<PAGE>

                     U.S. SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                   FORM 10-KSB

(Mark One)
[X]  Annual report under Section 13 or 15(d) of the Securities Exchange Act of
     1934

     For the fiscal year ended December 31, 1996

[ ]  Transition report under Section 13 or 15(d) of the Securities Exchange Act
     of 1934

     For the transition period from ___________________ to ___________________

     Commission file number   0-21168
                              -------

                  CHROMATICS COLOR SCIENCES INTERNATIONAL, INC.
--------------------------------------------------------------------------------
                 (Name of Small Business Issuer in Its Charter)

          NEW YORK                                       13-3253392
--------------------------------------         ----------------------------
(State or Other Jurisdiction of                      (I.R.S. Employer 
Incorporated or Organization)                      Identification Number)


      5 East 80th Street, New York, NY                    10021
-------------------------------------------    -----------------------------
 (Address of Principal Executive Offices)              (Zip Code)
     

                                 (212) 717-6544
                  ----------------------------------------------
                 (Issuer's Telephone Number, Including Area Code

       Securities registered under Section 12(b) of the Exchange Act: None

         Securities registered under Section 12(g) of the Exchange Act:


                    Common Stock, par value $0.001 per share
                    ----------------------------------------
                                (Title of Class)

                         Common Stock Purchase Warrants
                         ------------------------------
                                (Title of Class)


      Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.

                                  Yes   X       No
                                      -----        -----

      Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.

      Issuer's revenues for its most recent fiscal year:  $287,400.

      As of March 25, 1997, approximately 7,308,497 shares of common stock and
2,731,441 common stock purchase warrants of the registrant were outstanding and
the aggregate market value of the voting stock (computed based on the average of
the last bid and asked price on such date) held by non-affiliates was
approximately $35,050,302.

      Documents incorporated by reference: None




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                                    PART I

ITEM 1.          DESCRIPTION OF BUSINESS.


GENERAL

      Chromatics Color Sciences International, Inc. (the "Company") was formed
in 1984 to research and develop and to commercialize certain intellectual
property rights, proprietary technology and instrumentation in the field of
color science (collectively the "Intellectual Properties") for marketing to a
variety of industries, including the cosmetic, hair color, beauty-aid and
fashion industries. Certain of the Intellectual Properties are incorporated in a
proprietary color measurement system and software marketed as the "Colormate(TM)
II System." The Company has also developed and marketed its own line of
scientifically color coordinated proprietary cosmetics ("My Colors by
Chromatics") and scientifically color coordinated proprietary color charts and
material swatch packs for use in these industries. The Company's cosmetics line
and material swatch packs are referred to herein collectively as the "Products."
The Company believes that its Intellectual Properties are capable of detecting
and monitoring chromogenic disease (those which affect the color of skin or
human tissue), and has begun implementation of its long-range business plan to
seek commercial applications of its Intellectual Properties and technologies in

the medical field.

      To date, the Company's marketing activities have principally involved
licensing the Intellectual Properties, including conducting chromaticity
studies, leasing the Colormate(TM) II System and marketing the Products in the
cosmetic, hair color, beauty aid and fashion industries (i) in a national sales
program (the "Avon Project") with Avon Products, Inc. ("Avon") and in limited
test markets with Clairol Inc. ("Clairol") and Hanes Hosiery Inc. ("Hanes"), all
conducted prior to June 1991, (ii) under current agreements with Gordon
Laboratories Inc. ("Gordon Laboratories") and leasing arrangements with IMS
Cosmetics, Inc. ("IMS") and (iii) under current leases and licenses directly to
beauty-related businesses and beauty salons. In addition, from 1994 to 1996, the
Company conducted a limited consumer testing project for hair color analysis
with Clairol and Regis Corp. ("Regis") a U.S. beauty salon chain. See "Test
Marketing History." Although the Company from time to time is engaged in
preliminary discussions (including limited consumer testing and chromaticity
study activities) for use of its technology in the cosmetics and beauty aid
fields, there can be no assurance that any final agreements will be reached. In
this regard, the Company expects to complete (although there can be no
assurance) research and development for a hand-held, less expensive mass
manufacture prototype of the Colormate(TM) II System during 1997 which the
Company anticipates will enhance its marketing efforts. See "Risk Factors,"
"Proposed Marketing Plan" and "Possible Future Developments--Potential License
Arrangements--Other Potential Applications."

      Since 1988, the Company has also been engaged with Mt. Sinai Hospital in
clinical research studies (the "Bilirubin Project") involving the use of the
Colormate(TM) II System and, since 1996 the Colormate(TM) III, in the
detection and monitoring of bilirubin disease (infant jaundice). The initial
clinical studies conducted at Mt. Sinai Hospital were completed with positive
results, and, in November 1996 the Company filed an FDA application (including
the requisite completed clinical studies) for commercial sale of its system,
technologies and Intellectual Properties for certain medical applications. The
Company is continuing clinical studies at both Mt. Sinai Hospital and, since
November 1996, at Elmhurst Hospital in furtherance of multicenter studies for
the medical community.

      During 1996, the Company completed its offering of $5,000,000 of its 3%
convertible debentures due April 1, 1998 ("Debentures") (the "1996 Debenture
Offering"), which Debentures have been converted into shares of the Company's
common stock par value $.001 (the "Common Stock"). The Company has utilized a
substantial portion of the proceeds from its 1995 private placement offering of
1,800,000 shares of Common Stock (the "1995 Private Placement") and a portion of
the Debenture Offering to further its long-range business plan with respect to
such medical applications and for the development of the working prototype for
the Colormate(TM) III, a transcutaneous bilirubinometer. See "Possible Future
Developments--Potential Medical Applications", "Risk Factors," and "Management's
Discussion and Analysis."



                                      2


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      The Company has not achieved profitable operations since 1989, has not
generated material amounts of revenues from operations since 1990 and has never
achieved any revenues from the licensing of its Intellectual Properties or the
Colormate(TM) II System in any industry other than the cosmetics, hair color,
beauty aid and fashion industries. The Company has incurred significant research
and development and marketing expenses since inception, resulting in operating
losses and, prior to its February 1993 initial public offering (the "IPO"),
negative shareholders' equity. See "Risk Factors" and "Management's Discussion
and Analysis."


COLOR SCIENCE TECHNOLOGY

      General. The field of color science involves the objective standardized
analysis, description and scientific measurement by instrument of the colors
comprising the visible color spectrum and their related physical properties in
relation to each other. Historically, analysis of all aspects of color could
only be performed in a subjective manner through the visual perception of the
observer. By the 1930s, the first photoelectric instruments for objectively
measuring colors had been developed, and since that time increasingly precise
methodologies and instruments have been developed and refined.

      Based on its research in the field of color science, the Company has
determined that all people fall within one of approximately 200 scientifically
measurable human skin tone color categories and that each of these categories is
most compatible with specific ranges of various product color. The Company has
developed its Intellectual Properties and Colormate(TM) II System for the (i)
scientific measurement and classification of human skin color, (ii) scientific
color coordination of such skin classification in relation to products, (iii)
scientific measurement, classification and color-oriented organization of
various color sensitive consumer products, such as cosmetics, hair coloring,
hosiery, clothing, paint, and textiles and (iv) scientific color coordination of
products in relation to other products. The Company determines such scientific
color classifications by conducting laboratory product chromaticity studies (the
"Chromaticity Studies").

      Cosmetic, Beauty Aid and Fashion Industry. In the early 1980s a number of
authors, fashion consultants and retail companies promoted the concept of
marketing cosmetics, beauty aids and fashion based on the advertised
compatibility of the color in a consumer's skin, hair and eyes with the color of
the products being sold, in order to achieve a harmonious, "color coordinated"
effect. Marketing programs and product lines were introduced based on the
retailers' matching of its goods to the "personal colors" of the consumer, as
determined by the retailer or independent color consultants. Generally,
businesses in the cosmetics and fashion industries continue to employ color
compatibility techniques and concepts in their marketing efforts. Although the
fashion industry is subject to rapid and radical changes in styles and trends,
the Company's color science technology and instrumentation, which is keyed to
the comparison of skin color to products and of product colors to other product
colors, is not dependent on the popularity of any given fashion style or trend.


      Potential Medical Applications. The Company believes its color science
technology has potential medical applications. Clinical studies have
demonstrated, in the Company's opinion, a close and statistically meaningful
relationship and correlation between the yellow color of the skin (jaundice) and
the newborn's serum bilirubin concentration. The Company submitted a marketing
application for its Colormate(TM) III system with the U.S. Food and Drug
Administration (the "FDA") on November 14, 1996. The application was accepted
officially for filing and review by the FDA on November 18, 1996. See
"Business--Potential Medical Applications." The marketing application is known
as a premarket notification or 510(k) submission. The application requests
market clearance for use of the technology as an aid to the physician in
monitoring the status of newborn babies for the development of
hyperbilirubinemia. Following the physician's examination within the first hours
of birth, newborn babies would be initially measured and periodically monitored
by the Colormate(TM) III for incremental changes in the yellow content of their
skin color. The Company's 510(k) submission is currently under review by the
FDA's Center for Devices and Radiological Health (the "CDRH"). The Company
cannot market the Colormate(TM) III for this medical application in the United
States until it receives an order from the CDRH authorizing such marketing. See
"Governmental Regulations" for a discussion of 510(k) submission review times,
FDA marketing orders, and risks associated with the 510(k) submission process
(e.g., need for more onerous premarket ("PMA") approval instead of 510(k)
marketing clearance).



                                      3


<PAGE>




RESEARCH AND DEVELOPMENT HISTORY

      From 1979 to 1984, prior to inception of the Company, its founders sought
to research and develop an accurate and repeatable technology for the scientific
measurement of human skin color and commercial product colors and the
classification of these into scientific color categories. In 1982, the founders
filed a patent application relating to this technology and, in 1984, formed the
Company to continue such research and development, develop instrumentation and
seek commercial applications.

      Between 1984 and 1986, the Company developed the predecessor version of
the Colormate(TM) II System Unit, the Colormate(TM) I System (a color measuring
instrument that incorporated a computer, an industrial color measurement
instrument, and software incorporating certain of the Intellectual Properties,
including the Chromaticity Studies). These Intellectual Properties and
instrumentation permit the user, without any visual estimates or judgments, to
determine the color of a person's skin and assign it accurately to one of over
200 scientifically determined skin color categories identified by the Company.
These categories are proprietary and constitute part of the Company's
Intellectual Properties. The skin color categories can, for marketing purposes,

be scientifically defined by the Company within broader "cool/warm" color
spectrum categories. During this period, the Company researched and developed
and formulated its Products. Between 1984 and 1986, the Company also conducted
additional research and development, refined its methodology and created
software for use with the Colormate(TM) I System to enable it to conduct the
Chromaticity Studies for skin color compatibility with cosmetic, beauty aid and
fashion products, and product color to product color compatibility.

      During the early period of test marketing of its Intellectual Properties
and the Colormate(TM) I System with Hanes and Clairol, the Company engaged in
further research and development regarding scientific measurement and color
classification of hair and hair color products, hosiery, fabrics and cosmetics.
In 1987, the Company conducted further research and development involving
refining many aspects of the technology and instrumentation to create a
miniaturized and portable version of the Colormate(TM) I System unit capable of
machine to machine reproducibility of the system (i.e., consistent results when
different units are used to measure the same products or skin color). This
enabled the Company to arrange for the mass manufacture for Avon in 1988 of
2,000 portable, miniaturized Colormate(TM) II System Units in connection with
the Avon Project. See "Avon Project and Litigation," "Manufacturing,"
"Management's Discussion and Analysis" and Note 1 of Notes to Financial
Statements.

      From 1986 to 1991, the Company conducted additional research and
development, refined its methodology and created and upgraded software for use
with the Colormate(TM) I and Colormate(TM) II Systems for skin color measurement
for potential medical applications in detecting and monitoring certain
chromogenic diseases (such as infant jaundice) where skin coloration is
symptomatic of disease and for skin color compatibility to products, and for
product color to product color compatibility in the dental and printing
industries.

      Since the IPO, research and development and technical expenses have been
primarily incurred in connection with (i) the Bilirubin Project, including
preparation of the FDA application, (ii) conducting preliminary research and,
until June 1995, feasibility studies for clinical tests at Elmhurst Hospital in
New York City regarding use of the Company's technology to diagnose
tuberculosis, (iii) applying the Intellectual Properties to develop custom
blended cosmetic foundations and hair color applications, (iv) conducting
research for development of a working prototype of the Colormate(TM) III System
and mass-manufacture prototypes of the Colormate(TM) II and Colormate(TM) III
for medical applications and (v) conducting research for development of a
hand-held, less expensive version of the Colormate(TM) II System. Additionally,
the Company has achieved the ability to scientifically measure the color of hair
(and assign it to one of 57 scientifically defined hair color categories) and
has developed the technology and formulas for custom blending cosmetic
foundations for each individual skin color identified by the Company, which
foundations the Company anticipates marketing during the fourth quarter of 
1997 under arrangements with Gordon Laboratories. See "Possible Future 
Developments."


INTELLECTUAL PROPERTIES, PATENTS, PATENTS PENDING AND PRODUCTS


      The Company owns U.S. Patent Nos. 4,909,632 expiring in 2007 entitled
"Method For Selecting Personal Compatible Colors," U.S. Patents Nos. 5,311,293
(expiring in 2007) and 5,313,267 (expiring in 2011) both entitled "Method and
Instrument For Selecting Personal Compatible Colors," a European patent (No.
0446512), an application for a Singapore


                                        4


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registration of that European patent, an Australian patent and a Mexican patent
corresponding, at least in part, to U.S. Patent No. 4,909,632 and a Taiwanese 
patent corresponding, at least in part, to U.S. Patent No. 5,313,267
(collectively the "Patents"). The Company has developed intellectual property
rights in color analysis in a number of fields including medical, biological,
dental and materials testing. The intellectual property rights include trade
secrets, know how and a pending United States patent application Serial No.
08/239,733, filed May 9, 1994 entitled "Method and Apparatus for Detecting and
Measuring Conditions Affecting Color," and nine additional U.S. patent
applications. The Company also has filed various foreign patent applications
corresponding, at least in part, to the U.S. Patents and the U.S. patent
applications. The proprietary information protected by the Patents includes,
among other things: (i) the methodology for measuring and classifying skin color
of individuals, (ii) the methodology for the selection of product colors for
individual customers compatible with their skin colors, (iii) color charts, in
which the colors of materials or products compatible with one another have been
assigned to color categories based on their compatibility with skin colors, for
use as consumer aids in the selection of products with colors compatible with
one another and the consumer's skin color and the methodology for creating such
color charts and (iv) the methodology for conducting skin to product and product
to product color comparisons. The proprietary information protected by the
Patents, together with certain unpatented proprietary trade secrets, are
incorporated in the proprietary software used in the Colormate(TM) II System and
the Colormate(TM) III.

      The Company has registered "My Colors by Chromatics(R)" as a trademark of
the Company.  The Company believes it also has established common law rights
in the trademark "Colormate".  Further, the Company believes it has common
law copyright protection for all of the software used in the Colormate(TM) II
System and Colormate(TM) III.  See "Risk Factors--Protection of 
Intellectual Property."

      Colormate(TM) II System and Proposed Prototypes. The Colormate(TM) II
System consists principally of an industrial color measurement instrument to be
held against the subject's skin, a series of filters, and a computer (all such
parts having been manufactured by original equipment manufacturers ("OEMS") in
1987 in connection with the Avon Project) and related proprietary software all
housed in a portable briefcase. The color measurement instrument is held against
the subject's skin and performs scientific color measurement of skin coloration
and luminosity; the computer and related software then analyze the color
measurements so obtained, and assign the subject to one of the approximately 200

scientific skin color categories identified by the Company through its research
and development effort. In the beauty related applications, the Colormate(TM) II
System would then match each skin color type to a range of scientifically
pre-tested compatible product colors.

      The unit is equipped with a printer and when utilized in beauty aid or
fashion applications can provide the subject with a record of his or her skin
color category and color compatible shades of specific products (including the
Company's cosmetic products) appropriate for that skin color category and other
product colors.

      The Colormate(TM) II System can also be used to perform Chromaticity
Studies of various product lines in manufactured or applied forms (e.g., hair
coloring, hosiery, other cosmetic lines) on behalf of licensees. The
Colormate(TM) II System used in this capacity for Avon, and was test maketed in
this capacity for Hanes, Clairol and Regis, and is currently being used in this
capacity in tests being conducted for Gordon Laboratories and IMS. This
capability permits the organization of the licensee's products into scientific
color categories so that the consumer can be assisted with proper color
coordination within the licensee's product line.

      Of the 2,000 Colormate(TM) II System Units leased to Avon in 1988, the
Company negotiated the return of 1,947 System Units to the Company
during the Avon litigation in July 1991, of which approximately 1,400 units are
available for commercial use. 62 of these units are in commercial use in beauty
salons or beauty related installations located in the United States and
internationally. The balance will be available for use following refurbishing of
such units (when needed) for ordinary wear and tear incurred during the Avon
Project and minor alterations to the casing. Such refurbishing and alterations
are anticipated to cost $50,000; such expenses to date approximate $25,200.
Another 300 Colormate(TM) II Systems will be available for use following more
extensive refurbishing. 



                                       5
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Thereafter, the Company will need to source such components from suppliers
for additional manufacturing needs, if any.

      The Company anticipates completion in 1997 of mass manufacture prototypes
for new versions of its Colormate(TM) II System technology. In conjunction with
its filing of an FDA application for commercial marketing in the medical
industry, the Company developed the first version of new housing and related
packaging of its technology for potential use in medical applications, and has
developed the working prototype for the Colormate(TM) III. Finally, the Company
has conducted research and development and developed engineering specifications
regarding a hand-held version of the Colormate(TM) II System, which also may be
marketed directly to consumers for home and personal use. The Company expects
that these new versions will also be capable of being manufactured at a cost
substantially less than the cost incurred in manufacturing the Company's
existing Colormate(TM) II System Units. See "Manufacturing," "Risk Factors,"
Proposed Marketing Plan," "Possible Future Developments" and Note 1 of Notes to
the Financial Statements.



