prior to all classes or series of
capital stock of the Company issued prior thereto or thereafter issued,
(iii) cumulative dividends would accrue on the New Preferred beginning
on April 15, 2002 at a rate of 8% per annum (subject to increase to 11%
per annum during any period in which such cumulative dividends are not
currently paid), and (iv) the New Preferred would be subject to
involuntary conversion into shares of common stock at the option of the
Company at a conversion price of $4.68 per share if the average closing
bid price of the Company's common stock for ten consecutive trading
days exceeds $10.29. The Company also agreed with the holders (i) not
to incur or permit any future liens on any of its properties or assets,
(ii) not to grant any security interests in its future revenues and
(iii) not to consummate any future financings which contemplate the
issuance of debentures by the Company.
In December 2000, 12,158 of these shares were converted into 259,786
shares of common stock.
10. Capital Restructuring Program
Transaction Summary
On October 11, 2000, the Company obtained commitments from three of its
major investors, Millennium Partners, L.P. ("Millennium") (see Note
13), LBI Group, Inc. ("Lehman") (see Note 11) and the holders (the
"Holders") of its 14% senior convertible debentures, dated April15,
1999 (the "Debentures") (see Note 10) to restructure the terms of their
respective securities. The purpose of this restructuring was to assist
the Company in meeting the net tangible assets requirement for
continued listings of its common stock, on the NASDAQ Small Cap Market
("NASDAQ"). These commitments of the investors were subject to certain
conditions, which were subsequently satisfied on October 31, 2000,
including the Company's securing confirmation from NASDAQ of the
Company's eligibility for continued listing on NASDAQ and the closing
of a proposed additional financing with Crescent International Ltd.
("Crescent"), pursuant to which the Company would issue and sell to
Crescent, and Crescent would purchase, shares of a newly- authorized
series of preferred stock of the Company (the "Crescent Preferred") and
a five-year warrant to purchase up to 270,000 shares of Common stock at
an exercise price equal to $1.00 per share, subject to adjustment in
certain circumstances (the "Crescent Warrants"), for an aggregate
purchase price of not less than $2,000,000. In consideration of their
agreements to restructure their respective securities, the Company
agreed to issue to each of Lehman and the Holders 200,000 five-year
warrants to purchase shares of the common stock of the Company at an
exercise price of $1.50 per share (the "New Lehman Warrants" and the
"Holders' Warrants", respectively). The value of the warrants issued in
this restructuring program was deemed to be immaterial. The Company
also agreed with the holders (i) not to incur or permit any future
liens on any of its properties or assets, (ii) not to grant any
security interests in its future
78
revenues and (iii) not to consummate any future financings which
contemplate the issuance of debentures by the Company.
Transaction Details
Pursuant to a letter agreement (the "Millennium Letter Agreement"), the
Company and Millennium agreed to amend the Millennium Purchase
Agreement and the Adjustable Warrant to delete any provision granting
Millennium the right to require the Company to repurchase the
Millennium Shares or redeem the Adjustable Warrant Shares, as the case
may be, for cash except in the event that the Company (i) engages in a
"Rule 13e-3 Transaction" (as defined in Rule 13e-3 under the Securities
Exchange Act of 1934, as amended) or (ii) fails to file a request to
accelerate the effectiveness of the registration statement covering the
Millennium Shares and the shares underlying the warrants issued to
Millennium promptly after securing confirmation from NASDAQ of the
Company's eligibility for continued listing of the common stock on
NASDAQ. The Company has satisfied this condition by filing such
acceleration of effectiveness on November 3, 2000.
The Company and Millennium further agreed to amend the Adjustable
Warrant (i) to reduce the number of dates (each, a "Vesting Date") upon
which the number of shares to be issued upon the exercise of the
Adjustable Warrant would be determined from three to two, (ii) to
postpone the first Vesting Date thereunder (the "First Vesting
Date")until March 31, 2001, at which time the number of shares to be
issued thereunder would be determined based on an Adjustment Period
Price of not less than $1.00 and, (iii) to postpone the second Vesting
Date thereunder (the "Second Vesting Date") until November 1, 2001, at
which time the number of shares to be issued thereunder (in addition to
the number of shares determined as of the First Vesting Date) would be
determined based on an Adjustment Period price which would not be
subject to a $1.00 minimum (as was the case on the First Vesting Date).
The Company and Millennium also agreed (x) to amend that certain
Registration Rights Agreement, dated as of August 16, 2000, to
eliminate the provisions imposing monetary penalties upon the delisting
of the common stock from NASDAQ, (y) to waive any events of default
occurring prior to the execution of the Millennium Letter Agreement
that would entitle Millennium to any monetary penalties from the
Company and (z) to irrevocably waive its rights to adjust the exercise
price of the Adjustable Warrant or the number of AdjustableWarrant
Shares as a result of the issuance of up to $4,000,000 of financing
from the Crescent Preferred.
Lehman is the holder of (i) 25,000 shares of the Class B Series 2
Convertible Preferred Stock of the Company and 40,000 shares of the
Class B Series 3 Convertible Preferred Stock of the Company
(collectively, the "Lehman Preferred") and (ii) warrants (the "Lehman
Warrants") to purchase common stock (see Note 11). Pursuant to a letter
agreement, the Company and Lehman agreed to amend those certain
Preferred Stock Purchase Agreements, dated as of June 11, 1999 and
February 11, 2000, respectively, to eliminate the provisions imposing
monetary penalties in the event that the common stock is delisted from
NASDAQ.