      Cosmetics Line. The Company previously marketed its line of proprietary
chromatically balanced, laboratory tested cosmetics ("My Colors by Chromatics")
through the use of the Colormate(TM) II System. The Company is currently
developing a new line of cosmetics, as discussed below. The prior cosmetics line
included underbase makeup, eyeshadow, blushers, eyeliner pencils, lipliner
pencils, lipstick and nail polish, and was manufactured to the Company's color
specifications by private label manufacturers, including IMS. The Company is not
currently actively marketing this line, and renewed cosmetics marketing efforts
will be based on the new line which will include the same products. 

      The Company has been developing in conjunction with IMS, a completely new
line of cosmetic products featuring new formulas and updated packaging, but
which will continue to track the Company's existing scientifically determined
classifications and product shades. While unanticipated manufacturing delays
prevented marketing of this line in fiscal 1996, the Company anticipates
marketing the new line in the third quarter of 1997. The Company believes the
new cosmetics line will be comparable in quality and performance to cosmetics
sold in leading department stores, but will be priced generally lower than the
price charged by companies in the prestige end of the market. In addition, in
conjunction with the Gordon Laboratories contract, the Company anticipates
completion in the fourth quarter of 1997 of a new product line consisting of
custom blended foundations, which will be color compatible with the Company's
new cosmetics line. See "Proposed Marketing Plan," "Risk Factors," "Proposed
Marketing Plan" and Note 1 of Notes to the Financial Statements.

      The Colormate(TM) II System makes use of only skin coloration in assigning
each complexion to one of approximately 200 measurable skin color categories.
Each category is then assigned to one of four broader product color categories.
The Company's cosmetics are divided into these same four color classifications,
and the product shades in each have been scientifically measured and balanced
chromatically to be compatible with the approximately 200 skin colorations
within the four broad classifications. The product shades recommended by the
Colormate(TM) II System are individually prescribed for color coordination with
each of the approximately 200 skin color categories. The Company's cosmetics
line is scientifically formulated and balanced to provide color coordinated
products for the skin color of all races. Each product shade also has been
measured and cross-balanced to be compatible with all other shades in each of
the four broad classifications, so that the colors blend together, and color
coordinate with each other after they are applied. To date, the Company has
received insignificant revenues from cosmetics sales. See "Management's
Discussion and Analysis."

      Swatch Packs. The Company has marketed, through the use of the
Colormate(TM) II System, a line of fashion swatch packs consisting of
36 scientifically measured colors, coordinated with each other and with the
consumer's skin tone color to aid the consumer in selecting color compatible
fabrics and fashion accessories. Substantially all of the $1,300,000 revenue
generated to date from swatch pack sales occurred in connection with the Avon
Project. Sales revenues from swatch packs in 1996 was insignificant, and the
Company is not currently actively marketing the swatch packs.





                                       6
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TEST MARKETING HISTORY AND PRIOR MARKETING EFFORTS

      Between 1986 and 1987, the Company entered into a series of separate test
marketing arrangements and licenses of its Intellectual Properties and
Colormate(TM) I System with Clairol, Hanes and Bloomingdale's in connection with
marketing Clairol's hair color products and the Company's color coordinated
cosmetics line, in Clairol beauty salons, Hanes hosiery in department stores,
and the Company's Products in two Bloomingdale's department stores located in
suburban malls. Although the Company believes each of the test marketing
programs achieved successful results, the Clairol test terminated as a result of
failure to reach definitive agreement on licensing terms, and the Hanes and
Bloomingdale's tests were terminated when the Company entered into the Avon
Agreement, which required the Company not to compete in the department store
market.

      From the termination of the Avon Project until the IPO, marketing of the
Company's products primarily had been limited by inadequate financial and
personnel resources. Utilizing the proceeds of the IPO, the Company hired
additional personnel and implemented certain sales and marketing programs which
management believed were necessary to profitably market its existing products.
To date, these efforts have not produced significant revenues.

      In 1994, the Company entered into two separate domestic distribution
arrangements, and one foreign distribution arrangement. These relationships were
terminated in 1996 without generating any significant revenues.

      During 1996, the Company engaged in certain consumer testing, chromaticity
studies and other studies of its technologies with a number of companies in the
cosmetics, hair color and beauty aid fields. During 1994, Proctor & Gamble began
conducting in-house consumer tests on the Company's Colormate(TM) II System
technology, the first results of which were favorable. However, no definitive
agreement was reached between the parties. From June 1994 to September 1996, the
Company, in joint collaboration with Clairol, conducted consumer tests with
Regis, a salon chain operating in the United States. However, no definitive
agreement was reached between the parties. From 1993 to 1996, the Company
conducted chromaticity studies for Mary Kay, however no definitive agreement was
reached between the parties. The Company signed a joint venture and licensing
agreement with one of the companies, Gordon Laboratories, in December 1996. See
"Possible Future Developments--Potential License Arrangements."

      There can be no assurance the Company will ever develop a commercial
market for the licensing or leasing of its Colormate(TM) II System and
Intellectual Properties or for the sale of the Products, or for medical
applications of its technologies. See "Risk Factors--Prior Marketing Attempts,"

"Proposed Marketing Plan" and "Possible Future Developments--Potential License
Arrangements."


AVON PROJECT AND LITIGATION

      Avon Project. Commencing in November 1986 and through 1987, the Company
engaged in limited marketing activities with Avon and, in 1987 and 1988, engaged
in research and development in respect of the miniaturization and refinement of
the Colormate(TM) I System. These activities contributed to the development of
the portable Colormate(TM) II System which was marketed by Avon as the "Avon
Beauty Vision System." On October 15, 1987, the Company entered into an
exclusive master license agreement (the "Avon Agreement") with Avon under which
the Company (i) researched and developed, engineered and arranged for the
assembly by third party subcontractors of 2,000 Colormate(TM) II System Units
and (ii) conducted proprietary Chromaticity Studies of Avon's cosmetics line in
order to develop Avon's "Avon Color" cosmetics line. The cost of such research
and development (estimated at $1,000,000) as well as the manufacturing cost of
$4,600,000 for the Colormate(TM) II Units was paid by the Company from the
proceeds of the Avon Agreement. Under the Avon Agreement, the Company leased to
Avon 2,000 Colormate(TM) II System Units and granted to Avon an exclusive U.S.
license for use of its Intellectual Properties in drug store chains, supermarket
chains, certain discount mass market retail stores and in the door-to-door
market (the "Avon Project"), and under which the Company agreed not to compete
in certain other markets. The Company believes (based on published reports) that
Avon experienced positive feedback from its field representatives and customers
regarding the Avon Project and significant increases in its color cosmetic sales
with the introduction of its "Avon Color" cosmetics line (which was developed
under the license of the Company's Intellectual Properties), in particular when
marketed with the Colormate(TM) II System.




                                       7
<PAGE>


      Avon Litigation. In April 1990, the Company commenced a suit (the "Avon
Litigation") against Avon in the United States District Court for the Southern
District of New York for patent infringement, misappropriation of trade secrets,
breach of contract, federal antitrust violations and unfair competition. On
August 12, 1994, the Company and Avon entered into a Settlement Agreement under
which, among other recovery, Avon made a $2,000,000 cash payment to the Company,
the parties exchanged mutual releases regarding the subject matter of the Avon
Litigation and the Company and Avon entered into a stipulation dismissing the
Company's case with prejudice.


MANUFACTURING

      The Company believes, although there can be no assurance, that it will be
able to manufacture the Colormate(TM) II System, including for customized
applications use, at commercially marketable prices because the Company has

demonstrated its ability to mass manufacture and commercially market the
Colormate(TM) II Systems in connection with the Avon Project. The Company's
existing Colormate(TM) II Systems were mass manufactured for Avon at a
manufacturing cost for parts of $4,600,000 (an average per unit cost for parts
of approximately $2,300) pursuant to the Avon Agreement; of such amount
$3,000,000 was applied to obtaining parts of the nonproprietary components and
$1,600,000 was applied to obtaining parts of the proprietary components of the
Colormate(TM) II System. The cost of such research and development, estimated at
$1,000,000, and of such manufacture, was paid by the Company with proceeds
received under the Avon Agreement. The Company believes based on discussions
with a supplier of components of its existing Colormate(TM) II System and
published price lists that the components of the Colormate(TM) II System can be
purchased in quantities of 1,000 or more at a significant discount to the
individual part price currently quoted by the suppliers, although there can be
no assurance the Company will be able to obtain such terms or order in such
quantities, and manufacture of limited quantities of the Colormate(TM) II System
would be significantly more expensive.

      The Company believes that its relations with the parts manufacturers or
assemblers of the existing Colormate(TM) II Systems held in its inventory are
good; however, the Company does not have any current arrangements with such
parts manufacturers or assemblers with respect to the building of additional
Colormate(TM) II System Units and there can be no assurance the Company will be
able to enter into future arrangements with these parts manufacturers or
assemblers on terms satisfactory to the Company. See "Risk Factors--Dependence
on Third Parties for Manufacturing." The Company is not reliant on any sole
source of supply and believes that a number of OEMs are capable of manufacturing
and assembling parts for the Colormate(TM) II System.

      To the extent the Company completes development of and markets the mass
manufacture prototypes for medical applications, and the hand-held version of
the Colormate(TM) II System, the Company initially will use the nonproprietary
and proprietary components of a portion of the existing Colormate(TM) II System
Units in its inventory to manufacture a limited number of such devices for early
stage marketing and sales efforts and for commercial use. Thereafter, the
Company will need to source such components from suppliers for additional
manufacturing needs, if any. See "Risk Factors," "Proposed Marketing Plan,"
"Potential Future Developments" and Note 1 of Notes to the Financial Statements.

      The Company's new cosmetics line is being manufactured by IMS and two
independent suppliers; the Company believes its relations with these suppliers
are good, and that in any event the Company is not dependent on these suppliers
and can have its cosmetics line produced by other suppliers of goods to the
cosmetics industry.


LICENSE AND LEASE ARRANGEMENTS

      The Company has current leases for 24 Colormate(TM) II System Units and
licenses its Intellectual Properties for the sale of its Products at 24 beauty
salons/beauty-related installations in the United States. 12 of these leases are
due to expire in 1997, and the balance are month to month. See "Management's
Discussion and Analysis." The Company conducts its business in three foreign
countries. 24 Colormate(TM) II System Units are in Israel under the agreement

with IMS described below and six Colormate(TM) II System Units are in South
Africa the leases for which are month to month. See "Management's Discussion and
Analysis" and Note 1 to Notes to the Financial Statements.



                                       8
<PAGE>


In addition, the Company has entered into perpetual lease/licensing arrangements
in respect of two such units for an aggregate price of $5,000 each at two beauty
salons. The Company has received immaterial levels of sales revenue from these
leases and licenses. See "Proposed Marketing Plan" and "Management's Discussion
and Analysis."

      In April 1992, the Company entered into an agreement with IMS, a cosmetic
marketing, manufacturing and distribution company based in Israel, for the
license of the Intellectual Properties and the lease of the Colormate(TM) II
System for use in marketing in Israel, the Company's swatch packs and those of
IMS' chromatically balanced cosmetic products developed by the Company through
Chromaticity Studies utilizing the Intellectual Properties. Under this
agreement, the Company leases 24 Colormate(TM) II System Units to IMS. The
Company has continued to extend on a month-to-month basis, IMS' option to renew
its leases for a five-year period to permit IMS time to evaluate additional
cosmetic product colors provided by the Company at IMS's request based on prior
consumer tests conducted by IMS. IMS may lease up to 200 additional
Colormate(TM) II System Units during the five-year extension of this agreement.
There can be no assurance that this agreement will be renewed for the full
five-year renewal period or that IMS will lease additional Colormate(TM) II
System Units. In fiscal year 1996, the Company generated approximately 39% of
its lease, license and service contract revenues from IMS. See "Management's
Discussion and Analysis," "Possible Future Developments" and Note 1 to Notes to
Financial Statements.

      Other than the units provided to IMS, the Company has leased or intends to
lease the Colormate(TM) II System Units to beauty salons, beauty-related
businesses, direct sales representatives and distributors and specialty stores
(i) at a monthly rental fee ranging from $165 to $250 (depending on the length
of the lease terms), if rented on a full-time basis, and at a proportionately
higher rate if the machine is leased for shorter periods, or (ii) on a minimum
monthly guarantee cosmetic product purchase basis. The Company sells its
Products for resale to the public to persons leasing the Colormate(TM) II System
and licensing the Intellectual Properties. The Company intends to sell "tester"
sets of its new cosmetics line, in connection with the placement of the
Colormate(TM) II System Units, in order to stimulate cosmetic sales. The
Company's marketing plan currently anticipates that the skin color analysis
capability of the Colormate(TM) II System Units will be marketed in conjunction
with the Products at a variety of price points--i.e., the color analysis alone
will be priced at $25 and the analysis will be done on a complimentary basis for
a customer who purchases Products for at least $25.


PROPOSED MARKETING PLAN


      The Company's marketing plan for the beauty salon and beauty-related
business markets initially focused on direct marketing by the Company through
commissioned sales representatives and indirect marketing through independent
distributors. The Company now believes, based on its prior experience with
regional distributors, that, in order to achieve any significant penetration in
these markets, it will be necessary for the Company to establish relationships
with larger distributors having substantial sales forces and a national
presence. The pricing, revenue sharing or other terms on which it may establish
relationships with distributors will likely result in lower operating margins on
such sales than on sales effected through commissioned sales representatives.
The Company will seek to market by establishing relationships with national
distributors or other companies that it believes could effectively market and/or
utilize the Company's technology and Intellectual Property for medical
application following FDA clearances in the United States, in the cosmetics,
beauty aid, hair and fashion industries and for industrial applications. These
relationships could take the form of lease/license arrangements, marketing and
distribution arrangements, joint ventures or acquisitions.
      

      Subject to the availability of funds and the establishment of
relationships with suitable marketing partners, the Company will seek marketing
opportunities in the mass, door-to-door, specialty store and infomercial
markets.

      The Company has not achieved material levels of cosmetics sales from its
Colormate(TM) II System locations and expects that, at the cosmetics sales
levels achieved per location to date, the Company will have to greatly increase
the number of Colormate(TM) II System Units in use to achieve significant levels
of cosmetics sales revenue. The Company also believes, based on its operating
history since February 1993, that achieving such increased levels of cosmetics
sale revenues will take significantly longer than was originally anticipated.
However, the Company has begun to provide hair color analysis in certain of the
salons, and expects to complete its inventory of a new line of 


                                       9
<PAGE>

chromatically balanced and color coordinated cosmetics in the third quarter of
1997, which factors the Company believes (although there can be no assurance)
may enhance revenues from the beauty-related installations.

      The Company has not yet achieved commercial market penetration in any
industry and there can be no assurance the Company will be able to do so in the
future. In order to implement its marketing plans in the United States and
abroad, including in industries in which the Company does not have prior
experience, such as the medical industry, the Company will have to develop
additional marketing skills, and continue to incur significant expenses for
sales and marketing activities and the hiring of finders, distributors and new
personnel including consultants. There can be no assurance the Company's
marketing plan will be successful. See "Competition" and "Management's
Discussion and Analysis."



COMPETITION

      Competition in the cosmetics industry is principally based on price,
perceived market cachet or "image" and breadth and quality of product line. The
cosmetics industry is particularly sensitive to changing consumer preferences
and demands, which are difficult to predict and over which the Company has no
control.

      Competition in the cosmetics industry is diverse and fragmented, but is
nevertheless dominated in certain markets by a number of large, established,
well known corporations. Many of these companies have marketed, and continue to
market, their products based on their own color analysis system and advertised
claims of "color compatibility" with the personal color and/or wardrobe of the
consumer. However, these companies do not claim that their ability to deliver
color compatible products is scientifically based.

      In addition to the large dominant companies competing in the cosmetics
industry on the basis of color compatibility, there are a significant number of
other cosmetic/beauty aid companies, as well as color consultation companies and
independent color consultants, which currently market products and services with
which the Company's color science marketing approach and Products would have to
compete. Many of the competitors are established companies, having, among other
things, significantly greater financial, marketing and human resources than the
Company and broader, more recognizable product lines than the Company, as well
as established presence in the market and their own cosmetic manufacturing
facilities, unlike the Company.

      Many of the companies with which the Company competes rely on a variety of
subjective techniques to determine color compatibility, such as video simulation
techniques, computer processing of responses to questionnaires, material draping
techniques and "white card to wrist" techniques. Video simulation, previously
used by Elizabeth Arden and Clairol, consists of utilizing closed-circuit TV
monitors to project a face on the TV screen, freeze it there, and then
electronically "paint in" the colors recommended by the computer from a
subjectively established color system based on the customers responses to
questions asked regarding her color preferences and hair and eye color. Other
computers such as those used by Noxell, are sales aids reflecting answers
received from customers in response to general questions relating to the
customer's appearance and color preference. The draping technique, used by
BeautiControl and Mary Kay, among others, involves draping different colored
fabric swatches close to the customer's face, whereupon a sales representative
analyzes the results and recommends the appropriate colors for the customer.
This system depends on the accuracy of draping materials, consistent lighting
and the training and accurate color vision of the sales representative; results
can vary from customer to customer, from geographical region to region, etc.

      Many of the Company's competitors have been quite successful in marketing
their cosmetic lines based on the subjective techniques described above or by
marketing cosmetics advertised as "color coordinated" even without being sold in
connection with the subjective techniques. The Company believes that only its
Colormate(TM) II System and Intellectual Properties, and licensees thereof, can
provide scientifically accurate color analysis, and that this capability

provides significant marketing advantage as was demonstrated in certain of the
Company's test marketing activities and the Avon Project. There can be no
assurance that consumers will prefer products based on such determinations,
rather than the products sold by most of the Company's competitors based on
subjective techniques. However, the Company believes its objective scientific
techniques provide competitive marketing advantages to the consumer in that the
Company believes the subjective techniques do not produce accurate, consistent
results from 



                                       10
<PAGE>


consumer to consumer, or upon multiple readings of the same consumer at
different times. The inaccuracy inherent in the subjective techniques is
attributable to reliance on or interference from such variables as (i)
variations in the accuracy of draping materials and the inability of video
simulators to accurately reproduce color images, (ii) differences in the
training and color vision of the consultant (which vary from person to person
and which in any event cannot be as accurate as a scientific measuring
instrument), (iii) consistent lighting (i.e., natural light versus fluorescent
and/or non-fluorescent lighting) and (iv) surrounding hair and eye coloration
(which can result in misleading color analysis of adjacent skin tone, such as
trying to compare the skin of people of different races who both have black eyes
and hair). The Company's system relies solely on color measurement of the skin
by instrument and does not rely on, and achieves consistent, repeatable
scientific results independent of, such variables. The Company believes that
consumers will prefer a system that offers objective, accurate, repeatable
determination of skin color and the products most compatible with that skin
color over subjective techniques that offer inconsistent results. In addition,
because the Colormate(TM) II System is easy to use and virtually automatic, it
does not rely on the operator's color analysis expertise or require extensive
operator training, thereby resulting in training costs savings.

      The Company has not previously licensed its Intellectual Properties for
use in any industry other than the cosmetics, beauty aid and fashion industries.
In addition, management of the Company has not had any experience in marketing
the Intellectual Properties, Colormate(TM) II System and Products in any other
fields. Although the Company intends to retain consultants who will be able to
assist the Company in marketing in such fields, the Company's resources are
limited. To the extent the Company attempts to market products utilizing its
Intellectual Properties in other industries, the Company will compete with
established companies and technologies in those industries, which companies
have, among other things, significantly greater financial, marketing and human
resources than the Company, as well as an established presence in their own
industries. In particular, other companies, including the industrial color meter
divisions of camera companies, provide color measurement equipment in the paint,
textile, automotive and food industries, and are the leaders in scientific color
measurement of products in these industries. In fact, the Company would be
competing in these industries with suppliers of components for the Colormate(TM)
II System. These components employ the same color measurement technology and
methodology as does the Colormate(TM) II System when it is equipped with

standard non-proprietary software for industrial application. However, when the
Colormate(TM) II System is equipped with certain of the Company's proprietary
software programs, it provides machine to machine stability and reproducibility.
Other than in special applications, including applications requiring such
machine to machine stability and reproducibility, the Company's Intellectual
Properties and Colormate(TM) II System do not provide batch to batch (for
instance, dye lot to dye lot) color measurement superior to that provided by
existing technology. However, the Company believes that the Colormate(TM) II
System can be marketed at prices less than those currently charged by such
competitors for comparable color measurement instruments, even in standard
industrial applications.

      To the extent the Company implements its business plan to commercialize
medical applications for its Intellectual Properties, it will be entering a
field characterized by rapidly changing technology, intense competition and
extensive research and development. The Company will be competing with
established companies which have greater financial, technical, manufacturing,
marketing, research and development and management resources, including
companies such as Minolta Camera Co. Ltd. and Healthdyne Technologies, Inc.,
among others, which have actively pursued development of noninvasive detection
and monitoring of bilirubin disease (infant jaundice). In addition, the
detection methods currently in use for bilirubin and tuberculosis, the principle
diseases for which the Company intends to develop commercial applications for
its technologies, have already achieved acceptance by and are in widespread use
in the medical community, unlike the Company's proposed methods. See "Risk
Factors."


1996 DEBENTURE FINANCING

      During 1996, the Company received $5.0 million gross proceeds (before
deduction of transaction costs approximating $800,000) from the sale of its 3%
convertible debentures due April 1, 1998 ("Debentures"). The sale was made to
foreign investors pursuant to an exemption from the registration requirements of
the Securities Act of 1933, as amended. The Company has filed a registration
statement with respect to the shares into which such debentures were converted.




                                       11
<PAGE>


POSSIBLE FUTURE DEVELOPMENTS

      Potential License Arrangements. Since March 1994, the Company has been
engaged in certain consumer testing, chromaticity study engagements, preliminary
business discussions and early contract negotiations with a number of companies
in the cosmetics and beauty aid fields. Such activities with certain of such
companies have ceased, certain are ongoing and certain additional activities
with such companies only recently commenced, such as the contract with Gordon
Laboratories. Under this contract, the Company has granted a license to Gordon
Laboratories for its Colormate(TM) II systems and related proprietary

technology for custom blended foundation cosmetic products in the retail
specialty store market.

      Potential Medical Applications. The Company believes that the Intellectual
Properties and Colormate(TM) II System have commercial applications in (i)
health care relating to the non-invasive detection and monitoring of certain
diseases and disorders in which skin coloration is indicative of underlying
health problems, such as infant jaundice (bilirubin disease), tuberculosis and
anemia and (ii) dental care (i.e., the color matching of teeth and tooth
enamel). The future marketing of the Colormate(TM) II and Colormate(TM) III
Systems and Intellectual Properties in the medical field will require the
Company to develop additional marketing skills and demonstrate specific,
scientific and practical applications therefor, which to date has not been
achieved. In addition, medical and dental applications for the Intellectual
Properties require extensive and lengthy clinical testing, and will be subject
to various federal and state regulatory requirements and approvals, including
FDA review, and will be subject to comparable foreign regulatory approvals to
the extent the Company markets such applications abroad. Because the Company
believes the Colormate(TM) II System and Colormate(TM) III can provide
non-invasive diagnosing and monitoring of Bilirubin disease, it may have a
significant marketing advantage over the invasive, repeated, daily blood testing
techniques currently used, which in many cases leads to blood transfusion of the
infant. However, the medical and dental community is relatively slow to adopt
new technologies, and there can be no assurance that practitioners will perceive
a need for, or accept, the Company's technology, or be willing to commit funds
to its development or the purchase of any such completed technology. See "Risk
Factors" and "Government Regulations."

      Since 1988, the Company has been participating with Mt. Sinai Hospital in
clinical research studies using the Colormate(TM) II System and, more recently,
both the Colormate(TM) II Systems and Colormate(TM) III in both Mt. Sinai
Hospital and Elmhurst Hospital, on thousands of infants in detecting and
monitoring bilirubin disease, (infant jaundice). The initial studies conducted
in Mt. Sinai Hospital tracked, on a parallel basis, (i) the non-invasive skin
color measurements made of each infant by the Colormate(TM) II System and the
Colormate(TM) III and (ii) simultaneous blood samples drawn from the infant to
obtain a laboratory report on the patient's Bilirubin count. The first phase of
testing in 1988 and 1989 resulted in a positive feasibility study demonstrating
that the Colormate(TM) II System skin color measurements corresponded in direct
ratio to the laboratory reports of the blood samples drawn. The second phase,
which was concluded in November 1992, studied a larger volume of patients and
demonstrated the same results. In October 1993, the Company and Mt. Sinai
Hospital published the research results to that date. From October 1993 to April
1996, the Company and Mt. Sinai conducted the third phase of clinical testing
involving the compiling of certain additional clinical data relating to expanded
testing on a larger group of patients, with emphasis on skin color measurement
at birth and while under phototherapy (the current standard treatment for the
disease). In November 1996, the Company filed an application with the FDA for
commercial use of its technology for certain medical applications.

      The Company has applied significant proceeds of the 1995 Private Placement
and 1996 Debenture Offering to commence implementation of its long-range
business plan for medical applications for its technologies as well as approved
marketing and sales efforts. See "Management's Discussion and Analysis." In

this regard, in 1995 the Company hired a new president with experience in the
medical distribution field to develop and commercialize the Colormate(TM) II
System and the Colormate(TM) III for medical applications in the diagnosis of
disease where skin coloration may be indicative of the underlying condition.

      In August 1995, the Company established a research and development
facility in Spokane, Washington. This office is staffed, in addition to support
personnel, by two engineers who are former principals of R.B.H. Electronics, one
of the companies which originally engineered and manufactured the Company's
original Colormate(TM) II System 


                                       12
<PAGE>

Units. These engineers are engaged in developing the Company's housing of its
technology, for medical applications and mass manufacture prototypes for medical
applications and for a less expensive Colormate(TM) II System Unit, as well as
servicing the existing Colormate(TM) II System Units.

      The Colormate(TM) III working prototype was completed in 1996. The Company
also has retained government regulatory consultants and legal counsel, to
oversee compliance with applicable federal and state regulations for
commercialization of such medical applications, including obtaining FDA
clearance for commercializing medical applications of the Company's
technologies, and for complying with any applicable European Community
requirements. The Company submitted a marketing application for its
Colormate(TM) III system with the U.S. Food and Drug Administration (the "FDA")
on November 14, 1996. The application was accepted officially for filing and
review by the FDA on November 18, 1996. The marketing application is known as a
premarket notification or 510(k) submission. The application requests market
clearance for use of the technology as an aid to the physician in monitoring the
status of newborn babies for the development of hyperbilirubinemia. Following
the physician's examination within the first hours of birth, newborn babies
would be initially measured and periodically monitored by the Colormate(TM) III
for incremental changes in the yellow content of their skin color. The Company's
510(k) submission is currently under review by the FDA's Center for Devices and
Radiological Health (the "CDRH"). The Company cannot market the Colormate(TM)
III for this medical application in the United States until it receives an order
from the CDRH authorizing such marketing. See "Governmental Regulations" for a
discussion of 510(k) submission review times, FDA marketing orders, and risks
associated with the 510(k) submission process (e.g., need for more onerous
premarket ("PMA") approval instead of 510(k) marketing clearance). Assuming the
obtaining of necessary government approvals, as to which there can be no
assurance, the Company ultimately intends to market medical applications of its
Intellectual Properties for the diagnosis and monitoring of bilirubin to medical
device distributors, hospitals, pediatricians and Home Health Care facilities.
The Company anticipates it may need to obtain additional financing to
successfully implement such marketing program and to commercialize medical
applications of its technologies. See "Government Regulations" and "Risk
Factors."

      Although the Company does not believe that further basic technological
developments are required for the potential medical applications being targeted

by the Company, refinements of the Intellectual Properties embodied in the
software may be required and hardware housing specifications will need to be
developed to conform with government regulated hospital requirements. Such
refinements could potentially require additional FDA or foreign marketing
clearances or approvals. The Company believes that any such refinements will be
within its current technological expertise. The Company has spent approximately
$70,000 from the 1995 Private Placement and $50,000 of the 1996 Debenture
Offering proceeds for engineering expense to develop the Colormate(TM) III
working prototype in compliance with government regulated hospital
specifications in order to commercially market the Colormate(TM) II System and
the Colormate(TM) III to hospitals, pediatricians and home health care markets
following FDA and foreign regulatory clearance. There can be no assurance that
additional financing will not be needed for this purpose, that the Company's
efforts will be successful or that FDA clearance or foreign regulatory approvals
will be obtained. To the extent the Company develops and markets the
mass-manufacture prototype for the Colormate(TM) III, the Company initially will
use the nonproprietary and proprietary components of the existing Colormate(TM)
II System Units in its inventory to manufacture a limited number of such devices
for early stage marketing, sales efforts and for commercial use. Thereafter, the
Company will need to source such components from suppliers for additional
manufacturing needs, if any. The Company has commissioned a market research
study with Frost & Sullivan to determine the size of the U.S. or foreign markets
for the medical applications, including the market share related to the
detecting and monitoring methods currently in use with which the Company's
proposed medical applications and methods would compete. There can be no
assurance that the Company will be able to successfully market its proposed
medical applications and methods to the anticipated target customers, or that a
market for such applications will be large enough to support profitable
operations. See "Risk Factors."

      From February 1993 to June 1995, the Company conducted a feasibility study
for clinical tests at Elmhurst Hospital for use of its technology in the
diagnosis of tuberculosis through the measurement of skin color. The Company
stopped such studies in order to focus its limited resources on the more
advanced Bilirubin Project and its long-range business plan to commercialize
that application. Extensive further testing will be required to evaluate the use
of the Company's technology for the diagnosis of tuberculosis, and there can be
no assurance this application will have commercial applications or generate
revenue for the Company.




                                       13
<PAGE>



      In 1990, the Company concluded a feasibility study for Dentsply, Inc., a
dental supply company, for use of the Intellectual Properties and Colormate(TM)
II System in the color measurement and matching of human tooth color and tooth
enamel color for dentures, bonding, inlays and caps, for use by dentists and
dental laboratories. This study concluded that the Colormate(TM) II System could
accurately and reproducibly measure the colors of both human teeth and tooth

enamels, but needed further design research and engineering studies to develop a
stabilized housing system for such a small area of measurement. The project was
discontinued by both companies at that time due to an inability to agree on
financial terms for the project. The Company anticipates that approximately
$25,000 would be required for developing housing prototypes for dental
applications. The Company is in continued discussions with a dental supply
distribution company with respect to the possible development of such prototype
and the marketing of such application.

      Except for the test marketing with Clairol and Hanes in the hair and
fashion industries, respectively, and limited feasibility studies of the
Intellectual Properties and the Colormate(TM) II System for the color analysis
of tooth enamel, the Company has not test marketed the Colormate(TM) II System
or the Intellectual Properties in any field other than the cosmetics industry.
Except for the clinical tests in connection with the Bilirubin Project and
certain related marketing research conducted at hospitals, the Company has not
test marketed its technologies for medical applications. There can be no
assurance that the Colormate(TM) II System, the Intellectual Properties or the
Colormate(TM) III will be found to have commercial medical or dental
applications or commercial applications in other fields. See "Risk
Factors--Future Developments; Further Development and Marketing Activities
Required."

      Other Potential Applications. The Company believes that the Intellectual
Properties and Colormate(TM) II System may have commercial applications in
industrial color measurement applications, in order to achieve and confirm
uniformity of color shades within a given product line or between two products
of the same line (i.e., paint, textile and food products). To that end, the
Company intends to increase its efforts to lease the Colormate(TM) II System
and/or license the Intellectual Properties, including the Company's Chromaticity
Study capabilities, to industrial companies such as paint, textile and food
companies, that use or could use existing color measurement technologies in the
manufacturing and marketing of their own products. Many companies in these
industries currently use color measurement instruments to ensure uniformity of
product line colors (e.g., that manufacturing facilities are producing different
dye lots and/or goods of the same color). These instruments are generally
available at prices well in excess of the price at which the Company would
market the Colormate(TM) II System for such applications, because the Company
has been able to mass manufacture its color measurement technology, thereby
taking advantage of the economies of scale. In addition, the Colormate(TM) II
System provides machine to machine stability and reproducibility, i.e., that
each machine will achieve results consistent with that of other machines,
whereas the competing color measurement instruments available today generally
cannot produce such consistent machine to machine results without more complex
inter-machine calibration adjustments. The Company expects to complete in 1997
the development of a smaller, less expensive hand-held prototype of the
Colormate(TM) II System capable of use in industrial applications. See
"Manufacturing" and "Risk Factors."


GOVERNMENT REGULATIONS

      The Company's advertising, sales practices and cosmetic products
(including the labeling and packaging thereof) are and will be subject to

applicable federal, state and local regulation (including regulation by the FDA,
the Federal Trade Commission, the Federal Communications Commission, under the
Fair Packaging and Labeling Act and/or any comparable state authority, agency or
statute) and will be subject to regulation by comparable foreign authorities if
the Company markets its Colormate(TM) II System and Products abroad. The Company
will also be subject to additional FDA and foreign statutes and regulations
and/or clearances or approvals to the extent the Company continues its efforts
to test, manufacture and license the Intellectual Properties and lease the
Colormate(TM) II and III systems in the medical and dental industries. The
Company will also be subject to regulation by various governmental agencies that
regulate direct selling activities.  See "Risk Factors."

      Although the Company has filed its application for the FDA and is
preparing its application and Regulatory submissions for South America and the
European Community, there can be no assurance that regulatory clearances or
approvals will be obtained for any of the Company's proposed medical
applications and methods. Delays in 



                                       14
<PAGE>


obtaining such clearances or approvals could materially adversely affect the
Company's ability to successfully market any such proposed applications and
methods. The Company will attempt to market its products pursuant to Section
510(k) of the Federal Food, Drug and Cosmetic Act (the "Act"), which required
filing a premarket notification ("510(k) submission") but not a premarket
approval ("PMA") application with the FDA. According to the FDA's Office of
Device Evaluation Annual Report, Fiscal Year 1996, during fiscal year 1996 the
average 510(k) review time was 145 days, or approximately 5 months. There can be
no assurance that the 510(k) process will not take more than 5 months or that
the more expensive and time consuming PMA process will not be required by the
FDA, before completion of the FDA review process.

      The Company's products for its proposed medical applications and methods
would constitute "medical devices" as defined under the Act, and would be
subject to regulation by the FDA and the corresponding agencies of the states in
which the Company may in the future sell its proposed medical applications and
methods. Accordingly, the Company would be required to comply with FDA statutes
and regulations governing the manufacture, distribution and labeling of its
products and any third party manufacturers with which it may reach agreement
would have to comply with certain Good Manufacturing Practice ("GMP")
regulations and other relevant laws and regulations in the processing or
manufacture of the Products as medical devices. In addition, manufacturers of
medical devices are obligated to report to the FDA whenever they obtain
information reasonably suggesting that one of their products may have caused or
contributed to serious injury or death or has malfunctioned and is likely to
cause death or serious injury if the malfunction recurred. The Company would
also have to register its facilities as a device establishment and list its
devices with the FDA. If the FDA believes that its legal requirements have not
been fulfilled, it has extensive enforcement powers, including the ability to
bar or seize products from the market, to prohibit the operation of

manufacturing facilities, to require recalls of devices from customer locations
and to impose civil monetary fines and criminal penalties.

      Before being distributed commercially, most medical devices must undergo
FDA review and clearance of a 510(k) submission. A 510(k) submission is filed in
instances where the device in question can be shown to be "substantially
equivalent" to an already legally marketed device which does not require a PMA
application. The FDA must then determine whether the device is or is not
substantially equivalent to such a legally marketed device. In making its
determination, the FDA will examine, among other things, whether the subject
device is comparably as safe and effective as the legally marketed device; in
this regard, the FDA may request clinical data supporting the safety or efficacy
of the new product. Although there can be no assurance, the Company believes its
technologies for medical applications do qualify for the 510(k) procedure and
the FDA has notified the Company that its application presently is being
reviewed as a 510(k). However, because the "substantial equivalence"
determination takes into account the technology, performance, design, materials
and labeling used for the new product, and whether these factors present issues
regarding the safety and efficacy of the new product, the FDA could conclude
during its review that the medical applications of the Company's technologies
cannot qualify under the 510(k) procedure, and instead must undergo the
lengthier and more costly PMA procedure.

      A PMA must demonstrate that the device is independently safe and effective
and is typically a much more complex, time consuming and expensive submission
that generally includes information with respect to both animal and human
studies. According to FDA's Office of Device Evaluation Annual Report, Fiscal
Year 1996, during fiscal year 1996 the average original PMA application review
time was 344 days or approximately 1 year, although such time could be extended
and there can be no assurance that a PMA application will be approved by the
agency. A device requiring a PMA application may not be marketed in the United
States until FDA clearance has been obtained.