The Company and Lehman further agreed to amend the Certificate of
Incorporation of the Company to delete any provision granting Lehman
the right to require the Company to redeem the shares of Lehman
Preferred for cash. Pursuant to such amendments, the Company is now
required to convert the shares of Lehman Preferred into Common stock on
the third anniversary of their respective issuance dates unless the
Company elects, at its option, to extend the
79
mandatory conversion date to the fifth anniversary of the respective
issuance dates of the shares of Lehman Preferred. Lehman further agreed
to waive its right to decrease the conversion price of the Lehman
Preferred and the exercise price of the Lehman Warrants as a result of
(i) the issuance of the Crescent Preferred and the Crescent Warrant on
October 31, 2000 for aggregate proceeds of $2,000,000 or any further
issuances of preferred stock or warrants to Crescent which do not
exceed an additional aggregate purchase price of $2,000,000, (ii) the
issuance of warrants to the Company's financial adviser in connection
with the Crescent Financing, (iii) the issuance of the New Lehman
Warrants and the Holders' Warrants and (iv) the determination on the
First Vesting Date of the number of shares of Common stock issuable
with respect to the Adjustable Warrant. In addition, Lehman agreed (A)
that the deemed exercise price (the "Deemed Exercise Price") with
respect to the number of shares of Common stock issuable pursuant to
the Adjustable Warrant on the Second Vesting Date would be the greater
of (i) $1.00 and (ii) the exercise price calculated in the manner set
forth in that certain letter agreement, dated as of August 16, 2000, by
and between the Company and Lehman, and (B) to waive its right to
decrease the conversion price of the Lehman Preferred and the exercise
price of the Lehman Warrants to a price which is less than the Deemed
Exercise Price.
Pursuant to a letter agreement, the Company and the Holders agreed to
convert the entire principal amount of the Debentures, and any accrued
but unpaid interest thereon, into a newly- authorized series of
convertible preferred stock of the Company (the "New Preferred"),
effective October 31, 2000. Prior to their conversion, the Debentures
had a principal face amount of $5,000,000, accrued but unpaid interest
in the amount of $1,079,167 and were due on April 15, 2002. The Company
and the holders further agreed that (i) the New Preferred would be
convertible into shares of Common stock at a conversion price of $4.68
per share, subject to adjustment for stock splits, combinations and
similar recapitalizations affecting the Common stock, (ii) with respect
to the distribution of assets on the liquidation, dissolution or
winding up of the Company, the New Preferred shall rank senior and
prior to all classes or series of capital stock of the Company issued
prior thereto or thereafter issued, (iii) cumulative dividends would
accrue on the New Preferred beginning on April 15, 2002 at a rate of 8%
per annum (subject to increase to 11% per annum during any period in
which such cumulative dividends are not currently paid) and (iv) the
New Preferred would be subject to involuntary conversion into shares of
Common stock at the option of the Company at a conversion price of
$4.68 per share if the average closing bid price of the Company's
Common stock for ten consecutive trading days exceeds $10.29. The
Company also agreed with the holders (i) not to incur or permit any
future liens on any of its properties or assets, (ii) not to grant any
security interests in its future revenues and (iii) not to consummate
any future financings which contemplate the issuance of debentures by
the Company.
11. Sale of Common Stock
On August 16, 2000, the Company sold 641,026 shares of Common stock to
a private investor at a price per share of $4.68 for gross proceeds of
$3,000,000, less fees and expenses ("first closing"). In connection
with the above transaction, the Company issued to the investor 150,000
warrants to purchase Common stock at an exercise price of $5.26 per
share. Pursuant to the purchase agreement for the above transaction,
the Company issued to the private investor an "Adjustable
Warrant"pursuant to which the number of shares issuable upon the
exercise thereof (the "Adjustable Warrant Shares") is based upon a
formula involving closing bid prices of the Common stock on certain
future dates, as amended. Prior to the amendment of the purchasing
80
agreement, the private investor had the right to require the Company to
repurchase for cash the shares and Adjustable Warrant Shares issued to
the private investors under certain defined conditions. Accordingly, at
September 30, 2000, the Company recorded the net proceeds of $2,815,000
as redeemable Common stock. As a result of the amendment, which
eliminated the cash requirement, the amount has been classified in
Common stock in the fourth quarter of 2000.
As a result of the first adjustment of the adjustable warrant, the
Company is obligated as of March 31, 2001 to issue approximately
936,000 shares of common stock.
Also in 2000, the Company sold 79,491 shares of common stock for
$500,000.
12. Stock Options and Warrants
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.
Stock Option Plan
The Company has a Stock Option Plan which currently provides for
options to purchase up to 6,500,000 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 nonincentive 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 1998, 1999
and 2000, no dividend yield, expected volatility of 60%, 46% and 73%
risk-free interest rates of 5% to 7% and expected lives of
approximately 2.5 years for 1998 and 1999 and 6.64 years for 2000. The
weighted average fair market value for options granted in 1998, 1999
and 2000 was $2.26, $2.23 and $3.83, 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 1998, 1999 and
2000 by approximately $470,000, $121,000 and $497,000, respectively,
and loss per share would have been increased by $.03, $.01 and $.03,
respectively.
The following table summarizes information about stock options
outstanding at December 31, 2000:
Options outstanding Options exercisable
-------------------------------------------------------- --------------------------------
Weighted
Number average Weighted
outstanding remaining Weighted average
as of December 31, contractual life average Number exercise
2000 (years) price exercisable price
--------------------------- ------------------- ----------------- ------------- ------------- ------------
Range of exercise prices:
$1.02 - $2.92 1,003,748 0.80 2.87 993,748 2.88
$2.96 - $5.63 1,447,416 2.81 5.19 900,913 5.23
81
$6.84 - $8.25 573,834 2.40 7.64 337,665 7.81
$9.25 - $10.00 260,000 2.20 9.41 214,167 9.43
--------------------------- ------------------- ----------------- ------------- ------------- ------------
3,284,998 2.08 5.24 2,446,493 5.00
=================== ================= ============= ============= ============
Transactions under the Stock Option Plan are summarized as follows:
Weighted
average
Shares exercise price
---------------------------------------------------- ----------------- -----------------
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, 1999 3,111,548 5.08
Granted (at $1.94 to $6.84 per share) 160,000 6.20
Exercised (62,551) 5.39
Canceled (at $2.96 to $10.00 per share) (62,500) 4.47
---------------------------------------------------- ----------------- -----------------
Shares under option at December 31, 1998 3,146,497 5.14
Granted (at $4.68 to $9.375 per share) 467,500 5.75
Exercised (138,333) 3.00
Canceled (at $1.50 to $5.42 per share) (190,666) 6.98
---------------------------------------------------- ----------------- -----------------
Shares under option at December 31, 2000 3,284,998 5.24
---------------------------------------------------- ----------------- -----------------
Options exercisable at December 31,:
1998 1,470,715
1999 2,063,497
2000 2,446,493
---------- --- ---------------
The Company granted options to consultants and certain other
professionals who provide services to the Company. These options have
been valued in accordance with SFAS 123 and are being expensed over the
vesting period of the options. The amounts expensed in 1998, 1999 and
2000 amounted to $843,400, $984,000 and $690,000, respectively. The
activity for these options is included in the table above.
At December 21, 2000 the Company had the following warrants
outstanding:
Grant Date Amount Exercise Price Maturity Reason for Grant
---------------- ------------- ------------------ ------------- ---------------------------
2000 574,374 $1.00 - $4.68 2005 Preferred Stock
2000 259,491 5.26 - 6.29 2005 Common Stock
2000 400,000 1.50 2005 Refinancing
2000 298,718 4.68 2005 Other
1999 270,690 4.68 2004 Preferred Stock
Prior years 429,600 1.67 2002 various financings
2,232,873
=============
All warrants are exercisable.
13. Related Party
In connection with the Avon Settlement in an earlier year and her
Transactions employment agreement, Mrs. Macfarlane, the Company's CEO
and a principal shareholder, was to receive a bonus of $361,200, of
which $110,900 had been paid. The remaining $250,300 accrued interest
at the rate of 10% per annum. In December 1997, Mrs. Macfarlane agreed
to delay demand for
82
payment until January 1999, and further extended this payment to April
2000. At December 31, 1999, $256,100, including interest, remained due.
This amount was paid by the Company in 2000.
Approximately $31,000 per year related to rent paid to Mrs. Macfarlane
under month-to-month lease agreements. Such rent is equal to Mrs.
Macfarlane's actual cost for such premises.
14. Commitments
Leases
The Company leases its office and warehouse space on a month-to-month
basis. Rent expense under these leases totaled $383,400, $296,800 and
$266,000 in 2000, 1999 and 1998, respectively.
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-, $-0- and $93,200 in 2000, 1999
and 1998, respectively.
15. Quarterly Financial Information (Unaudited)
Unaudited quarterly financial information for the two years ended December 31,
2000 is summarized as follows:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----- ------------------------- ------------------- ------------------ ------------------ ------------------
2000
-------------------------
Net sales $ 38,600 $ 41,100 $ 700 $ -
Gross profit/(loss) 17,900 174,700 329,800 (548,800)
Net loss (3,428,700) (2,959,100) (3,023,300) (10,085,300)
Loss per share (0.26) (0.20) (0.19) (0.75)
1999
Net sales -- -- 362,100 741,100
Gross profit/(loss) -- -- 315,800 (110,700)
Net loss (2,078,600) (3,892,700) (3,145,800) (3,690,900)
Loss per share (0.13) (0.33) (0.21) (0.26)
----- ------------------------- ------------------- ------------------ ------------------ ------------------
In the fourth quarter of 2000, in light of the serious liquidity and
other problems at the Company and because of the lack of viable levels
of sales of its medical equipment, the Company recorded the following
impairment charges and write-offs:
Continuing Discontinued
Operations Operations
-------------------------- ------------------ ---------------
Inventory $ 733,100* $ -
Property and equipment 257,600 -
Gordon goodwill - 5,276,500
Other intangibles 1,250,100 -
-------------------------- ------------------ ---------------
$ 2,240,800 $ 5,276,500
========================== ================== ===============
* Included in cost of sales
83
Also in the fourth quarter of 2000, the Company recorded an additional
deemed dividend of $2,325,000 relating to the adoption of EITF 00-27.
16. Subsequent Events
Litigation
On January 16, 2001, a lawsuit was commenced against the Company and
Darby Macfarlane in the federal district court for the Southern
District of New York entitled Richard Sommers and Linda Sommers
v.Chromatics Color Sciences International, Inc. and Darby S.
Macfarlane. The plaintiffs allege that certain statements purportedly
made by or on behalf of the Company concerning the Company's success,
the extent of use of the ColorMate System and the Company's cash flow
constituted violations of Section 10(b) of the Securities Exchange Act
of 1934 and SEC Rule 10b-5 promulgated thereunder and Section 12(a)(2)
of the Securities Act of 1933 as well as common law claims alleging
fraudulent misrepresentation, concealment and nondisclosure and seek
unspecified damages in an amount to be proven at trial. On March 1,
2001, the defendants moved to dismiss the complaint for failure to
state a claim upon which relief can be granted, for failure to plead
fraud with requisite particularity and for failure to comply with the
statutory requirements for federal securities fraud claims. No
decision has been rendered by the court on this motion. Oral argument
was held before the court (Grisea, J.) on January 17, 2002, and the
court entered an order granting the defendants' motion and dismissing
the case without prejudice, but with leave for the plaintiffs to
refile. Defendants believe that the claims asserted against them are
without merit and intend to vigorously defend this action, assuming
that the complaint is refiled. The Company can not predict the
effects, if any, of the ultimate outcome of this matter.
Nasdaq SmallCap Market Listing ("Nasdaq")
Trading of the Company's stock on Nasdaq is condition upon the
Company's continuing to meet certain financial and stock price tests.
In 2001, the Company failed to meet certain of the tests. Further, in
March 2001, trading on the Company's stock was suspended by Nasdaq,
pending the Company providing certain information to Nasdaq. The
Company is currently negotiating with Nasdaq to resume trading in its
stocks.