      The Company filed its application with the FDA under the 510(k) procedure
in November, 1996. The company promptly responded to certain FDA inquiries
regarding the usages of certain "substantially equivalent" devices in January
and February of 1997. The FDA is continuing its review of the Company's 510(k)
submission to date. While any 510(k) submission or PMA application is pending at
the FDA, commercial marketing in the United States of the Company's medical
applications and methods would be prohibited. If the Company's proposed products
do not qualify for the 510(k) procedure and are, prior to the completion of the
FDA's review process, required to undergo the PMA procedure, or if any required
clearances or approvals are delayed or denied, sales of the Company's proposed
medical devices would be prohibited during the period the Company does not have
such clearances or approvals.




                                       15
<PAGE>


EMPLOYEES


      The Company currently employs 19 persons on a full-time basis. None
of the Company's employees is represented by a union. The Company believes that
its relationship with its employees is good. The Company intends to hire
additional employees and consultants to carry out its proposed marketing plans.
Such persons will be compensated with salaries, or on a fee or commission basis,
as applicable. See "Management's Discussion and Analysis" and "Possible Future
Developments--Potential Medical Applications."


RISK FACTORS

      Accountant's Report; Going Concern Considerations. The report of Wiss &
Company, LLP, independent auditors for the Company, includes an explanatory
paragraph relating to substantial doubt as to the ability of the Company to
continue as a going concern. The Company has suffered significant losses from
operations since 1990, as well as other factors impacting the viability of the
Company as a going concern. A "going concern" explanatory paragraph could have a
material adverse effect on the Company's ability to obtain bank financing or to
raise capital in the future.

      Limited Operating History. Until 1986, the Company was principally engaged
in research and development relating to its Intellectual Properties and
Products. From early 1986 through October 1987, the Company was engaged in
limited test-marketing of certain of the Intellectual Properties and Products
through its former licensees. From October 1987 until June 1991, the Company was
principally engaged in the Avon Project. From October 1990 to date, the Company
has not conducted any material revenue producing operations and there can be no
assurance it will be able to do so in the future.

      Operating Losses. The Company has incurred significant losses from
operations for the years ended December 31, 1996 and 1995 ($4,442,300 and
$2,494,300, respectively). The Company anticipates incurring increased operating
expenses as the Company attempts to expand its marketing and sales activity and
otherwise continue to implement its business plan, including its long-range
business plan for potential medical applications. 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.

      Lack of Market Penetration. The Company has not yet achieved commercial
market penetration in any industry and there can be no assurance the Company
will be able to do so in the future. The Company currently has 62 Colormate(TM)
II Systems units in commercial use. The Company has not achieved significant
levels of cosmetics sales from its Colormate(TM) II System locations, and
expects based on the cosmetics sales levels achieved per location to date, that
it will have to greatly increase the number of Colormate(TM) II System
installations to achieve significant levels of cosmetics sale revenues. The
Company has experienced declining cosmetic revenues from its salon installations
in 1996. See "Management's Discussion and Analysis." The Company also believes,
based on its operating history since February 1993, that obtaining such
increased cosmetic sales revenue will take significantly longer to achieve than
was originally anticipated. At December 31, 1996, most of the inventory of the
Company's products was in excess of requirements based on the recent level of
sales. After giving effect to the $100,000 write off in 1996 actual inventory,

Management believes no further significant loss will be incurred on the
disposition of inventory. No estimate can be made of a range of amounts of loss
that are reasonably possible should the Company's expectations not be met. There
can be no assurance that no such loss will be incurred upon the disposition of
inventory. However, the Company has begun to provide hair color analysis in
certain salons, expects to complete its inventory of a new line of chromatically
balanced and color coordinated cosmetics in the third quarter of 1997, and
expects to commence marketing of its new line of custom blended foundations.
Although there can be no assurance, the Company believes these factors may in
1997 enhance revenues from its beauty-related operations. In order to implement
its marketing plans in the United States and abroad, including in industries in
which the Company does not have prior experience, the Company will have to
develop additional marketing skills and spend proceeds from additional financing
and from the exercise of its outstanding Warrants on sales and marketing
activities, including hiring finders and new personnel including consultants,
and entering into arrangements with distribution companies having a national
presence. There can be no assurance the Company's marketing plan will be
successful.




                                       16
<PAGE>


      Need for Additional Financing; Cessation of Operations. The Company has
limited resources and has not been able to finance its activities with cash flow
from operations since fiscal 1989. There can be no assurance that the Company
will not continue to incur operating losses, that it will receive any additional
proceeds from exercise of Warrants, that proceeds of the 1996 Debenture Offering
will be sufficient to fund operations beyond April 1998, that sufficient sales
levels, if any, will be achieved thereafter to fund operations or that the
Company will not incur additional unanticipated expenses. In this regard, if the
Company is unable to successfully market its Intellectual Properties,
Colormate(TM) II Systems and Products, it is extremely doubtful it will be able
to obtain additional future financing and, at such point, may have to cease
operations. The Company's continued operation will depend on its ability to
obtain significant commercial sales of the Products and/or licensing and leasing
fees from its Intellectual Properties and the Colormate(TM) II System, the
successful marketing of The Colormate(TM) II System and the Colormate III
in medical applications and the availability of future financing. There can be
no assurance that the Company will be able to obtain additional financing, such
commercial sales or fees, in which case the Company's operations would be
materially adversely affected and it may be forced to cease operations.

      Prior Marketing Attempts. Other than the Avon Project, its more recent
arrangements with IMS and its beauty salon placements, the Company's own
attempts to license and/or lease its Intellectual Properties and the
Colormate(TM) II System and market its Products independently and/or through
licensees never proceeded beyond the test marketing stage. There can be no
assurance the Company will in the future achieve commercial leasing of its
Colormate(TM) II System and the Colormate(TM) III and commercial licensing of
the Intellectual Properties or the sale of the Products. In addition, other than

its installation of Colormate(TM) II System Units in beauty salons and beauty
related businesses, the Company's revenue generating activities have been
primarily conducted in conjunction with its former licensees (i.e., Clairol,
Hanes and Avon), that provided substantial economic, administrative, marketing
and advertising support. There can be no assurance that without the support of a
marketing partner with financial resources, an advertising budget, market
presence and consumer recognition, the Company will be able to achieve
successful operations. Further, there can be no assurance the Company will ever
develop a commercial market for the licensing or leasing of its Colormate(TM) II
and Colormate(TM) III Systems and Intellectual Properties, for the sale of the
Products or for any medical applications of its technologies.

      Competition. To the extent the Company implements its business plan to
commercialize medical applications for its Intellectual Properties, it will be
entering a field characterized by rapidly changing technology, intense
competition and extensive research and development. The Company will be
competing with established companies which have greater financial, technical,
manufacturing, marketing, research and development and management resources,
including companies such as Minolta Camera Co. Ltd. and Healthdyne Technologies,
Inc., among others, which have actively pursued development of noninvasive
detection and monitoring of bilirubin infant jaundice. In addition, the
detection methods currently in use for bilirubin and tuberculosis, the principle
diseases for which the Company intends to develop commercial applications for
its technologies, have already achieved acceptance by and are in widespread use
in the medical community, unlike the Company's proposed methods. There can be no
assurance that the Company's proposed methods will be accepted by the medical
community.

      In addition, the Company's proposed medical applications will compete with
existing devices, technologies and methods in achieving acceptance in the
medical community and in attracting support from independent medical device
distribution organizations which sell medical equipment to the anticipated
target market (i.e., hospitals and pediatricians). While the Company believes
its medical applications are superior to the existing devices, technologies and
methods, no assurance can be given that the medical community will accept and
support the Company's methods.

      Further, technological developments by others could result in the
Company's proposed medical applications and devices becoming obsolete even
before the expenses of bringing the proposed applications to market, if ever,
are recouped. There can be no assurance that the Company will be able to upgrade
its medical applications and devices to compete with such competitors or with
persons who may in the future develop products or detection methods competitive
with the Company's proposed medical applications and devices.

      Independent medical supply distributors who may be retained by the Company
will distribute other products which may compete with those of the Company or
which would provide greater revenues to such distributors than would be provided
by the Company. In addition, many medical supply companies with which the
Company's 



                                       17

<PAGE>

proposed medical applications and devices would compete, and which have
significantly greater resources and broader product lines than the Company, have
their own in-house marketing and distribution capabilities and have established
relationships with potential customers for the Company's proposed medical
applications, such as pediatricians and hospitals. No assurance can be given
that the Company will successfully and effectively market its medical products.

      The cosmetics industry and fashion industry are particularly sensitive to
changing consumer preferences and demands, which are difficult to predict and
beyond the Company's control. Competition in the cosmetics industry is diverse
and fragmented, but is nevertheless dominated by a number of large, established,
well-known corporations having, among other things, significantly greater
financial, marketing and human resources than the Company. Virtually all of
these companies referenced under the heading "Competition" have in the past
marketed, and continue to market, their products based on their own color
analysis system and advertised claims of "color compatibility" with the personal
color and/or wardrobe of the consumer. These competitors also have established
presence in the market and their own cosmetic manufacturing facilities, unlike
the Company. There can be no assurance that consumers will prefer products based
on the Company's scientifically based color determinations, rather than the
products sold by the Company's competitors based on subjective techniques.

      The Company has not previously licensed its Intellectual Properties for
use in any industry other than the beauty aid, hosiery and cosmetics industries.
In addition, management of the Company has not had any experience in marketing
the Intellectual Properties, Colormate(TM) II System or Products in any other
field. To the extent the Company commences marketing activities in other
industries, the Company will compete with established companies and technologies
in such industries, which companies may have, among other things, significantly
greater financial, marketing and human resources than the Company, as well as an
established presence in their own industries. In fact, the Company would be
competing in these industries with suppliers of components for the Colormate(TM)
II System.

      Protection of Intellectual Property. The Company's U.S. Patents Nos.
4,909,632 and 5,311,293 expire in 2007; the Company's U.S. Patent No. 5,313,267
expires in 2011; after the respective expiration date of each, the proprietary
technology and instrumentation disclosed in each Patent will be available for
use by others without compensation to the Company, unless protected by the
claims of other U.S. patents that may be issued to the Company in the future.
The Company has developed intellectual property rights in color analysis in a
number of fields including medical, biological, dental, cosmetic and materials
testing. The intellectual property rights include trade secrets, know how and a
pending United States patent application Serial No. 08/239,733, filed May 9,
1994 entitled "Method and Apparatus for Detecting and Measuring Conditions
Affecting Color," and nine additional U.S. patent applications. These rights
also include various foreign patent applications corresponding, at least in
part, to the U.S. Patents and the U.S. patent applications. There can be no
assurance that patents will issue based on these patent applications or that any
patent claims will provide sufficient protection to exclude others from the
Company's proprietary technology and instrumentation. There can be no assurance
that the Company will not be involved in litigation to protect its trade secrets

and know how or that the Company will prevail in such litigation. There can be
no assurance that challenges will not be instituted against the validity or
enforceability of any patents owned by or issued in the future to the Company,
or that such challenges will not be successful. There can be no assurance that
patent infringement claims will not be asserted against the Company and found to
have merit, that the Company will not be enjoined from using its proprietary
technology and instrumentation and from manufacturing and selling certain of its
Products, or would not be forced to obtain a license and pay future royalty fees
as well as past damages to the party claiming infringement in amounts not
presently determinable. There can be no assurance that any such license will be
available to the Company. Conversely, to the extent third parties infringe upon
the Company's patented Intellectual Properties, the Company may have to litigate
against such third parties in order to prevent further infringement. There can
be no assurance the Company will have the resources to prosecute any such
litigation, or that any such litigation would be resolved in favor of the
Company. In the event it is unable to bring such litigations or obtain a
favorable outcome, the Company's operations could be materially adversely
affected in that the Company's failure to enforce its Patents could result in
increased competition. If the Patents are declared invalid, the Company would
lose patent protection for certain of its Intellectual Properties, which could
have a material adverse effect on its operations.


                                       18
<PAGE>



      There can be no assurance that the Company's Intellectual Properties will
provide it with a competitive advantage in that it may be possible for a
competitor independently to develop similar non-infringing technologies,
independently duplicate the Company's unpatented technology through reverse
engineering, design around the patented aspects of the Company's technology, or
otherwise independently develop scientifically accurate processes, instruments
or color charts to measure skin tone color categories and conduct comparative
color analysis without infringing the Company's Patents.

      The Company's U.S. Patents apply only to the United States. The Company
has filed corresponding patent applications in a number of foreign jurisdictions
which correspond, at least in part, to the Company's U.S.  Patents. The Company
has been granted a European Patent No. 0446512, an application for a Singapore
registration of that European patent, Australian and Mexican patents
corresponding, at least in part, to its U.S. Patent No. 4,909,632 and a
Taiwanese patent corresponding, at least in part, to its U.S. Patent No.
5,313,267. The Company has not yet been granted any other foreign patents for
its Intellectual Properties and there can be no assurance it will be granted any
such patents. Consequently, wherever the Company does not have foreign patents,
third parties currently could exploit outside the United States, the technology
disclosed in the U.S. Patents, thereby increasing competition in such foreign
markets. In addition, persons gaining access to the Company's unpatented
proprietary information and technology and who are not bound by or who violate
confidentiality agreements with the Company would have the ability to exploit
the Company's unpatented proprietary information and technology both inside and
outside the United States, thereby increasing competition.


      The Company has not applied for patent protection for many aspects of the
Intellectual Properties (i.e., its proprietary trade secrets and other
confidential information). The Company typically imposes on its consultants, key
employees and advisers confidentiality obligations in connection with their
employment, consulting or advisory relationship with the Company. There can be
no assurance that such confidentiality obligations will be observed or that the
Company will have adequate remedies if those obligations are breached. To the
extent that consultants, key employees or other advisors apply technological
information taken from the Company in violation of confidentiality obligations,
disputes may arise as to the proprietary rights to such information which may
not be resolved in favor of the Company. There can be no assurance that others
will not independently develop technology that is substantially equivalent or
superior to that included in the Company's Intellectual Properties which are not
protected by patents.

      There can be no assurance that the Company's copyright protection for the
software used in the Colormate(TM) II System and the Colormate(TM) III will
provide it with a competitive advantage in that it may be possible for a
competitor independently to develop similar software, design around the
Company's copyrighted software or otherwise independently develop software with
the capacity accurately to measure skin tone categories and conduct comparative
color analysis.

      Dependence on Third Parties for Manufacturing. The Company does not itself
manufacture the Colormate(TM) II System or the Products, and in the past has
been wholly dependent on third party original equipment manufacturers of parts,
assemblers, cosmetics suppliers and textile suppliers. To the extent the Company
completes development of the mass manufacture prototypes for the hand-held
Colormate(TM) II and Colormate(TM) III Systems devices or for medical
applications, the Company will have to establish relationships with such third
party suppliers, manufacturers and assemblers, for the production of such
devices. The Company does not have any current arrangements with such suppliers,
parts manufacturers or assemblers for the building of any additional
Colormate(TM) II System Units or the mass production of such prototype devices
(or of the hand held device or modified devices for medical application), and
there can be no assurance the Company will be able to enter into future
arrangements with these or other parts manufacturers or assemblers on terms
satisfactory to the Company. The manufacturer's warranties covering certain
parts incorporated in the Colormate(TM) II System Units and the Colormate(TM)
III are renewable but, if not renewed for any reason, the costs of any repairs
of such parts, or of any uncovered parts, would be borne by the Company.

      The Company's costs of parts for the Colormate(TM) II System Units and the
Colormate(TM) III are based on original mass manufacturing costs in connection
with the Avon Project. There can be no assurance that the Company can arrange
for manufacture of additional comparable quantities at costs of parts comparable
to those manufactured in the Avon Project. Costs of parts in manufacturing
smaller quantities of Colormate(TM) II System Units or 


                                       19
<PAGE>



manufacturing the Colormate(TM) III could involve significantly greater costs to
the extent the Company does not use existing components from its inventory of
Colormate(TM) II System Units.

      In connection with any future manufacturing of the Colormate(TM) II System
Units or the Colormate(TM) III, the Company could be required to make
significant advance payments, obtain letters of credit, cause potential
customers or licensees to advance funds under their agreements entered into with
the Company or otherwise secure its payment obligations to manufacturers. There
can be no assurance the Company will be able to enter into such agreements on
acceptable terms, be able to secure its payment obligations itself or by having
customers and/or licensees advance funds, or otherwise be able to manufacture
the Colormate(TM) III or obtain further manufacture of the Colormate(TM) II
System or its Products.

      Future Developments; Further Development and Marketing Activities
Required. Prior to licensing the Company's Intellectual Properties in any
industry other than the cosmetic, beauty aids and fashion industries, the
Company will be required to develop additional marketing skills relevant to such
industries and conduct significant further marketing activity, and in certain of
these industries, overcome regulatory hurdles, professional skepticism and
develop specific practical applications therefor, which to date has not been
achieved. Accomplishing the foregoing will require the Company to incur
significant additional expenses. The Company is subject to the risks of failure
inherent in the commercialization of products based on innovative technologies,
many of which are beyond the Company's control, such as unanticipated
development, manufacturing and regulatory delays and expenses.

      To date, except for the Bilirubin Project, the medical community generally
has had no exposure to the Company or its proposed medical applications and
methods. Because the medical community is generally relatively slow to adopt new
technologies, procedures or devices, the Company might be unable to gain access
to potential customers in order to attempt to demonstrate the operation and
efficacy of its Intellectual Properties in the medical field. Even if the
Company gains access to potential customers, no assurance can be given that
members of the medical community will perceive a need for or accept the
Company's proposed medical applications and methods. Some purchasers, such as
hospitals, pediatricians and independent medical supply and home health care
distributors, might also be reluctant to purchase products from a Company that
has not demonstrated the ability to satisfy ongoing delivery requirements. In
addition, hospitals, clinics and pediatricians may be unwilling or unable to
commit funds to the purchase of the Company's proposed medical applications due
to institutional budgetary constraints, particularly in a slower economy. The
Company expects that additional financing will be required to commercialize
medical applications of its technologies. To the extent the Company develops and
markets production units for medical applications, the Company initially will
use the nonproprietary and proprietary components of the existing Colormate(TM)
II System Units in its inventory to manufacture a limited number of such devices
for commercial use and early stage marketing and sales efforts. Thereafter, the
Company will need to source such components from suppliers for additional
manufacturing needs, if any. The Company has not commissioned any market
research studies to determine the size of the U.S. market for such applications.
The Company has not conducted research regarding the market share, pricing or

profit margins related to the detecting and monitoring methods currently in use
with which the Company's proposed medical applications and methods would
compete. There can be no assurance that the Company will be able to successfully
market its proposed medical applications and methods to the anticipated target
customers, or that the market for such applications and methods will be large
enough to support profitable operations. There can be no assurance that the
Intellectual Properties or Colormate(TM) II System or Colormate(TM) III System
will be found to have commercial medical applications.

      Government Regulations. The Company's advertising, sales practices and
cosmetics products (including the labeling and packaging thereof) are and will
be subject to applicable federal, state and local regulation (including
regulation by the FDA, the Federal Trade Commission, the Federal Communications
Commission, under the Fair Packaging and Labeling Act and/or any comparable
state authority, agency or statute) and will be subject to regulation by
comparable foreign authorities if the Company markets its cosmetic products
abroad. The Company will also be subject to additional FDA regulations and
foreign statutes, and/or clearances and approvals to the extent the Company
continues its efforts to test, manufacture and license the Intellectual
Properties and lease the Colormate(TM) II and the Colormate(TM) III System Units
in the medical and dental industries. The Company will also be subject to
regulation by various governmental agencies that regulate direct selling
activities.



                                       20
<PAGE>



      There can be no assurance that regulatory clearances or approvals will be
obtained for any of the Company's proposed medical applications and methods.
Delays in obtaining such clearances or approvals could materially adversely
affect the Company's ability to successfully market any such proposed
applications and methods. The Company will attempt to market its products
pursuant to Section 510(k) of the Act, which required filing a 510(k) submission
but not PMA application with the FDA. This filing was made in November, 1996.
According to FDA's Office of Device Evaluation Annual Report, Fiscal Year 1996,
during fiscal year 1996 the average 510(k) review time was 145 days, or
approximately 5 months. Although the FDA has notified the Company that it is
reviewing its submission under the 510(k) review process, there can be no
assurance that the 510(k) submission will not take more than 5 months or that
the FDA will not require the more expensive and time consuming PMA application,
prior to completing its review of the Company's application.

      The Company's products created from its proposed medical applications and
methods would constitute "medical devices" as defined under the Act, and would
be subject to regulation by the FDA and the corresponding agencies of the states
in which the Company may in the future sell its proposed medical applications
and methods. Accordingly, the Company would be required to comply with FDA
statutes and regulations governing the manufacture, distribution and labeling of
its products and any third party manufacturers with which it may reach agreement
would have to comply with certain GMP regulations and other relevant laws and

regulations in the processing or manufacture of the products as medical devices.
In addition, manufacturers of medical devices are obligated to report to the FDA
whenever they obtain information reasonably suggesting that one of their
products may have caused or contributed to serious injury or death or has
malfunctioned and is likely to cause death or serious injury if the malfunction
recurs. The Company would also have to register its facilities as a device
establishment and list its devices with the FDA. If the FDA believes that its
legal requirements have not been fulfilled, it has extensive enforcement powers,
including the ability to bar or seize products from the market, to prohibit the
operation of manufacturing facilities, to require recalls of devices from
customer locations and to impose civil monetary or criminal penalties.

      Before being distributed commercially, most medical devices must undergo
FDA review and clearance of a 510(k) submission. A 510(k) submission is filed in
instances where the device in question can be shown to be "substantially
equivalent" to an already legally marketed device which does not require a PMA
application. The FDA must then determine whether the device is or is not
substantially equivalent to such a legally marketed device. In making its
determination, the FDA will examine, among other things, whether the subject
device is comparably as safe and effective as the legally marketed device. The
FDA may request clinical data supporting the safety or efficacy of the new
product. Although there can be no assurance, the Company believes its
technologies for medical applications qualify for the 510(k) procedure. However,
because the "substantial equivalence" determination takes into account the
technology, performance, design, materials and labeling used for the new
product, and whether these factors present issues regarding the safety and
efficacy of the new product, the FDA could conclude prior to completion of its
review of the Company's 510(k) application, that the medical applications of the
Company's technologies cannot qualify under the 510(k) procedure, and instead
must undergo the lengthier and more costly PMA procedure.

      A PMA must demonstrate that the device is independently safe and
effective, and is typically a much more complex, time consuming and expensive
submission that generally includes information with respect to both animal and
human studies. According to FDA's Office of Device Evaluation Annual Report,
Fiscal Year 1996, during fiscal year 1996 the PMA application review time was
344 days or approximately 1 year, although such time could be extended. There
can be no assurance that a PMA application will be approved by the agency. A
device requiring a PMA application may not be marketed in the United States
until FDA clearance has been obtained.

      While the Company's 510(k) submission is pending at the FDA, commercial
marketing of the Company's proposed medical applications and methods is
prohibited in the United States. If during the FDA's review process, the Company
is required to undergo the PMA procedure, or if any required clearances or
approvals are delayed or denied, sales of the Company's proposed medical devices
would be prohibited during the period the Company does not have such clearances
or approvals.



                                       21
<PAGE>




      Product Liability. The Company maintains its own product liability
insurance with respect to cosmetic and beauty aid applications. There can be no
assurance that such insurance will be adequate to protect the Company from
claims that may be brought against it by users of the Colormate(TM) II System or
its Products or the Colormate(TM) III. To the extent the Company implements its
business plan for medical applications for its Intellectual Properties, it will
be entering a field where it may become subject to product liability claims by
patients and/or doctors and might become a defendant in product liability and/or
malpractice litigation. The Company does not have malpractice insurance for such
applications and does not intend to obtain such insurance prior to achieving
commercialization of such proposed medical applications. Even if the Company
obtains such insurance, there can be no assurance that it could retain such
insurance or that such insurance would be sufficient to protect the Company
against any such liabilities.

      The Company has not established, and the Company does not intend to
establish, any reserves against any of the foregoing liabilities. In the event
of an uninsured or inadequately insured product liability or malpractice claim
in the future based on the performance of the Company's Colormate(TM) II System,
Products or the Colormate(TM) III, the Company's business and financial
condition could be materially adversely affected and the Company could be forced
to cease operations.

      Control; Dependence on Management. Darby Simpson Macfarlane, Chief
Executive Officer of the Company, owns shares of Common Stock and Preferred
Stock aggregating 2,090,793 of the shares eligible to vote on matters presented
to the shareholders which amount is sufficient to permit her to significantly
influence, if not control, the election of directors or to approve any matter
submitted to a vote of shareholders, and otherwise be in control of the Company.
The Company is dependent primarily on the services of Darby Simpson Macfarlane
and David Kenneth Macfarlane, Vice President, Research & Development. The loss
of either of their services could have a material adverse effect on the Company.
Although the Company has purchased key-man life insurance policies in the
amounts of $1,000,000 on the lives of both Mrs. and Mr. Macfarlane, there can be
no assurance that the proceeds from such policies would enable the Company to
retain suitable replacements for them.

      Lack of Public Market; Possible Volatility of Stock Price. Prior to the
IPO, there was no public market for the Common Stock or the Company's Warrants.
In February 1993, the Company's Common Stock and Warrants began trading on
NASDAQ. However, there is no assurance that a regular trading market for the
Company's securities will be sustained. The market price for the Company's
Warrants and Common Stock may be significantly affected by such factors as the
Company's financial performance, the results of the Company's efforts to license
its Intellectual Properties and to market its Products, and various factors
affecting the color science industry and the beauty aid and cosmetics industries
generally. Additionally, in recent years, the stock market has experienced a
high level of price and volume volatility for many companies, particularly small
and emerging growth companies traded in the over-the-counter market, and these
wide price fluctuations are not necessarily related to the operating performance
of these companies. Accordingly, there may be significant volatility in the
market for the Company's securities.


      Shares Eligible for Future Sale. Of approximately 7,308,497 shares of
Common Stock outstanding as of March 25, 1997, 6,597,704 shares will be
unrestricted and can be sold at any time, and 710,793 shares will be
"restricted" securities within the meaning of Rule 144 under the Securities Act
of 1933 (the "Securities Act"), all of which are held by directors and officers
of the Company. Under Rule 144, a person who has held restricted shares for two
years may, subject to certain volume limitations and other restrictions, sell
such shares; a person who has not been an affiliate of the Company for at least
three months immediately preceding the sale and who has beneficially owned
shares of Common Stock for at least three years generally may sell shares under
Rule 144 without regard to any of the volume limitations contained in Rule 144.
Future sales of such shares could adversely affect the market price of the
Common Stock and could impair the Company's ability to raise capital through the
sale of its equity securities.

      Possible Absence of Liquidity; Commission Regulations. NASDAQ requires,
among other things, that the Company maintain $2,000,000 total assets for
continued listing of the Common Stock on NASDAQ.



                                       22
<PAGE>



      There is no assurance that the Company will be able to maintain compliance
with the NASDAQ asset requirement or its other requirements and the Company's
securities again could become subject to delisting, as occurred in 1994 when the
Company's total assets fell below $2,000,000, the Company's receipt of proceeds
from settlement of the Avon litigation permitted the Company to meet the NASDAQ
requirements, and in August 1994 the delisting proceedures were terminated by
NASDAQ.

      If the Company does fail to meet such requirements and the Company's
securities are delisted from NASDAQ, trading in the Common Stock and Warrants,
if any, would then be conducted in the over-the-counter market and would be
quoted in what are commonly referred to as the "pink sheets" or in the "OTC
Bulletin Board" of the National Association of Securities Dealers, Inc.
("NASD"). As a result, an investor may find it more difficult to dispose of, or
to obtain current quotations of the price of, the Company's securities. If the
Company's securities cease to trade on the NASDAQ, the Company's ability to
raise additional financing will be materially adversely affected.

      In addition, if the Company's securities were to be delisted from NASDAQ,
such securities may thereby be deemed to be "penny stocks" within the meaning of
Section 15(g) of the Exchange Act and the rules thereunder (the "Penny Stock
Rules"). A broker-dealer wishing to sell such stocks to or for prospective
customers ("New Customers"), excluding certain institutional investors (among
others, banks, insurance companies and registered investment companies), will be
required to provide to New Customers certain written information prior to
effecting any such transactions. Under certain circumstances, if the stock were
removed from listing on NASDAQ, the Penny Stock Rules would apply if, for

example, the Company's net tangible assets failed to meet certain requirements,
as set forth in Rule 15g-9, i.e., generally, assets in excess of $2,000,000, or
transaction price of $5 or more excluding commissions or markups. For
transactions covered by the Penny Stock Rules, a broker-dealer must make a
special suitability determination for the purchaser and must have received the
purchaser's written consent to the transactions prior to the purchase.
Consequently, the Penny Stock Rules, were they to apply, may restrict the
ability of a broker- dealer to sell the Common Stock and Warrants and may affect
the ability of persons acquiring Common Stock upon exercise of Warrants or
acquiring Common Stock pursuant hereto, to sell such securities in the secondary
market. The loss of continued quotation on NASDAQ could also cause a decline in
share price, decline or loss of news coverage of the Company and greater
difficulty in obtaining subsequent financing.

      If applicable, the Penny Stock Rules require a broker-dealer to deliver,
prior to a transaction in a penny stock that is not otherwise exempt from the
penny stock rules, a standardized risk disclosure document prepared by the
Commission and provides information about penny stocks and the nature and level
of risks in the penny stock market. Broker-dealers also are required to provide
customers with disclosure regarding, among other things, the broker-dealer's
duties to its customer, customer rights upon violation of such duties, the
compensation of the broker-dealer and its salesperson in the transaction, and
monthly account statements showing the market value of each penny stock held in
the customer's account. A description of the penny stock market, including the
nature of bid and offer quotations and the significance of the difference
between such prices, and compensation information have to be provided by the
broker-dealer prior to effecting the transaction and also have to be contained
in the customer's confirmation.

      As a result of the foregoing disclosure requirements and restrictions on
broker-dealer activity in the penny stock market, the level of trading activity
in the secondary market for penny stocks may be lower than was the case prior to
enactment of such regulations and, accordingly, investors may find it more
difficult to sell their shares of Common Stock and Warrants.

      Possible Adverse Effect of Redemption of Warrants. Warrants may be
redeemed by the Company with the prior consent of Investors Associates Inc.
("IAI"), the managing underwriter of the IPO, at a price of $0.001 per Warrant,
at any time they are exercisable, subject to 60 days prior written notice to the
holders thereof, provided that the closing bid quotation of the Common Stock of
the Company on NASDAQ (or the last sales price or the average of the bid and
asked price if there is no reported sale, if principally traded on an exchange)
has been at least 200% of the then exercise price of the Warrants on each of the
20 consecutive trading days ending on the third day prior to the day on which
notice is given. Notice of redemption of the Warrants could force the holders to
exercise the Warrants and pay the exercise price at a time when it may be
disadvantageous for them to do so, to sell the Warrants at the current market
price when they might otherwise wish to hold the Warrants, or to accept the
redemption price which is likely to be substantially less than the market value
of the Warrants at the time of redemption.





                                       23
<PAGE>



      Exercise of Warrants. The price which the Company may receive for the
Common Stock issued upon exercise of the Warrants issued in respect of the
Bridge Financing, the IPO and to the placement agent in the 1995 Private
Placement may be less than the market price of the Common Stock at the time such
Warrants are exercised. For the life of such Warrants, the holders thereof are
given, at little or no cost, the opportunity to profit from a rise in the market
price of the Common Stock, if any, without assuming the risk of ownership. So
long as such Warrants remain unexercised, the terms under which the Company
could obtain additional equity financing may be adversely affected. Moreover,
the holders of such Warrants may be expected to exercise them at a time when the
Company would, in all likelihood, be able to obtain any needed capital by a new
offering of securities on terms more favorable than those provided by such
Warrants. To the extent of any exercise of the Warrants, the interests of the
Company's shareholders will be diluted proportionately.

      Market Making Activities. The Company has agreed to pay IAI a Warrant
solicitation fee of five percent (5%) of the exercise price of each IPO Warrant
exercised after February 5, 1994 the exercise of which is solicited by IAI. If
IAI is a market maker of the Company's units, Warrants or shares of Common Stock
at the time the Warrants are exercised, a decision by IAI to solicit the
exercise of Warrants (and receive an exercise fee) may, upon issuance of the
Common Stock, result in a distribution of the underlying Common Stock (based on,
among other things, the amount of such stock issued). Rule 10b-6 under the
Exchange Act would require that IAI cease any market-making activities during
any such distribution, and for two or nine business days preceding the
commencement of the distribution, depending on the price of the stock and the
size of its public float. If such a cessation in IAI's market-making activities
occurs at a time when there is no other broker-dealer making a market in such
securities, the liquidity in the market for such securities may be adversely
affected during such time. Alternatively, IAI may continue to make a market in
the stock based on the guidelines in Rule 10b-6A under the Exchange Act for
passive market making.

      Outstanding Voting Preferred Stock. The Company has outstanding 1,380,000
shares of Series A Convertible Preferred Stock. Each share of Preferred Stock
has voting rights equivalent to each share of Common Stock and is convertible to
Common Stock if (i) the Company's earnings (i.e. pre tax operating income,
before interest expense, but excluding extraordinary items and revenues or
earnings generated by acquired businesses) for any two consecutive calendar
years ending on December 31, 1997 exceed $20,000,000 or (ii) the closing bid
price of the Common Stock has been at least $46.67 on 30 consecutive trading
days at any time ending on December 31, 1997. Further, the Preferred Stock has a
$13,800 liquidation preference and earns an annual non-cumulative dividend of
$0.001 per share. The voting rights, conversion rights, dividend rights and
liquidation preference of the Preferred Stock may adversely affect the trading
value or the market price of the Common Stock and the Warrants.


ITEM 2.     DESCRIPTION OF PROPERTY.


      The Company's executive offices are located in New York, New York and are
subleased pursuant to a sublease expiring in March 1998 and cancelable at any
time by the Company upon three months' written notice. Rentals under such
sublease (including storage facilities) are $13,000 per month, plus occupancy
costs. The sublease may be renewed for three years at $15,000 per month.
Additionally, the Company's Spokane, Washington facility is leased pursuant to a
one year lease, expiring in June 30, 1997, such lease renewable annually. 
Rentals under such lease are $1,975 per month.

      The Company also occupies office space located in Riverdale, New York,
at a cost of $1,500 per month, which space is subleased by the Company from
Darby Simpson Macfarlane, a director, officer and principal shareholder of
the Company; such rent is equal to Mrs. Macfarlane's actual lease cost for
such premises.  The Company paid Mrs. Macfarlane $18,500 for such space in
fiscal 1996.  The Company also maintains offices at 10 Old Jackson Avenue,
Hastings-on-Hudson, New York, at the residence of Mrs. Macfarlane.  The
Company paid Mrs. Macfarlane approximately $9,800 for such space in fiscal
1996.  See "Certain Relationships and Related Transactions."


ITEM 3.     LEGAL PROCEEDINGS.

      None.




                                       24
<PAGE>



ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.

      None.




                                       25
<PAGE>



                                    PART II


ITEM 5.  MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.

      The Company has registered the Common Stock and the Warrants with the
Commission under the provisions of Section 12(g) of the Exchange Act.
Registration under the Exchange Act requires the Company to comply with certain

reporting, proxy solicitation and other requirements of the Exchange Act.

      On February 8, 1993, the Company qualified the Common Stock and the
Warrants for quotation on NASDAQ. There can be no assurance that an active
public trading market for the Common Stock or the Warrants will continue. Prior
to February 8, 1993, the date on which the Company's Common Stock, par value
$0.001 per share, was approved for quotation on the NASDAQ System, there was no
public market for the Common Stock. The quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commissions, and may not necessarily
reflect actual transactions. On March 25, 1997, the last reported bid price for
the Common Stock was $5.3125 per share. On March 25, 1997, the last reported bid
price for the Warrants was $2.625 per warrant. There were 130 holders of record
of the Common Stock as of March 25, 1997, including nominees for an unknown
number of beneficial holders and 14 holders of record of Warrants as of March
25, 1997, including nominees for an unknown number of beneficial holders.