17. Valuation Reserves
For the year ended December 31, 2000, the Company had the following
valuation reserves:
(a) Inventory reserve
Balance, January 1, 2000 $ --
Additions 733,100
----------------
Balance, December 31, 2000 $ 733,100
================
(b) Goodwill and other intangible assets
Balance, January 1, 2000 --
Additions - CCSI 1,507,700
Additions - Gordon 5,276,500
----------------
Balance, December 31, 2000 $ 6,784,200
================
84
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, 2001
------------------
(unaudited)
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 157,700
Accounts receivable 72,900
Inventories 714,000
Prepaid expenses and other current assets 67,300
Subscriptions receivable 310,000
Deferred financing costs 680,500
----------------
Total Current Assets 2,002,400
PROPERTY AND EQUIPMENT - NET 178,400
SOFTWARE DEVELOPMENT COSTS - NET 104,600
PATENT COSTS - NET 505,700
OTHER ASSETS 306,600
----------------
$ 3,097,700
================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses:
Attorneys and accountants $ 1,021,100
Consultants 385,600
Trade 294,300
Severance payable 700,000
Notes payable (including $325,000
payable to an affiliate) 1,260,000
----------------
Total Current Liabilities 3,661,000
----------------
COMMITMENTS AND CONTINGENCIES
REDEEMABLE PREFERRED STOCK:
Class A, Par Value $.01 per share:
Authorized - 1,400,000 shares
Issued and outstanding - 1,380,000
shares at par value
and redemption value 13,800
----------------
13,800
----------------
SHAREHOLDERS' EQUITY (DEFICIENCY)
Preferred Stock, authorized 10,000,000 shares,
issued and outstanding 113,769 shares 12,344,800
Subscribed stock
(8,333,334 shares of common stock) 500,000
Common Stock, par value $.001 per share:
Authorized - 50,000,000 shares
Issued and outstanding -
19,991,952, (2001) and 19,033,308
(2000) shares 20,000
Capital in excess of par value 46,718,500
Accumulated deficit (60,160,400)
----------------
Total Shareholders' Equity (Deficiency) (577,100)
----------------
$ 3,097,700
================
See accompanying notes to consolidated financial statements
85
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Months Ended Sept. 30,
-------------------------------
2001 2000
------------- --------------
Sales $ 6,000 $ 80,400
------------- --------------
COSTS AND EXPENSES:
Cost of sales - 27,000
Sales, marketing and trade show costs 281,500 1,667,100
Medical regulatory expenses 304,300 617,000
Research and development 597,200 958,300
Patent application costs 179,600 216,400
Compensation costs relating to (non cash) options granted - 690,000
Provision for estimated payments for terminated employees 1,000,000 -
General and administrative:
Compensation - Officers, employees and consultants 853,200 1,258,800
Legal fees 332,300 571,800
Accounting fees 83,600 114,100
Rent and storage 270,500 248,400
Insurance 171,100 224,400
Repairs and maintenance 47,900 123,100
Depreciation and amortization 353,400 538,900
Taxes 57,500 58,100
Stock administrative fees 80,400 65,800
Public relations 41,200 162,000
Other 128,000 308,300
------------- --------------
4,781,700 7,849,500
------------- --------------
OPERATING LOSS (4,775,700) (7,769,100)
------------- --------------
OTHER INCOME (EXPENSE):
Interest income 2,800 111,600
Interest expense and non-cash financing costs
including $285,500 and $834,200 in non-cash OID
costs in 2001 and 2000, respectively (309,900) (1,379,200)
------------- --------------
(307,100) (1,267,600)
------------- --------------
LOSS FROM CONTINUING OPERATIONS (5,082,800) (9,036,700)
LOSS FROM DISCONTINUED OPERATIONS (Note 3) (1,000,000) (374,400)
------------- --------------
NET LOSS $ (6,082,800) $ (9,411,100)
============= ==============
NET LOSS TO COMMON STOCKHOLDERS:
LOSS FROM CONTINUING OPERATIONS $ (5,082,800) $ (9,036,700)
DEEMED DIVIDEND FOR CLASS B, SERIES 2 AND 3
CONVERTIBLE PREFERRED STOCK 834,000 1,259,000
------------- --------------
LOSS FROM CONTINUING OPERATIONS TO
COMMON STOCKHOLDERS (5,916,800) (10,295,700)
LOSS FROM DISCONTINUED OPERATIONS (Note 3) (1,000,000) (374,400)
------------- --------------
NET LOSS TO COMMON SHAREHOLDERS $ (6,916,800) $ (10,670,100)
============= ==============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 19,521,176 16,283,021
============= ==============
BASIC AND DILUTED LOSS PER SHARE:
LOSS FROM CONTINUING OPERATIONS $ (0.30) $ (0.63)
LOSS FROM DISCOUNTINUED OPERATIONS (0.05) (0.02)
------------- --------------
NET LOSS TO COMMON STOCKHOLDERS $ (0.35) $ (0.66)
============= ==============
See accompanying notes to consolidated financial statements
86
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
(UNAUDITED)
Common Stock
----------------------------
Number Capital
Preferred of Shares Par in Excess of Accumulated
Stock Outstanding Value Par Value Deficit
--------------- --------------- ---------- --------------- ----------------
Balances, December 31, 2000 $ 11,510,800 19,033,308 $ 19,100 $ 45,934,400 $ (54,077,600)
Nine Months Ended September 30, 2001:
Net Loss - - - - (6,082,800)
Issuance of common stock - Gordon 22,894 - 653,000
Issuance of common stock - Private
investor 935,750 900 (900)
Warrants issued in connection
with bridge notes 966,000
Deemed dividend on Class B,
convertible preferred stock 834,000 (834,000)
--------------- --------------- ---------- --------------- ----------------
Balances, September 30, 2001 $ 12,344,800 19,991,952 $ 20,000 $ 46,718,500 $ (60,160,400)
=============== =============== ========== =============== ================
See accompanying notes to consolidated financial statements
87
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30,
---------------------------------
2001 2000
---------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss from continuing operations $ (5,082,800) $ (9,036,700)
Loss from discontinued operations (1,000,000) (374,400)
Adjustments to reconcile net loss to net cash flows
from operating activities:
Non-cash impairment charge and net change in net assets
of discontinued operations 1,000,000 374,400
Depreciation and amortization 353,400 538,900
Compensation cost relating to options granted to consultants - 690,000
Non-cash interest and financing costs 285,500 834,200
Changes in operating assets and liabilities:
Accounts receivable - 769,400
Inventories 33,100 (206,700)
Prepaid expenses and other assets 204,700 (162,700)
Accrued interest on senior convertible debentures - 525,000
Accounts payable and accrued expenses 1,840,300 262,500
-------------- ---------------
Net cash flows from continuing operating activities (2,365,800) (5,786,100)
-------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capitalized patent costs - (337,300)
Net cash used for investment in subsidiary - (1,937,000)
Purchase of property and equipment (5,500) (77,100)
-------------- ---------------
Net cash flows from investing activities (5,500) (2,351,400)
-------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of subscribed stock, net
of related costs 190,000 3,672,700
Proceeds (payments) of notes payable and warrants 960,000 (256,100)
Net proceeds from the issuance of preferred stock and