      The following tables set forth the high and low bid prices for the Common
Stock and the Warrants for each of the periods indicated:

Common Stock

           Period                               Price
           ------                               -----
                                             High       Low
                                             ----       ---
January 1, 1995 to March 31, 1995            4.75        3.375
April 1, 1995 to June 30, 1995               4.625       4.00
July 1, 1995 to September 30, 1995           4.375       2.375
October 1, 1995 to December 31, 1995         4.9375      1.875


January 1, 1996 to March 31, 1996           10.625        3.875
April 1, 1996 to June 30, 31, 1995          13.25         7.00
July 1, 1996 to September 30, 1996           7.4375       2.75
October 1, 1996 to December 31, 1996         5.875        3.50
January 1, 1997 to March 25, 1997            9.625        4.25






                                       26
<PAGE>



WARRANTS


           Period                               Price
           ------                               -----
                                            High       Low
                                            ----       ---


January 1, 1995 to March 31, 1995           1.875      1.375
April 1, 1995 to June 30, 1995              1.875      1.125
July 1, 1995 to September 30, 1995          1.75       0.75
October 1, 1995 to December 31, 1995        1.625      0.75


January 1, 1996 to March 31, 1996           5.625      0.75
April 1, 1996 to June 30, 1996              8.375      3.00
July 1, 1996 to September 30, 1996          3.25       0.9375
October 1, 1996 to December 31, 1996        2.4375     0.6875
January 1, 1997 to March 25, 1997           5.125      0.9375



DIVIDEND POLICY

      The Company has not paid, during the two fiscal years ended December 31,
1996, and has no present intention to declare or pay, cash dividends on the
Common Stock in the foreseeable future. The Company intends to retain any
earnings which it may realize in the foreseeable future to finance its
operations. The Company has outstanding 1,380,000 shares of Preferred Stock,
entitled to an annual non-cumulative dividend of $0.001 per share, when and as
declared by the Board of Directors of the Company, payable quarterly, which
dividend must be paid before any cash dividend may be paid with respect to the
Common Stock.


ITEM 6.     MANAGEMENT'S DISCUSSION AND ANALYSIS.

      EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, CERTAIN OF THE
MATTERS DISCUSSED ARE FORWARD- LOOKING STATEMENTS THAT INVOLVE MATERIAL RISKS TO
AND UNCERTAINTIES IN THE COMPANY'S BUSINESS WHICH MAY CAUSE ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THOSE ANTICIPATED BY THE STATEMENTS MADE BELOW. SUCH
RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHER THINGS, THE AVAILABILITY OF ANY
NEEDED FINANCING, THE COMPANY'S ABILITY TO IMPLEMENT ITS LONG RANGE BUSINESS
PLAN FOR INDIVIDUAL APPLICATIONS FOR ITS TECHNOLOGIES, IMPACT OF COMPETITION,
THE MANAGEMENT OF GROWTH, AND OTHER RISKS AND UNCERTAINTIES THAT MAY BE DETAILED
FROM TIME TO TIME IN THE COMPANY'S REPORTS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION INCLUDING FORM 10-KSB.


OVERVIEW

      Since inception, the Company has been principally engaged in the research
and development of the Intellectual Properties and the Colormate(TM) II System
for the application of scientific color measurement principles to the
classification of human skin and the classification and color-oriented
organization of various color sensitive consumer products such as cosmetics,
hair color, hosiery, fashion, print and textiles. The Company from time to time
has also been engaged in test marketing the Intellectual Properties,
Colormate(TM) II System and Products in the beauty aid and fashion industries,
marketing them in the cosmetics industry, and in cooperation with Mt. Sinai
Hospital, New York, New York, since 1988 has conducted the Bilirubin Project.


      In 1996, the Company furthered implementation of its long-range plans to
exploit certain medical applications for its technology. In this regard, the
Company filed its application with the FDA for certain medical applications of
its technologies and developed the working prototype of the Colormate(TM) III
for such medical applications. See "Risk Factors," "Possible Future
Developments--Potential Medical Applications" and "Liquidity and Capital
Resources" below.

      The Company has incurred significant losses from operations since 1990.
The Company has incurred significant research and development and marketing
expenses and, prior to consummation of its IPO in February


                                       27
<PAGE>


1993, negative shareholders' equity. The Company also has not achieved
significant operating revenues since the conclusion of the Avon Project. See
Note 1 of Notes to Consolidated Financial Statements. The foregoing factors
raise substantial doubt as to the Company's ability to continue as a going
concern and have made it difficult for the Company to obtain credit on
commercial terms, market its products and attract licensees.

      The Company has financed its operations through (i) private placements of
its securities, which generated an aggregate of $1,167,500 (including $620,400
from Darby Simpson Macfarlane) from 1988 through 1992 (excluding the Bridge
Financing, which was repaid with proceeds of the IPO, (ii) collaborative
research and development arrangements with licensees, (iii) cash receipts from
lease and licensing agreements, which generated in the aggregate $8,386,200 from
inception through December 31, 1992, including $6,944,200 in the period from
January 1, 1988 to December 31, 1992 (primarily attributable to the Avon
Project), (iv) loans from private investors and certain shareholders which
aggregated $549,000 in 1991 and 1992 (excluding $775,000 in a bridge financing
effected in September and October 1992 (the "Bridge Financing")), (v) the IPO,
(vi) private placements of securities from October 1994 to June 1995 (which have
generated gross proceeds of $4,500,000 and net proceeds of $3,729,800), and
(vii) the 1996 Debenture Offering which raised net proceeds of approximately
$4,200,000. In addition, during 1996, the Company received an aggregate of
$2,738,925 from exercise of its Warrants and $207,500 from the exercise of stock
options. From January 1, 1997 to February 19, 1997 the Company received an
aggregate of $215,000 from exercise of its Placement Agent Warrants.

      Since 1990 limited revenues have been derived from licenses, leases,
service contracts and Product sales to several beauty-related businesses,
testing and laboratory fees from potential licensees evaluating the Company's
technology, and from an exclusive licensing and lease contract with IMS
Cosmetics Inc. In fiscal year 1996, the Company generated approximately 39% of
its lease, license and service contract revenues from IMS. From December 31,
1990 until the IPO, the Company had been primarily engaged in (a) pursuing the
Company's litigation against Avon, (b) developing and testing further
applications of the Intellectual Properties and Colormate(TM) II Systems, such
as the clinical research studies for medical applications, and (c) obtaining

additional financing to support marketing of the Company's Intellectual
Properties, systems, Products and related services.

      The Company's ability to generate revenues in the future will depend on
its success in marketing its Intellectual Properties, the related Chromaticity
Study capabilities, the Colormate(TM) II System and its Products. In addition,
pending FDA approval (which cannot be assured) the Company's future ability to
generate revenues in the United States will depend on successful marketing of
the Company's technology in medical applications. If such marketing is not
successful in the future, the principal effect may be a substantial write-down
of the book value of the Colormate(TM) II System Units and a substantial
impairment of the Company's capital resources and ability to obtain any future
financing, which would result in a substantial diminution in the value of an
investment in the Company. There can be no assurance the Company will be able to
timely place such units or identify alternative markets. See Notes 1 and 4 of
Notes to Financial Statements.


RESULTS OF OPERATIONS


FISCAL YEAR 1996 COMPARED TO FISCAL YEAR 1995

      The Company incurred net losses of $4,442,300 and $2,494,300 for fiscal
years 1996 and 1995, respectively, as revenues received have not been
significant relative to the Company's expenses incurred in implementing its
business plan. The $1,948,000 increase in such losses in 1996 as compared to
1995 is primarily attributable to $1,381,000 of expenses incurred to, prepare
and complete the Company's FDA application and related patent application,
$476,700 in patent applications costs (including related research and
development expenses) write-offs of uncollectible receivables and certain
inventory,  expenses for compensation of officers and employees, and legal fees
and deferred costs incurred in connection with the Company's financing
activities and potential acquisition activities.

      The Company believes that the level of expenses relating to the FDA
application and the related patent application will not be recurring in the
future and that any future expenses incurred in connection with its FDA
application will be significantly less than the amount incurred in 1996,
although no assurance can be given of such result.




                                       28
<PAGE>




      Bad debt expense increased to $257,700 in 1996 from $42,900 in 1995
primarily attributable to the settlement of the Perfect Look litigation and the
adjustment of amounts due from IMS. Depreciation and amortization expense
increased to $178,600 in 1996 from $52,900 in 1995, primarily attributable to

the amortization of deferred legal expenses incurred in 1996 in respect of
financing activities. Compensation expense for employees, officers and directors
increased to $810,500 in 1996 from $556,100 in 1995, primarily attributable to
preparing and filing the Company's FDA application and a discretionary bonus
granted by the Company to an officer.

      Assets increased to $6,747,500 in 1996 from $3,489,900 in 1995 primarily
attributable to increased cash and cash equivalents from the 1996 Debenture
Offering, proceeds received from the exercise of Warrants and interest income.
See Note 4 of Notes to Financial Statements. Current liabilities increased to
$791,500 in 1996 from $599,700 in 1995 primarily attributable to increases in
legal and accounting payables associated with the Company's financing activities
and the preparation and filing of its FDA application.

      Revenues from lease, license and service contracts decreased in 1996 as
the Company has focused its resources on implementation of its long range
business plan for medical applications of its technologies and incurred bad debt
expense as described above. The Company receives payments from licensees,
distributors or other sources sporadically during the year. Accordingly, these
payments have had, and payments that may be received in the future will have, a
significant impact on quarter-to-quarter comparisons inasmuch as the Company has
not developed stable recurring revenues.

      The Company incurred research and development expenses primarily
consisting of compensation of officers, employees and consultants of $       
and $         for fiscal years 1996 and 1995, respectively. The Company
estimates that such expenses for fiscal 1997 will approximate $700,000 although
there can be no assurance that such expenses will not exceed that amount. Of
such amount, approximately $300,000 will be applied to developing the mass
manufacture housing prototype for the medical application of the Company's
technology in the detection and monitoring of infant jaundice, approximately
$100,000 will be applied to completing the hand-held, less expensive version of
the Colormate(TM) II System, $100,000 will be applied to fabricate molds
for each of the foregoing prototypes, and $200,000 will be applied to the
Company's ongoing research and development efforts.


      The Company anticipates that it will continue to incur substantial and
increasing net losses for the foreseeable future as increased expenses are
incurred in implementing its long-range business plan for medical applications
of its technologies and as revenues from the Company's existing activities in
the cosmetics, beauty aid and fashion areas are anticipated to continue to be
insignificant relative to its anticipated expenses in the foreseeable future.


LIQUIDITY AND CAPITAL RESOURCES


FISCAL YEAR 1996 COMPARED TO FISCAL YEAR 1995

      In 1996, the Company continued to experience significant negative net cash
flows from operating activities. Net cash flows from operating activities
decreased by $1,030,300 in 1996 as compared to 1995, primarily due to the
increase in net loss associated with the Company's preparation and filing of its

FDA application.

      Cash flows from financing activities increased to $7,387,800 from
$3,773,800 in 1996 as compared to 1995, primarily attributable to proceeds from
the 1996 Debenture Offering and the exercise of Warrants.

      The Company has applied a substantial portion of the proceeds of the 1995
Private Placement and 1996 Debenture Financing to begin implementation of its
long-range business plan for commercialization of its technologies for medical
applications in diagnosing certain diseases, including the preparation of the
FDA application and the related patent applications. See "Business--Possible
Future Developments." In this regard, the Company has hired FDA and governmental
regulatory consultants (in addition to legal counsel) to assist in obtaining
hospital and regulatory clearances for such medical applications and is
currently compiling foreign regulatory approvals of commercial use of its
technology for the diagnosis and monitoring of Bilirubin disease. The Company
anticipates that any initial penetration of the medical marketplace will be
accomplished through relationships with specialized distributors, rather than
through a direct sales force.

      Management believes that if its proposed marketing plans for non-medical
applications of its technology are successful, then it will generate revenues
from fees from the licensing of the Intellectual Properties and leasing of the
Colormate(TM) II System Units, sales of swatch packs, consulting fees, and sales
of cosmetics, although there can be no prediction or assurance as to which or
any of these potential revenue sources will be successful. However, since
consummation of the IPO, the Company's marketing of its Intellectual Properties,
Products and Colormate(TM) II Systems in the beauty aid industry have resulted
in immaterial revenues.




                                       29
<PAGE>





      As of December 31, 1996, management expects that the Company will have
sufficient liquidity at least until April 1, 1998, even if no revenues from
operations are generated. If the Company is able to profitably market its
Intellectual Properties, the Colormate(TM) II System and Products and the
Colormate(TM) III, the Company would use any cash flow obtained from operations,
and may seek additional debt or equity financing, to further support and expand
its operations. There can be no assurance that the Company will not require
additional funding. If the Company has not been able to attract additional
future financing at such point in time it may have to cease operations.



                                       30
<PAGE>







ITEM 7.    FINANCIAL STATEMENTS

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                          Page

      Independent Auditors' Report..........................................32

      Consolidated Balance Sheets as of December 31, 1996 and 1995..........33

      Consolidated Statements of Operations for the years ended
       December 31, 1996 and 1995...........................................34

      Consolidated Statements of Changes in Stockholders' Equity as of
       December 31, 1996 and 1995...........................................35

      Consolidated Statements of Cash Flows for the years ended
       December 31, 1996 and 1995...........................................36

      Notes to Consolidated Financial Statements............................37



 
                                       31
<PAGE>



                         INDEPENDENT AUDITORS' 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 subsidiary as of December 31, 1996 and 1995 and
the related consolidated statements of operations, changes in stockholders'
equity and cash flows for each of the two years in the period ended December 31,
1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

      We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain

reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Chromatics
Color Sciences International, Inc. and subsidiary as of December 31, 1996 and
1995, and the results of their operations and their cash flows for each of the
two years in the period ended December 31, 1996 in conformity with generally
accepted accounting principles.

      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 suffered significant
losses from operations since 1990, which together with other factors, raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 2. The ability of
management to successfully license the Colormate(TM) II units and the Company's
proprietary technology, market the related products and obtain financing to meet
anticipated cash needs cannot be determined at this time. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.


                                          WISS & COMPANY, LLP

Livingston, New Jersey
February 19, 1997




                                       32
<PAGE>

 CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS
                                                                December 31,
                                                                ------------
                                                              1996        1995
                                                              ----        ----

ASSETS

CURRENT ASSETS:

 Cash and equivalents                                   $5,352,400  $1,827,400
 Accounts receivable, less allowance for doubtful
  accounts of $10,000 in 1996 and $17,800 in 1995           87,400     315,700
 Inventories                                               223,400     291,600

 Prepaid expenses and other current assets                  89,200      98,800
                                                        ----------  ----------
   Total Current Assets                                  5,752,400   2,533,500

Colormate(TM) II UNITS, LESS ACCUMULATED
   DEPRECIATION OF $26,000 (1996) AND $16,800 (1995)       674,000     683,200

PROPERTY AND EQUIPMENT, LESS ACCUMULATED
   DEPRECIATION OF $155,300 (1996) AND $86,900 (1995)      293,700     210,600

OTHER ASSETS                                                27,400      62,600
                                                        ----------  ----------
                                                        $6,747,500  $3,489,900
                                                        ==========  ==========

     LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:

 Notes payable - collateralized by equipment            $   10,000  $   14,400
 Notes payable to related party                            326,000     341,700
 Accounts payable and accrued expenses:
   Attorneys and accountants                               269,700     107,400
   Consultants                                              65,600      10,100
   Trade                                                   109,700     120,100
 Security Deposits                                          10,500       6,000
                                                        ----------  ----------
     Total Current Liabilities                             791,500     599,700
                                                        ----------  ----------
COMMITMENTS AND CONTINGENCIES

REDEEMABLE CLASS A PREFERRED STOCK,
   PAR VALUE $.01 PER SHARE:
   Authorized - 1,400,000 shares
   Issued and outstanding - 1,380,000 shares
   at par and redemption value                              13,800      13,800
                                                        ----------  ----------
STOCKHOLDERS' EQUITY
 Common Stock, par value $.001 per share:
   Authorized - 25,000,000 shares
   Issued and outstanding - 7,168,730 (1996) and
   4,661,936 (1995) shares                                   7,200       4,700
 Capital in excess of par value                         15,370,300   7,864,700
 Accumulated deficit                                    (9,435,300) (4,993,000)
                                                        ----------  ----------
     Total Stockholders' Equity                          5,942,200   2,876,400
                                                        ----------  ----------
                                                        $6,747,500  $3,489,900
                                                        ==========  ==========


                See accompanying notes to financial statements.

                                       33



<PAGE>


<TABLE>
<CAPTION>

         CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                     CONSOLIDATED STATEMENTS OF OPERATIONS

                                                             Year Ended December 31,
                                                             ------------------------
                                                                 1996          1995
                                                              ----------   ----------
REVENUES:
<S>                                                           <C>          <C>       
   Lease, license and service contracts                       $   66,100   $  167,000
   Interest income                                               220,800      117,800
   Other                                                             500        3,100
                                                              ----------   ----------
                                                                 287,400      287,900
                                                              ----------   ----------
COSTS AND EXPENSES:
   Food and Drug Administration ("FDA")
     medical application expenses                              1,281,500      207,000
   Patent application costs (including
     $100,000 of FDA related costs and
     $282,300 of research and development costs in 1996)         382,300      111,000
   Research and development costs                                194,400      419,500
   General and administrative:
     Compensation - officers and employees                       810,500      556,100
     Consultants                                                 205,900      238,500
     Legal fees                                                  296,300      215,000
     Accounting fees                                              51,600       51,100
     Rent and storage                                            195,400      189,000
     Insurance                                                   195,800      175,500
     Travel and entertainment                                     25,900       83,300
     Repairs and maintenance                                      85,100       57,000
     Depreciation and amortization                               178,600       52,900
     Bad debt expense                                            257,700       42,900
     Payroll taxes                                                80,000       61,700
     Stock administrative fees                                    52,500       28,300
     Interest                                                     65,900       28,600
     Other                                                       370,300      264,800
                                                              ----------   ----------
                                                               4,729,700    2,782,200
                                                              ----------   ----------
NET LOSS                                                      $4,442,300   $2,494,300
                                                              ==========   ==========
 WEIGHTED AVERAGE NUMBER OF COMMON
   SHARES AND EQUIVALENTS OUTSTANDING                          5,825,006    4,231,600


                                                              ==========   ==========
NET LOSS PER SHARE                                            $     0.76         0.59
                                                              ==========   ==========
                                                           

</TABLE>




                See accompanying notes to financial statements.



                                      34


<PAGE>



         CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY   
<TABLE>
<CAPTION>

                                                                   
                                                                   
                                                                        COMMON STOCK              Capital               
                                                                --------------------------       in Excess              
                                                                NUMBER OF            PAR           of            Accumulated
                                                                  SHARES            VALUE       Par Value           Deficit 
                                                                ---------         --------      ----------       -----------

<S>                                                              <C>           <C>              <C>               <C>          
BALANCES, DECEMBER 31, 1994                                      2,783,900     $      2,800     $  4,114,300      $ (2,498,700)

Year Ended December 31, 1995:
   Net Loss                                                           --               --               --          (2,494,300)
   Exercise of options to purchase 52,312 shares
     at $1.53 per share each by CEO and Vice
     President less aggregate payment of 36,588 shares              68,036              100             (100)             --
   Exercise of options to purchase 10,000 shares                    10,000             --             22,500              --
   Proceeds from private placement offering
     costs of $770,200                                           1,800,000            1,800        3,728,000              --   
                                                              ------------     ------------     ------------      ------------
BALANCES, DECEMBER 31, 1995                                      4,661,936            4,700        7,864,700        (4,993,000)

Year Ended December 31, 1996:

   Net Loss                                                           --               --               --          (4,442,300)
   Exercise of stock options and warrants                          715,785              700        2,946,000              --
   Conversion of convertible debentures

     into  common stock                                          1,791,009            1,800        4,329,200              --
   Contribution of "short swing" profit
     under SEC rules                                                  --               --            230,400              --
                                                              ------------     ------------     ------------      ------------
BALANCES, DECEMBER 31, 1996                                      7,168,730     $      7,200     $ 15,370,300      $ (9,435,300)
                                                              ============     ============     ============      ============
</TABLE>


                  See accompanying notes to financial statements.



                                        35


<PAGE>

<TABLE>
<CAPTION>
         CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                                                           Year Ended December 31,
                                                          ------------------------
                                                              1996          1995
                                                          ----------    ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                      <C>            <C>         
   Net loss                                              $(4,442,300)   $(2,494,300)
    Adjustments to reconcile net loss to
     net cash flows from operating activities:

     Depreciation and amortization                           178,600         52,900
     Provisions for losses on accounts receivable              7,800         42,900
     Provision for slow moving inventories                   100,000           --
     Changes in operating assets and liabilities:

      Accounts receivable                                    220,500       (146,400)
      Inventories                                            (31,800)       (10,500)
      Prepaid expenses and other current assets                9,600         (5,500)
      Other assets                                            34,400        (27,300)
      Accounts payable and accrued expenses                  207,400        (93,300)
      Other                                                    4,500            500
                                                         -----------    -----------
          Net cash flows from operating activities        (3,711,300)    (2,681,000)
                                                         -----------    -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchases of property and equipment                      (151,500)      (123,700)
                                                         -----------    -----------
          Net cash flows from investing activities          (151,500)      (123,700)
                                                         -----------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES:

   Proceeds from issuance of common stock net of
related cost                                               7,407,100      3,864,100
   Payments of notes payable from related parties            (14,900)       (86,400)
   Payments of notes payable                                  (4,400)        (3,900)
                                                         -----------    -----------
          Net cash flows from financing activities         7,387,800      3,773,800
                                                         -----------    -----------
NET CHANGE IN CASH AND EQUIVALENTS                         3,525,000        969,100

CASH AND EQUIVALENTS, BEGINNING OF PERIOD                  1,827,400        858,300
                                                         -----------    -----------
CASH AND EQUIVALENTS, END OF PERIOD                      $ 5,352,400    $ 1,827,400
                                                         ===========    ===========
SUPPLEMENTAL CASH FLOW INFORMATION

   Interest paid                                         $    39,600    $    28,600
                                                         ===========    ===========
   Income taxes paid                                     $      --      $      --
                                                         ===========    ===========

</TABLE>

                See accompanying notes to financial statements.



                                      36


<PAGE>



         CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1  -- Nature of Business and Summary of Significant Accounting Policies:

         Since its formation in 1984, the Company has been principally engaged
         in research and development and licensing activities. The Company's
         business encompasses all of the risks inherent in the establishment of
         a new business enterprise, including a limited operating history with
         significant competition possessing substantially greater resources.
         Current and future operations also depend upon the continued employment
         of certain key executives, the ability to further commercialize its
         proprietary technology and products and the Company's ability to obtain
         sufficient revenues and/or outside financing.

         Estimates and Uncertainties - The preparation of financial statements
         in conformity with generally accepted accounting principles requires
         management to make estimates and assumptions that affect the reported
         amounts of assets and liabilities and disclosure of contingent assets
         and liabilities at the date of the financial statements and the

         reported amounts of revenues and expenses during the reporting period.
         Actual results, as determined at a later date, could differ from those
         estimates.

         At December 31, 1996, most of the inventory of the Company's products
         is in excess of current requirements based on the recent level of
         sales. The Company had not sold its new line of cosmetics because the
         manufacturer has had trouble color matching certain shades to be
         scientifically claimable for the Company's scientifically color
         coordinated cosmetics line. The Company believes it will be ready to
         ship in the third quarter of 1997. Management believes a $100,000 loss
         will be incurred on the disposition of this inventory and has provided
         for such loss in 1996.

         Principles of Consolidation - The consolidated financial statements
         include the accounts of the Company and its wholly-owned subsidiary.
         All significant intercompany transactions have been eliminated in the
         consolidation.

         Colormate(TM) II Systems - In connection with a license with Avon
         Products, Inc. ("Avon"), Avon paid approximately $4,600,000 to purchase
         color measurement instruments and related equipment for its use during
         the term of the license period. Due to missing and damaged units, Avon
         and the Company executed mutual releases at the termination of the
         lease on June 24, 1991 with the principal effect that the Company
         received 1,947 units of which 1,400 were useable and not in need of
         significant repair. For accounting purposes, the $700,000 estimated
         fair value of the Nonproprietary equipment (based upon an independent
         appraisal of the complete units with allowances for the lack of a
         verifiable used equipment market, varying usage, the need for
         refurbishment and similar factors) was recorded as an asset
         ("Colormate(TM) II Units"). 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.

         Depreciation - Depreciation on a straight-line basis over 5 years
         commences upon initial rental of the Colormate(TM) II System Units. The
         Company continually evaluates the life and carrying amount of such
         equipment in light of current conditions. Given present conditions, it
         is reasonably possible that the Company's estimate that it will recover
         the carrying amount from future operations may change in the near term,
         but the Company currently believes it is more likely than not that
         writedown for impairment will not be necessary. For assessing whether a
         writedown is necessary, management compares the greater of the
         estimated undiscounted net future revenues and a current appraisal with
         the carrying amount of this specialized equipment.



                                      37



<PAGE>


         CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1  -- Nature of Business and Summary of Significant Accounting Policies:
           (continued)


         Lease, License and Service Revenues - Lease, license and service
         revenues consist of short term contracts relating to the Colormate(TM)
         II System Units reported on a straight-line basis over the terms of the
         contracts.

         Inventories - Inventories are stated at the lower of first-in,
         first-out cost or market.

         Property and Equipment - 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.

         Patent Application Costs - Patent application costs are expensed as
         incurred.

         Reclassification - Certain amounts previously reported have been
         reclassified to conform to current year presentation.

         Cash Equivalents - The Company considers certificates of deposit, money
         market funds and all other highly liquid debt instruments purchased
         with an original maturity of three months or less to be cash
         equivalents.

         Financial Instruments - Financial instruments include cash and
         equivalents, accounts receivable, other assets, accounts payable,
         accrued expenses 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, 1996. The
         use of different market assumptions and/or estimation methodologies
         could have a material effect on the estimated fair value amounts.

         Concentration of Credit Risk/Major Customers - The Company maintains
         its cash balances in a money market fund and financial institutions
         insured by the Federal Deposit Insurance Corporation to a maximum of
         $100,000. At December 31, 1996, the Company had uninsured cash balances
         of approximately $5,000,000. The Company generated approximately 39%
         and 17% of its revenues from IMS in 1996 and 1995, respectively, and
         31% of its 1995 revenues from Perfect Look.

         Loss Per Share - Loss per common share was based upon the number of
         common shares and equivalents outstanding. Options and Warrants are

         excluded as losses have been incurred. The 900,000 common shares into
         which the preferred shares may be convertible are being excluded from
         primary earnings (loss) per share until either the Company's earnings
         before interest, income taxes and extraordinary items exceed
         $20,000,000 (excluding the effects of business combinations) for two
         consecutive calendar years, or the closing bid price exceeds $46.67 for
         30 consecutive trading days at any time prior to January 1, 1998. Fully
         diluted earnings per share will be reported in future years when such
         conditions are reasonably possible of occurrence and the effect results
         in a material dilution of earnings per share; if non-cumulative
         preferred dividends are declared, they will reduce earnings per share.

         Employee Stock Options - The Company measures compensation cost for
         stock options issued to employees using the intrinsic value method
         which recognizes compensation expense to the extent the current fair
         market value of Common Stock exceeds the exercise price of the option.
         Had the fair market value method (which values the option based upon
         its fair market value at the date of grant) been used, pro forma net
         loss would have been $4,866,000 ($0.84 per share) in 1996 and
         $2,633,800 ($0.62 per share) in 1995.



                                      38


<PAGE>


         CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2 --Management's Plans to Overcome Operating and Liquidity Difficulties:

         Since 1989, the Company has incurred losses from operations and net
         cash outflows from operations and has owned Colormate(TM) II units
         since June 1991 whose ultimate recoverability depends upon the
         Company's future marketing success. The Company expects to license its
         patents and proprietary technology, rent its equipment and market its
         related services and products to ultimately overcome these
         difficulties. In the event the Colormate(TM) II units and related
         proprietary technology are not successfully leased/licensed and/or the
         products are not successfully marketed in the future, the principal
         effect may be a substantial writedown of their book value.

         Management expects that the Company will have sufficient liquidity at
         least until April 1, 1998 even if no revenues from operations are
         generated and no additional financing is obtained. If the Company is
         able to profitably market its Intellectual Properties, Colormate(TM) II
         System and Products, the Company would use any cash flow obtained from
         operations, and may seek additional debt or equity financing, to
         further support and expand its operations.


Note 3 --Litigation:

         In May 1994, the Company entered into a five year distributorship
         agreement beginning in July 1994 with Perfect Look Distribution, Ltd.,
         ("Perfect Look") under which Perfect Look was to act through June 1996
         as the exclusive distributor in the United Kingdom of the Company's
         Colormate(TM) II System Units and Products. On January 10, 1995, the
         Company sued Perfect Look and two of its principals (collectively
         "Perfect Look") in New York State Supreme Court for breach of contract,
         seeking monetary damages and injunctive relief. On September 26, 1996,
         the parties entered into a Settlement Agreement whereby the Company
         received $7,513 and three Colormate(TM) II units and related materials
         were returned to the Company.

Note 4 --Related Party Transactions, Commitments and Contingencies:

         Rent - The Company rents facilities for $1,545 per month, plus
         occupancy costs, from Darby Simpson Macfarlane, principal stockholder,
         and David Macfarlane, who rent the facilities at the same amount. The
         Company also paid Mr. and Mrs. Macfarlane approximately $9,800 in 1996
         and $6,000 in 1995 for use of their personal residence as an office.

         Related Party Transactions - Mrs. Macfarlane's employment agreement
         entitles her to receive a bonus payment of 33% of the first million of
         the Company's net recovery from the Avon lawsuit over $2,000,000. In
         connection with the Avon Settlement and her employment agreement, Mrs.
         Macfarlane is to receive $361,200, of which $98,800 has been paid. The
         remaining $262,400 is currently payable and accrues interest at the
         rate of 10% per annum. In addition, Mrs. Macfarlane is due $12,100 for
         unpaid salary which is currently payable without interest. Royalties
         and notes payable to related party also include unpaid royalties of
         $26,100 incurred through December 31, 1996.

         On April 10, 1995 the Company hired Arthur Guiry as its new president
         at an annual salary of $200,000 through April 10, 2000. In addition,
         Mr. Guiry received an aggregate of 200,000 incentive stock and
         non-qualified options at an exercise price of $3.375, expiring April
         10, 2000. The options vest at the rate of 66,666 per year commencing
         April 10, 1996 and will not be exercisable in whole or in part until
     

                                      39


<PAGE>


         CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 4 --Related Party Transactions, Commitments and Contingencies:
         (continued)


         April 10, 1996. The shares underlying such options are subject to a
         two-year lockup which expires April 10, 1997.

         On August 21, 1995 the Company entered into employment contracts with
         two new Engineering employees for salaries aggregating $130,000
         annually, through August 21, 1998.

         Agreement in Israel - In April 1992, the Company granted an exclusive
         license in Israel, during the term of the Agreement, for the use of its
         color science technology, Colormate(TM) systems and software. In August
         1994, the option to extend the Agreement was extended until the end of
         April 1995 for an additional leasing and license fee. The option to
         extend the Agreement was not subsequently exercised. Consequently, the
         option has been extended on a month-to-month basis.

         Employment Agreements - As part of the public offering, Mr. and Mrs.
         Macfarlane entered into five year employment agreements.

         Lease - The Company leases its main facilities under an operating lease
         cancelable by the Company with three months' notice. The lease provides
         for monthly minimum rental charges of approximately $13,000 plus
         occupancy costs. The lease expires March 31, 1998. Rent expense and
         storage charges were $221,000 and $189,000 in 1996 and 1995,
         respectively.

Note 5 --Income Taxes:

         For income tax purposes, the Company uses the modified cash basis of
         accounting and provides depreciation on all present property and
         equipment including Colormate(TM) II Systems commencing July 1, 1991
         using the declining balance method (cumulative temporary differences at
         December 31, 1996 were $150,000).

         At December 31, 1996, the Company had net operating loss carryforwards
         of approximately $8,390,000 for Federal income tax. SFAS 109 requires
         the recording of a deferred tax asset of approximately $2,852,000 and
         the recording of a valuation allowance of an equal amount when it is
         more likely than not that the deferred tax asset will not be realized;
         however, if and when the valuation allowance is reduced, the tax
         benefit will reduce the provision for income taxes.

         For federal income tax purposes the net operating tax loss
         carryforwards expire through December 31, 2011.

Note 6 --Capital Stock and Options:

         Preferred Stock - The Company's shares of Class A Convertible Preferred
         Stock are entitled to non-cumulative dividends, if declared, at $.001
         per annum. In the event either the Company's earnings before interest,
         income taxes and extraordinary items exceed $20,000,000 (excluding the
         effects of business combinations) for two consecutive calendar years,
         or the closing bid price exceeds $46.67 for 30 consecutive trading days
         at any time prior to January 1, 1998, each share of Class A Preferred
         Stock shall be convertible into .6521739 shares of Common Stock. Such

         shares shall otherwise be called for redemption during 120 days
         following December 31, 1997 at $.01 per share plus any declared but
         unpaid dividends.



                                      40


<PAGE>


         CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 6 --Capital Stock and Options:

         Stock Option Plan - The Company has a 1992 Stock Option Plan which
         currently provides for options to purchase up to 1,000,000 shares of
         Common Stock. The Plan provides for the granting of incentive stock
         options to all employees and non-incentive stock options to all
         employees and certain consultants at an exercise price equal to at
         least the fair market value of a share of Common Stock at the date of
         grant for incentive options (other than for the holders of more than
         10% of the outstanding Common Stock which must be at least 110% of the
         fair market value on the date of grant) and at least 85% of the fair
         market value on the date of grant for non-incentive options. Stock
         options are generally exercisable in 33-1/3% annual increments
         commencing one year after the date of grant and generally expire five
         years after the date of grant.

         Outstanding options under the 1992 Stock Option Plan are summarized as
         follows:

                                              Year Ended December 31,

                                                   1996            1995
                                                  -----           -----
         Outstanding options at beginning
           of year                                682,500       249,624
         Options granted                          757,500       547,500
         Options exercised                        125,000       114,624
                                            ---------------   ----------------
         Options outstanding at year end        1,315,000       682,500
                                            ===============   ================
         Option price per share            $4.125 to $4.375   $2.50 to $4.4375
                                            ===============   ================
         Expiration dates                     June 1999 to December 2001


         At December 31, 1996 outstanding Warrants to purchase one share of
Common Stock are as follows:


     Holder           Number of Warrants   Exercise Price     Expiration Date

To the public
 and the bridge
 financing investors     1,046,200             $5.00           August 5, 1997
Placement Agent          1,710,000              2.50           (see below)

     Warrants held by the public and the bridge financing investors are subject
     to a call for redemption under certain conditions. On January 6, 1997, the
     original expiration date of all such warrants was extended from February 5,
     1997 to August 5, 1997. Between the dates of January 1 and February 19,
     1997, the Company received approximately $217,000 from the exercise of
     Warrants. In addition to the above, in May 1996 the IPO underwriter
     exercised its options to purchase 115,000 units consisting of one share of
     Common Stock and one warrant to purchase one share of Common Stock at an
     exercise price of $6.00 per share.

     The Agent Warrants expire as follows: (i) 708,000 Agent Warrants issued on
     January 6, 1995 expire January 6, 2002; (ii) 86,000 Agent Warrants issued
     on March 13, 1995 expire March 13, 2002; (iii) 440,000 Agent Warrants
     issued on May 4, 1995 expire May 4, 2002; and (iv) 476,000 Agent Warrants
     issued on June 8, 1995 expire June 8, 2002.

     In March 1996, the holder of 75,000 Private Investor warrants converted
     such Warrants to Common Stock at an exercise price of $2.50 per share,
     pursuant to the terms of the Warrants.


                                       41


<PAGE>



ITEM 8      CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
            FINANCIAL DISCLOSURE

      None.



                                     42


<PAGE>



                                   PART III

ITEM 9     DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
           COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.