warrants, net of costs - 3,610,000
-------------- ---------------
Net cash flows from financing activities 1,150,000 7,026,600
-------------- ---------------
NET CHANGE IN CASH AND EQUIVALENTS (1,221,300) (1,110,900)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 1,379,000 2,790,400
-------------- ---------------
CASH AND EQUIVALENTS, END OF PERIOD $ 157,700 $ 1,679,500
============== ===============
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ - $ 20,300
============== ===============
Issuance of debt to pay accrued expenses $ 300,000 $ -
============== ===============
Issuance of stock to pay Gordon liability $ 653,000 $ -
============== ===============
Deemed dividends $ 834,000 $ 1,259,000
============== ===============
Subscribed stock $ 310,000 $ -
============== ===============
See accompanying notes to consolidated financial statements
88
CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Basis of Presentation:
Nature of Report - The consolidated balance sheet at the end of the preceding
fiscal year has been derived from the audited consolidated balance sheet
contained herein and is presented for comparative purposes. All other financial
statements are unaudited. In the opinion of management, all adjustments, which
include only normal recurring adjustments necessary to present fairly the
financial position, results of operations and changes in cash flows, for all
periods presented have been made. The results of operations for interim periods
are not necessarily indicative of the operating results for the full year.
Footnotes - Certain footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted in accordance with the published rules and regulations of the
Securities and Exchange Commission. These consolidated financial statements
should be read in conjunction with the financial statements and notes thereto
included in the Company's December 31, 2000 Financial Statements included
herein.
Note 2 - Commitments and Contingencies:
Business Risks - 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 outside financing.
Operating Difficulties - Since 1989, the Company has incurred losses from
operations and net cash outflows from operations. The Company expects to license
its patents and proprietary technology, sell its equipment and market its
related services and products to ultimately overcome these difficulties.
Although the Company has taken steps to substantially reduce personnel and
ongoing operating expenses, the Company expects that it will continue to incur
costs in connection with the required research and development on its new LED
instrument and technology, complete filings, administration and maintenance for
certain intellectual properties and regulatory requirements; supply updated
products and sales support to its medical distributor; complete FDA filings for
upgrades to its medical products, and explore the possibility of either
renegotiating its current distribution agreement for its medical products or
selling the exclusive rights to its medical products and technology. 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.
The Company anticipates that it will continue to incur net losses for the
foreseeable future as expenses are incurred in implementing its long-term
business plan.
89
The Company is currently taking steps to improve operating results and has
initiated a plan to significantly reduce operating costs. The Company is
experiencing a major liquidity crisis and requires an immediate infusion of cash
to continue operations. The Company is seeking additional capital to facilitate
liquidity and is currently reviewing various financing proposals. If the Company
is unable to obtain such financing, or sell its assets to obtain a cash
infusion, it may be forced to seek protection from its creditors in bankruptcy.
Even if the Company is successful in obtaining this cash infusion, the Company
will require additional future financing to further execute its long range
business plan. If the Company is not able to attract additional future
financing, generate significant revenue from operations and/or successfully
market its products and technologies, it may have to significantly curtail
and/or cease operations and be forced to seek protection from its creditors in
bankruptcy.
The Company has previously received notifications from NASDAQ that its common
stock failed to comply with the $1.00 minimum bid price and $2,000,000 minimum
net tangible asset conditions required for coninued listing of the common stock
on the NASDAQ SmallCap Market. A hearing on the proposed delisting of the
Company's common stock was held on August 16, 2001. At that hearing the NASDAQ
Hearing Committee requested additional information regarding the Company's plans
to achieve compliance with the minimum net tangible asset requirement. To date,
NASDAQ has publicly announced a temporary suspension of all delisting
proceedings regarding the listing requirement for a $1 minimum per share price
in the aftermath of the September 11th attacks on the World Trade Center and the
Pentagon. Additionally, on October 30, 2001, NASDAQ has granted a temporary
exception to the Company to remain listed until November 30, 2001, pending the
Company's ability to be in compliance with the terms of the exception, including
the Net Tangible Asset requirement. On November 30, 2001 the Company's
securities ceased to be listed on the Nasdaq Small Cap Market and are listed on
the OTC Bulletin Board. The Company has requested that the Listing Council
review this decision. However the institution of a review will not operate as a
stay of delisting based on this decision.
Legal Proceedings - On January 16, 2001, a lawsuit was commenced against the
Company and Darby Macfarlane in the federal district court for the Southern
District of New York entitled Richard Sommers and Linda Sommers v. Chromatics
Color Sciences International, Inc. and Darby S. Macfarlane. The plaintiffs
allege that certain statements purportedly made by or on behalf of the Company
concerning the Company's success, the extent of use of the ColorMate (Registered
Trademark) System and the Company's cash flow constituted violations of Section
10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 promulgated
thereunder and Section 12(a)(2) of the Securities Act of 1933 as well as common
law claims alleging fraudulent misrepresentation, concealment and nondisclosure
and seek unspecified damages in an amount to be proven at trial. On March 1,
2001, the defendants moved to dismiss the complaint for failure to state a claim
upon which relief can be granted, for failure to plead fraud with requisite
particularity and for failure to comply with the statutory requirements for
federal securities fraud claims. Oral argument was held before the court
(Grisea, J.) on January 17, 2002, and the court entered an order granting the
defendants' motion and dismissing the case without prejudice, but with leave for
the plaintiffs to refile. Defendants believe that the claims asserted against
them are without merit and intend to vigorously defend this action, assuming
that the complaint is refiled.
Note 3 - Discontinued Operations:
On June 2, 2000, the Company purchased Gordon Laboratories, Inc. ("Gordon"). Due
to the recent financial results of Gordon and CCSI's inability to continue
funding Gordon, the Company decided to sell Gordon in the first quarter of 2001.
On July 3, 2001 the Company completed the sale of Gordon (see below). The
Company retains the right to repurchase Gordon within the one year anniversary
of July 3,
90
2001. Accordingly, results of this operation have been classified as
discontinued, and prior periods have been restated. The net assets of Gordon
were written-down to zero as of March 31, 2001.
In connection with the purchase of Gordon, the Company was required to issue
additional shares of its common stock to certain Gordon options holders on June
2, 2001 at a price of $6.29 per share. In accordance with this provision, the
Company issued 22,894 shares on July 3, 2001. The financial statements reflect
these shares as if they had been fully issued on June 2, 2001.
Net sales and loss from the discontinued operation are as follows:
Nine Months Nine Months
ended ended
Sep. 30, 2001 Sep. 30, 2000
----------------- ---------------
Net Sales $ 2,590,000 $ 2,350,200
Loss from discontinued operation $ 1,000,000 $ 374,400
Impairment cost (gain) $ 0 $ 0
Net Loss from discontinued operation $ 1,000,000 $ 374,400
* Note - Gordon's net assets were written-down to zero at March 31, 2001. Losses
subsequent to March 31, 2001 at Gordon had no effect on the Company's financial
statements. Results for 2001 are through June 30, 2001 and do not reflect
results after the sale of Gordon.
Sale of Gordon
On July 3, 2001, pursuant to the Share Subscription and Redemption Agreement,
dated as of June 19, 2001 (the "Purchase Agreement"), among the Company, Abilene
Investments Corp. ("Abilene"), GAC- Labs, LLC ("GAC- Labs" and collectively with
Abilene, the "Purchasers") and Gordon Acquisition Corp., a wholly-owned
subsidiary of the Company ("Gordon"), Gordon issued 200 shares of common stock,
par value $.001 per share, of Gordon ("Gordon Stock") to Abilene and 800 shares
of Gordon
91
Stock to GAC-Labs for an aggregate purchase price of $1,000,000. Simultaneously,
the shares of Gordon Stock that were outstanding immediately prior to the
closing of this transaction, all of which were owned by the Company, were
redeemed for one dollar. In addition, the Company assigned to the Purchasers its
right, title and interest in the indebtedness of Gordon and/or H.B. Gordon
Manufacturing Co., Inc., its wholly-owned subsidiary, owed to the Company in the
ratio of 20% to Abilene and 80% to GAC-Labs.
As part of the same transaction, pursuant to the Purchase Option Agreement,
dated as of July 3, 2001 (the "Option Agreement"), among the Company, Abilene
and GAC-Labs, the Company was granted the option to purchase from the Purchasers
the shares of Gordon Stock issued to them and the indebtedness assigned to them
under the Purchase Agreement within one year for an aggregate purchase price of
$1,000,000 plus interest thereon at the rate of 14% per annum, subject to
reduction under certain conditions, as described below.
Furthermore, the Company granted to the Purchasers one-year warrants (the
"Warrants") to purchase (i) an aggregate of 2,000,000 shares of common stock,
par value $.001 per share, of the Company ("CCSI Stock") at the exercise price
of $.50 per share, if the Company does not consummate a rights offering/ private
placement by the Company of its securities prior to the one year expiration of
such warrants, or alternatively (ii) an aggregate of 11,200,000 shares of CCSI
Stock at the exercise price of $.10 per share and 4.8 million shares at $0.001
per share, subject to price adjustment, if the Company consummates a rights
offering/private placement by the Company of its securities prior to the one
year expiration of such warrants and obtains shareholder approval with respect
to such rights offering/private placement by the Company of its securities and
such increase in warrants. The fair market value of the 2 million warrants was
immaterial. If the alternative additional warrants are issued at a later date,
the fair market value of such warrants will be recorded as a further loss on the
disposal of Gordon.
If (i) pursuant to the Option Agreement the Company exercises its option to
purchase from the Purchasers the shares of Gordon Stock issued to them and the
indebtedness assigned to them under the Purchase Agreement, (ii) the Company has
not effected a reverse stock split of the CCSI Stock in a ratio greater than ten
to one, (iii) the Company has consummated a rights offering/private placement by
the Company of its securities and (iv) the market price of CCSI Stock exceeds
$1.00 per share for at least ten consecutive trading days from and after the
date of exercise under the Option Agreement, the Warrants will be subject to
mandatory exercise. In the event of such a mandatory exercise, the Company will
accept as payment of the aggregate exercise price the shares of Gordon Stock
that the Purchasers acquired under the Purchase Agreement, and the exercise
price under the Option Agreement will be reduced to one dollar. The Warrants are
also subject to mandatory exercise if (i) a registration statement filed by the
Company with respect to the shares of CCSI Stock issuable upon exercise of the
Warrants has been declared effective by the Securities and Exchange Commission,
(ii) the Company has not effected a reverse stock split of the CCSI Stock in a
ratio greater than ten to one, (iii) the Company has consummated a rights
offering/private placement by the Company of its securities and (iv) the market
price of CCSI Stock exceeds $1.00 per share for at least ten consecutive trading
days from and after the effective date of such registration statement. In the
event of such a mandatory exercise, the Company will accept payment of the
aggregate exercise price through the means of a broker's cashless exercise
transaction.
92
Note 4 - Issuance of Common Stock:
In connection with an "adjustable warrant" granted to a private investor in
2000, the Company issued 935,750 shares of its common stock to such investor as
a result of the first adjustment of such warrant which occurred on March 31,
2001.
In connection with the purchase of Gordon, the Company issued 22,894 of its
common shares in July 2001. See Note 3.
Note 5 - Employee termination payments
Since March 2001, the Company terminated many of its employees or has been
unable to pay many of its existing employees. Some of these employees have
employment contracts that provide for severance and other payments upon the
termination of employment or breach in such contracts. Accordingly, the Company
has recorded a $1,000,000 provision for the estimated exposure to these
employees for additional amounts due to them. As of September 30, 2001, $300,000
of this provision has been utilized via payments by an officer of the Company.
The Company believes the remaining $700,000 accrual is reasonable.
Note 6 - Notes payable
During the nine months ended September 30, 2001 the Company received $1,260,000
through the issuance of bridge notes ($300,000 resulted from the payment by an
officer of Company liabilities). The notes bear interest at a fixed rate of 10%
and are due in one year. In connection with the debt, the Company issued an
aggregate of 13 million warrants to investors and an additional 4 million
warrants to the finder. All of the warrants have a five year life and are
exercisable at $0.10 per share upon registration of the underlying shares. The
fair market value of these warrants amounted to $966,000 determined using the
Black-Scholes option pricing model. The fair market value of these warrants
issued in connection with debt has been recorded as deferred financing costs, is
included in current assets, and is being amortized over the life of the relative
debt. For the nine months ended September 30, 2001, approximately $285,500 was
charged to non-cash financing costs relating to the amortization of the deferred
financing costs.
Note 7 - Stock subscriptions
In August 2001, the Company retained Janssen Partners, Inc. to serve as its
placement agent in connection with an offering of 10,333,333 shares of common
stock and warrants to raise $620,000 in proceeds. Attached to each share is a
Series A Common Stock Purchase Warrant which vests immediately, has a five year
life and is exercisable at $0.10 per share after registration of the underlying
shares. Upon the exercise of each Series A Common Stock Purchase Warrant, the
holder will receive a Series B Common Stock Purchase Warrant which vests
immediately, has a five year life from date of issuance and is exercisable at
$0.15 per share after registration of the underlying shares. The offering will
expire upon the earlier of November 30, 2001 or the full subscription of the
offering. As of September 30, 2001, 8,333,334 shares of common stock have been
subscribed for in an aggregate amount of $500,000, of which $190,000 was
received in September 2001 and $310,000 included in
93
current assets as these amounts were received in October 2001 after required
shareholder approval for additional authorized shares was obtained October 31,
2001. In addition, 12,500,000 Series A Common Stock Purchase Warrants and
12,500,000 Series B Common Stock Purchase Warrant are issuable in connection
with the offering.
The Company is in the process of completing documentation including an
additional proxy to obtain stockholder approval for an additional proposed
private placement by the Company involving potential issuance of additional
shares of common stock by the Company in an aggregate amount in excess of 20% of
the Company's common stock outstanding immediately prior to such private
placement at a price per share less than the market value of the common stock.
On October 31, 2001, at a special shareholder meeting an amendment to the
Company's Certificate of Incorporation to increase the number of authorized
shares of common stock, $.001 par value per share, from 50,000,000 to
550,000,000 was approved by the following votes: 18,110,383 for; 1,033,794
against; and 71,069 abstained. Additionally, an amendment to the Company's
Certificate of Incorporation to effect a one share for up to forty shares
reverse stock split of the Company's issued and outstanding shares of common
stock, as determined by the Company's Board of Directors was approved by the
following votes: 18,078,117 for; 1,052,519 against; and 84,550 abstained. Due to
NASDAQ's temporary suspension of all delisting proceedings regarding the listing
requirement for a $1.00 minimum per share price, the Company's Board of
Directors does not see the necessity to execute a reverse split in the Company's
common stock at this time, but reserves the right to reconsider this action at a
later date within time frames proposed in the Proxy which were approved by the
Company's shareholders at the October 31, 2001 Special Meeting of the
Shareholders.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
PART II - INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers.
Section 722 of the Business Corporation Law of the State of New York
and Article X of Chromatics' Certificate of incorporation contain provisions for
the indemnification of officers and directors of Chromatics. The Certificate of
Incorporation requires Chromatics to indemnify officers and directors to the
full extent permitted by New York law. Each person will be indemnified in any
proceeding if he or she acted in good faith and in a manner which he or she
reasonably believed to be in, or not opposed to, the best interests of
Chromatics. Indemnification would cover judgments, fines, amounts paid in
settlement and reasonable expenses, including attorney's fees.
Chromatics has directors' and officers' liability insurance. This
insurance may cover liabilities asserted against any present or past director or
officer incurred in the capacity of director or officer arising out of his or
her status, whether or not Chromatics would have the power to indemnify this
person.
Item 25. Other Expenses of Issuance and Distribution.
The following table sets forth the various estimated amount of fees
and expenses payable in connection with this offering. All of these expenses
will be borne by the registrant.
Amount of
Item Expenses
---- -----------------
SEC Registration Fee ....................... $ 388
Printing Expenses .......................... 15,000 *
Accounting Fees and Expenses ........ 20,000 *
Legal Fees and Expenses .................. 50,000 *
Miscellaneous Expenses ................... 64,612 *
-----------------
Total ........................... $ 150,000
*Estimated
94
Item 26. Recent Sales of Unregistered Securities.
On August 16, 2000, the Company sold 641,026 shares of Common stock
to a private investor at a price per share of $4.68 for gross proceeds of
$3,000,000, less fees and expenses ("first closing"). In connection with the
above transaction, the Company issued to the investor 150,000 warrants to
purchase Common stock at an exercise price of $5.26 per share. Pursuant to the
purchase agreement for the above transaction, the Company issued to the private
investor an "Adjustable Warrant"pursuant to which the number of shares issuable
upon the exercise thereof (the "Adjustable Warrant Shares") is based upon a
formula involving closing bid prices of the Common stock on certain future
dates, as amended. Prior to the amendment of the purchasing agreement (see Note
12), the private investor had the right to require the Company to repurchase for
cash the shares and Adjustable Warrant Shares issued to the private investors
under certain defined conditions. Accordingly, at September 30, 2000, the
Company recorded the net proceeds of $2,815,000 as redeemable Common stock. As a
result of the amendment, which eliminated the cash requirement, the amount has
been classified in Common stock in the fourth quarter of 2000.
As a result of the first adjustment of the adjustable warrant, in
April 2001 the Company issued 935,750 shares of common stock. As a result of the
second adjustment of the adjustable warrant, in November 2001 the Company issued
997,598 shares of common stock.
Also in 2000, the Company sold 79,491 shares of common stock for
$500,000.
In July 2001 in connection with the sale of Gordon, we granted to
Abilene and GAC-labs one- year warrants to purchase (i) an aggregate of
2,000,000 shares of our common stock at the exercise price of $.50 per share, if
we do not consummate a rights offering prior to the expiration of such warrants,
or (ii) an aggregate of 11,200,000 shares of our common stock at the exercise
price of $.10 per share, if we consummate a rights offering prior to the
expiration of such warrants and obtain shareholder approval for the increase in
warrants.
In May through December, 2001 Janssen Partners, Inc. served as our
agent in financing approximately two-thirds of $1,700,000 in Bridge Loans to the
Company. These Bridge Loans were subject to 1 year promissory notes with
interest. 11,875,001 Common Stock purchase Warrants exercisable at $0.06 per
share, and 28,875,001 Common Stock purchase Warrants exercisable at $0.10 per
share are issuable in connection with these Bridge Loans.
Item 27. Exhibits.
Number Description of Document
-------- -----------------------
3.1 - Restated Articles of Incorporation of Chromatics
(incorporated by reference to Exhibit 3.1 to Chromatics
Quarterly Report on Form 10-Q for the Quarter Ended
June 30, 1999.
3.2 - Certificate of Amendment to Articles of Incorporation of
Chromatics (incorporated by reference to Exhibit 3.1.1 to
Chromatics' 1999 Annual report on Form 10-K).
95
Number Description of Document
--------- -----------------------
3.3 - Certificate of Amendment to Articles of Incorporation of
Chromatics' (incorporated by reference to Exhibit 4.4 to
Chromatics' Current Report on Form 8-K filed November
3, 2000).
3.4 - Certificate of Amendment to Articles of Incorporation of
Chromatics (incorporated by reference to Exhibit 4.7 to
Chromatics' Current Report on Form 8-K filed November
3, 2000).
3.5 - By-Laws of Chromatics (incorporated by reference to
Exhibit 3.2 to Chromatics' 1999 Annual Report on
Form 10-K).
4.1 - Restated Articles of Incorporation of Chromatics
(incorporated by reference to Exhibit 3.1 to Chromatics'
Quarterly Report on Form 10-Q for the Quarter Ended
June 30, 1999).
4.2 - Certificate of Amendment to Articles of Incorporation of
Chromatics, filed on February 10, 2000 (included in
Exhibit 3.2).
4.3 - Certificate of Amendment to Articles of Incorporation of
Chromatics (incorporated by reference to Exhibit 4.4 to
Chromatics' Current Report on Form 8-K filed November
3, 2000).
4.4 - Certificate of Amendment to Articles of Incorporation of
Chromatics (incorporated by reference to Exhibit 4.7 to
Chromatics' Current Report on Form 8-K filed November
3, 2000).
4.5 - Stock Purchase Agreement dated as of October 31, 2000,
between Chromatics and Crescent International, Ltd.
(incorporated by reference to Exhibit 4.1 to Chromatics'
Current Report on Form 8-K filed November 3, 2000).
4.6 - Warrant, dated as of October 31, 2000, made by Chromatics
in favor of Crescent International Ltd. (incorporated by
reference to Exhibit 4.2 to Chromatics' Current Report on
Form 8-K filed November 3, 2000).
5 - Opinion Regarding Legality.
23.1 - Consent of BDO Seidman, LLP.
23.3 - Consent of Patterson, Belknap, Webb & Tyler, LLP
(included in Exhibit 5.1).
24.1 - Power of Attorney (see page II-3).
99.1 - Form of Letter to Brokers
99.2 - Notice of Guaranteed Delivery
99.3 - Instructions for Use of Subscription Certificates
99.4 - Form of Subscription Certificate
99.5 - Form of Letter to Shareholders
99.6 - Form of Letter to Clients
Item 28. Undertakings.
The undersigned registrant hereby undertakes to supplement this
prospectus, after the end of the subscription period for this offering, to
include the results of the subscription offer, and the terms of any later
reoffering. If the underwriters make any public offering of the securities on
terms different from those on the cover page of the prospectus, the small
business issuer will file a post-effective amendment to state the terms of such
offering.
96
SIGNATURES
In accordance with the requirements of the Securities Act of 1933,
the registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in the City of New
York, State of New York on February 8, 2002.
CHROMATICS COLOR SCIENCES
INTERNATIONAL, INC.
By: /s/ Darby S. Macfarlane
---------------------------
Darby S. Macfarlane,
Chairperson of the Board and
Chief Technology Officer
In accordance with the requirements of the Securities Act of 1933, this
registration statement was signed by the following persons in the capacities and
on the dates stated:
Signature Capacity Date
/s/BRIAN T. FITZPATRICK Director, President and Feb. 8, 2002
-------------------------------- Acting Chief Executive
Brian T. Fitzpatrick Officer (Principal
Executive Officer)
/s/DARBY S. MACFARLANE Director, Chairperson of Feb. 8, 2002
-------------------------------- the Board and Chief
Darby S. Macfarlane Technology Officer
/s/LESLIE FOGLESONG Director, Secretary, and Feb. 8, 2002
-------------------------------- Asst. Treasurer
Leslie Foglesong
/s/DAVID KENNETH MACFARLANE Director, Vice-President- Feb. 8, 2002
-------------------------------- Research and Development
David Kenneth Macfarlane
/s/EDMUND VIMOND Director Feb. 8, 2002
--------------------------------
Edmund Vimond
/s/EDWARD MAHONEY Director Feb. 8, 2002
--------------------------------
Edward Mahoney
97