DIRECTORS AND EXECUTIVE OFFICERS


      The following table sets forth information concerning each of the
directors and executive officers of the Company:

      Name                     Age              Position
      ----                     ---               --------

Darby Simpson Macfarlane       52          Director, Chairperson of the Board,
                                           Chief Executive Officer,
                                           Assistant Treasurer

Arthur Guiry                   57          President

David Kenneth Macfarlane       50          Director, Vice President, Research 
                                           and Development

Leslie Foglesong               41          Director, Secretary and Treasurer


      Mrs. Macfarlane co-founded the Company in March 1984. She has been
Chairperson of the Board, Chief Executive Officer, 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 her husband 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 used 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(TM) II System. In
addition, Mr. Macfarlane developed the manufacturing, technical and engineering
specifications necessary to have miniaturized and mass manufactured the
Colormate(TM) II 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 and a director of the
Company since its formation.

      From January 1, 1995 to March 1995, Mr. Arthur Guiry provided consulting
services to the Company in connection with the marketing of the Company's
medical applications for its technology. On April 10, 1995, Mr. Guiry commenced
his duties as President of the Company under a five year employment agreement
between the Company and Mr. Guiry which provides Mr. Guiry an annual base salary
of $200,000 plus an aggregate of 200,000 options to purchase shares of the
Company's Common Stock under the Company's 1992 Stock Option Plan. Mr. Guiry has
held positions as an executive in sales for divisions of Bristol-Myers, Smith &
Nephew Ltd. and Solzer for the past 18 years. He also holds a physics degree

from Manhattan College.

      Darby Simpson 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. There is no family relationship among any other directors or executive
officers of the Company.



                                      43


<PAGE>



      The Company has agreed with the placement agent of the Company's 1995
Private Placement that they will have the option of selecting a designee of the
placement agent to the Company's Board of Directors for a period of five years
following the completion of the 1995 Private Placement. The Company will use its
best efforts to elect such designee of the placement agent. To date, the
placement agent has not requested that the Company elect such designee.

      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 and hold office until their respective successors are
elected and qualified.


SCIENTIFIC ADVISERS AND CONSULTANTS

      The Company relies on the services of certain consultants.

      The Company has a consulting agreement with Dr. Fred W. Billmeyer, Jr.,
Professor Emeritus at Rensselaer Polytechnic Institute, a color scientist and
recognized expert in the color science field for more than 40 years. Dr.
Billmeyer has published numerous books and articles on the field of color
science. The consulting agreement with Dr. Billmeyer provides that Dr. Billmeyer
will provide color consulting services to the Company at a fee of $125 per hour,
plus travel expenses. Such services would include providing advice and
supervisory assistance in connection with any further research and development,
modification, enhancement or marketing activity relating to the Colormate(TM) II
System and Intellectual Properties in specific applications and assisting in
obtaining patent protection for the unpatented Intellectual Properties. To the
extent Dr. Billmeyer renders any services as an expert witness in the field of
color science in any litigation involving the Company, the Company has agreed to
pay him a fee of $250 per hour therefor. 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 1996, the Company paid Dr.
Billmeyer $50,075.

      The Company has entered into a three year consulting agreement when

terminated in February 1996 with George Teichner, a shareholder of the Company,
under which he agreed to provide financial and accounting services and for which
he was paid $50,000 in 1996.

The Company employed consultants and temporary personnel for various purposes
such as the FDA application, engineering, research and development associated
with the Bilirubin Project during fiscal year 1996. These consultants and
temporary personnel were paid $650,684 in the aggregate.


COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

      The Company became subject to the reporting requirements of Section 13 of
the Exchange Act on February 5, 1993 and, accordingly, the Company's officers,
directors and greater than 10 percent beneficial owners were subject to the
reporting requirements of Section 16(a) of the Exchange Act during the year
ended December 31, 1993. The Company believes that except as described below,
during the fiscal year ended December 31, 1996, all filing requirements under
Section 16(a) applicable to its officers, directors and greater than ten percent
beneficial owners were complied with on a timely basis.

      Janssen/Meyers Associates, L.P., a direct beneficial owner of more than 10
percent of the Company's Common Stock, Meyers Janssen Securities Corporation,
Bruce Meyers and Peter Janssen, each as indirect beneficial owners of more than
10 percent of the Company's Common Stock by virtue of ownership of
Janssen/Meyers Associates, L.P. and Meyers Janssen Securities Corporation, as
applicable, failed to file on a timely basis a number of Form 4s with respect to
certain transactions in the Company's securities.

      Darby S. Macfarlane and David Kenneth Macfarlane each failed to file on a
timely basis one Form 4 with respect to one option grant. Leslie Foglesong
failed to file on a timely basis two Form 4s with respect to two separate option
grants. Filings on Form 4 with respect to these transactions have since been
made for Mr. Macfarlane, Mrs. Macfarlane and Ms. Foglesong.



                                      44


<PAGE>





Item 10. Executive Compensation

Summary Compensation Table

      The following table summarizes all compensation awarded to, earned by, or
paid to, the Company's executive officers for services rendered in all
capacities to the Company for the fiscal years ended December 31, 1994, 1995 and
1996. See "Certain Relationships and Related Transactions" for information with

respect to the shares of Preferred Stock issued to Mrs. Macfarlane in 1992 in
consideration of her transfer to the Company of certain intellectual properties,
and "Description of Properties" regarding certain payments made to her by the
Company for office space.

<TABLE>
<CAPTION>

                                               
                                                                    Long-Term     All Other  
                     Annual Compensation                          Compensation   Compensation 
                     -------------------                          ------------   ------------ 
                                                                     Awards
                                                                     ------
 Name and
 Principal                               Salary        Bonus          Options
 Position                     Year        ($)            ($)            (#)
 --------                     ----        ---            ---            ---
<S>                           <C>        <C>            <C>          <C>        <C>      
Darby S. Macfarlane,          1994       125,000              0            0    85,000(1)
  Chief Executive Officer     ----
                              1995       125,037              0            0    26,689(2)  
                              ----                                             
                              1996       125,000         20,000      300,000
                              ----

Arthur Guiry, President       1995       168,101(4)                        0         0
                              1996      $200,000                           0         0

David Kenneth Macfarlane,     1994       100,000              0            0         0
  Vice President,             1995       114,034(5)           0            0         0
  Research and Development    1996       125,000          4,500      200,000         0
                                        
Leslie Foglesong,             1994        75,000              0       10,000
  Secretary and Treasurer     1995        75,000              0       50,000
                              1996        75,000        103,650      100,000
</TABLE>



----------------------

(1)  Represents payment pursuant to Mrs. Macfarlane's employment agreement,
     under which she is entitled to receive 33% of the first $1,000,000 of the
     Company's net recovery in excess of $2,000,000 from the Avon lawsuit.

(2)  Represents interest payments pursuant to the $262,400 balance owed to Mrs.
     Macfarlane pursuant to the Avon Settlement.

(3)  Includes $23,000 of fees paid to Mr. Guiry in 1995 as a consultant prior to
     his employment as President.

(4)  Includes $14,000 of fees paid to Mr. Macfarlane in 1995 as a consultant.




                                         45


<PAGE>



AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR END OPTION VALUE TABLE


      The following table sets forth information with respect to stock options
exercised during the fiscal year ended December 31, 1996 and the value at
December 31, 1996 of unexercised stock options held by the Chief Executive
Officer:

                                                                     Value of  
                                                                    Unexercised
                                                     Number of     In-the-Money
                                                    Unexercised     Options   
                                                      Fiscal       at Fiscal  
                                                     Year-End      Year-End(2)
                                                     --------      -----------
                         Shares   
                       Acquired on     Value       Exercisable/    Exercisable/ 
                        Exercise     Realized(1)   Unexercisable   Unexercisable
Name                       (#)           ($)              #              $
----                    --------     -----------   -------------   -------------
Darby Simpson             40,000     210,000         0/300,000            NA/O
Macfarlane             
Arthur Guiry(3)              N/A         N/A    66,666/133,334  75,000/150,000
David Kenneth             40,000     330,000         0/200,000            NA/O
Macfarlane
Leslie Foglesong          20,000      73,750    50,000/100,000   10,000/18,750




---------------------------

(1) Based on the fair market value of securities underlying the options minus
    the exercise price of the options. On January 26, 1996, Mrs. Macfarlane
    exercised an option to purchase 40,000 shares of Common Stock at an exercise
    price of $2.50. On April 23, 1996, Mr. Macfarlane exercised an option to
    purchase 40,000 shares of Common Stock at an exercise price of $2.50 per
    share.

(2) Based on the fair market value of securities underlying the options minus
    the exercise price of the options at the fiscal year end. At December 31,
    1996 (the last business day of the fiscal year), the closing bid price of
    the Common Stock on NASDAQ was $4.50.


(3) As of March 20, 1997, 133,334 options were exercisable.


COMPENSATION OF DIRECTORS

    Directors who are not salaried employees of the Company do not receive any
compensation or reimbursement of expenses 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 Chief Executive Officer and for Mr. Macfarlane's
employment as Vice President, Research and Development. The agreements with Mrs.
and Mr. Macfarlane provide for current annual base salaries of $125,000 and
$125,000, respectively, subject to annual increases at the discretion of the
board of directors. 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. Mrs. Macfarlane is to receive
$361,200, of which $98,800 has been paid. The remaining $262,400 is currently
payable and accrues interest at the rate of 10% per annum. 


                                       46

<PAGE>


Under the agreements, the Company is obligated to provide Mr. Macfarlane with
$300,000 and Mrs. Macfarlane with a $500,000 term life insurance policy and
disability insurance. The Company maintains key man life insurance on each of
Mrs. and Mr. Macfarlane in the amount of $1,000,000.

    The agreements 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, disability or "cause" as set forth therein, or (ii) by reason
of death or disability. If Mr. or Mrs. Macfarlane's employment is terminated by
the Company for any reason other than death, disability or "cause," the Company
is required by each agreement to pay to the terminated employee an amount equal
to the greater of (a) the aggregate base salary payable for the remainder of the
employment period of the agreement and (b) the aggregate base salary payable
thereunder for two years, plus, in each case, 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 applicable, an amount
equal to two years aggregate base salary in the case of Mrs. Macfarlane, and one
year's base salary in the case of Mr. Macfarlane, plus in each case an amount
not less than the pro rata portion of any bonus granted to the employee in the
year immediately preceding the year in such termination occurs.

    The Company has entered into a five year employment agreement, commencing on

April 10, 1995, with Arthur Guiry providing for Mr. Guiry to serve as President
of the Company. The agreement provides for an annual base salary of $200,000,
subject to annual increases at the discretion of the Board of Directors, plus
options to purchase an aggregate of 200,000 shares of Common Stock at an
exercise price of $3.375 per share under the Company's 1992 Stock Option Plan.
Mr. Guiry shall be entitled to an annual bonus subject to the discretion of the
Board of Directors. The Company, at its option, can maintain key-man insurance
on Mr. Guiry in the amount of $1,000,000.

    The agreement provides for the payment of termination benefits by the
Company if employment thereunder is terminated by the Company for any reason
other than death, disability, "cause" as set forth therein, or voluntary
resignation. If Mr. Guiry's employment is terminated by the Company for any
reason other than death, disability, "cause," or voluntary resignation, the
Company is required to pay to Mr. Guiry an amount equal to the aggregate base
salary for the remainder of the employment period plus an amount equal to the
bonus granted for the year immediately preceding the year in which such
termination occurs. If Mr. Guiry's employment is terminated by reason of death,
disability, cause or voluntary resignation, he will not receive any other
compensation besides accrued salary through the date of such termination and an
amount equal to the pro rata portion of any bonus granted for the year
immediately proceeding the year in which such termination occurs.

    The Company has entered into separate five year employment agreements
commencing on August 21, 1995, with Arthur Rocco and Mark Harwood, providing for
each to serve as an engineer of the Company (the "Agreements"). Mr. Rocco's
agreement provides for an annual base salary of $75,000 per annum, subject to
annual increases at the discretion of the Board of Directors, plus options to
purchase an aggregate of 50,000 shares of Common Stock at an exercise price of
$2.6875 per share under the Company's 1992 Stock Option Plan. Mr. Harwood's
agreement provides for an annual base salary of $55,000 per annum, subject to
annual increases at the discretion of the Board of Directors, plus options to
purchase an aggregate of 20,000 shares of Common Stock at an exercise price of
$2.6875 per share under the Company's 1992 Stock Option Plan.

    The Agreements provide for the payment of termination benefits by the
Company if employment thereunder is terminated by the Company for any reason
other than death, disability, "cause" as set forth therein, or voluntary
resignation. If employment is terminated by the Company for any reason other
than death, disability, "cause," or voluntary resignation, the Company is
required to pay an amount equal to the aggregate base salary for the remainder
of the employment period. If employment is terminated by reason of death,
disability, "cause," or voluntary resignation, no compensation will be received
other than accrued salary through the date of such termination.

    All of 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.



                                         47



<PAGE>



Item 11.     Security Ownership of Certain Beneficial Owners and Management.

    The following table sets forth, as of March 25, 1997, the beneficial
ownership of the Common Stock: (i) by each stockholder known by the Company to
beneficially own more than 5% of the Common Stock; (ii) by each director of the
Company; (iii) by the Company's Chief Executive Officer; and (vi) by all
executive officers and directors of the Company as a group. Except as otherwise
indicated below, each named beneficial owner has sole voting and investment
power with respect to the shares of Common Stock listed.


     Name and Address of           Amount and Nature of
     Beneficial Owner              Beneficial Ownership     Percent of Class
     ----------------              --------------------     ----------------

     Darby Simpson Macfarlane (1)           2,090,813            24.1%
     10 Old Jackson Avenue, #28            
     Hastings-on-Hudson, NY 10706          
                                           
     David Kenneth Macfarlane (2)           2,090,813            24.1%
     10 Old Jackson Avenue, #28            
     Hastings-on-Hudson, NY 10706          
                                           
     Leslie Foglesong (3)                      50,000                *
     116 Lafayette Avenue                  
     Brooklyn, NY 11217                    
                                           
     Mellon Bank Corporation (4)            1,035,000            11.9%
     One Mellon Bank Center                
     Pittsburgh, PA 15258                  
                                           
     Janssen-Meyers Associates, L.P. (5)    1,641,100            18.9%
     17 State Street                       
     New York, NY 10001                    
                                           
     All directors and executive officers   2,140,813            24.5%
     as a group (3 persons) (6)           

----------------------------
*     Less than one percent

(1)   Includes all of the 1,380,000 issued and outstanding shares of the
      Company's redeemable Convertible Preferred Stock owned by Mrs. Macfarlane.

(2)   Includes the 1,380,000 issued and outstanding shares of the Company's
      redeemable Convertible Preferred Stock owned by Mrs. Macfarlane, and the
      710,813 issued and outstanding shares of the Company's Common Stock
      beneficially owned by Mrs. Macfarlane.


(3)   Includes 50,000 shares issuable upon the exercise of options which are
      exercisable within the next 60 days.

(4)   Includes indirect beneficial ownership of the holdings of two 
      subsidiaries, Mellon Bank N.A. and the Dreyfus Corporation.

(5)   Based on Amendment No. 17 to Form 13D dated February 11, 1997. Includes
      1,570,626 shares issuable upon the exercise of Warrants which are
      exercisable within the next 60 days.

(6)   Includes 50,000 shares issuable upon the exercise of options which are
      exercisable within the next 60 days and 1,380,000 issued and outstanding
      shares of the Company's redeemable Convertible Preferred Stock.


ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

      If (i) the Company's earnings for any two consecutive calendar years
during the period commencing on March 18, 1992 and ending on December 31, 1997
exceeds $20,000,000 or (ii) the closing bid price of the Common Stock has been
at least $46.67 on 30 consecutive trading days at any time commencing on
February 5, 1993 and ending on December 31, 1997, each outstanding share of
Preferred Stock shall be converted into 0.6521739 shares of Common Stock,
subject to adjustment for stock-split, stock dividends, reclassification or
other combinations or subdivisions. If neither 

                                       49
<PAGE>


condition is satisfied by December 31, 1997, the Preferred Stock shall be
redeemed by the Company at a price of $0.01 per share, plus any declared but
unpaid dividends.

     Since August 1990, the Company has occupied office space leased from Darby
Simpson Macfarlane. The Company pays Mr. and Mrs. Macfarlane $1,500 per month
under the lease (representing their actual lease cost for such premises). For
each of the years ended December 31, 1996 and 1995, the Company paid Mr. and
Mrs. Macfarlane $18,000 in connection with such lease. In addition, the Company
also paid Mrs. Macfarlane approximately $6,000 for the years ended December 31,
1996 and 1995, respectively, for the use of her residence as the principal
executive offices of the Company. See "Description of Property."

      Accrued royalties under the prior license arrangements were $147,200 at
December 31, 1992. $80,000 of this amount was paid to Pink & Peach Computer
Corp. from the proceeds of the IPO, $41,100 of this amount was paid to Pink &
Peach Computer Corp. in 1996 and the balance of $26,100 is currently due and
payable.

      In connection with the Avon Settlement and Mrs. Macfarlane's employment
agreement, Mrs. Macfarlane is to receive $361,200 from the proceeds from the
Avon Settlement, of which $98,800 has been paid. The remaining $262,400 is
currently payable and accrues interest at the rate of 10% per annum. In

addition, Mrs. Macfarlane is due $12,100 for unpaid salary, which is currently
payable without interest.

      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. In the case of the Intellectual Property transfers
and the issuance of stock for past due salary or repayment of loans involving
Mrs. Macfarlane, the properties and services contributed to the Company could
not have been obtained elsewhere, and in the case of all the other loan
transactions referred to above, the Company was unable to obtain financing from
other sources on better terms despite attempts to do so.

<TABLE>
<CAPTION>

ITEM 13.    EXHIBITS, LIST AND REPORTS ON FORM 8-K

(a)   Exhibits:

Number      Description of Document

<S>        <C>                                                                  
 3.1        Restated Articles of Incorporation of the Company (incorporated by
            reference to Exhibit 3.1 to the Company's Registration Statement on
            Form S-1 (File No. 33-54256), filed on November 5, 1992, as amended
            (The "Registration Statement")).

3.1.1       Certificate of Amendment to the Certificate of Incorporation of the
            Company regarding the change of the Company's name (incorporated by
            reference to Exhibit 3.1.1 to the Registration Statement).

+3.1.2      Certificate of Amendment to the Certificate of Incorporation of the
            Company increasing the authorized number of shares for issuance and
            increasing the number of shares of Preferred Stock

 3.2        By-Laws of the Company (incorporated by reference to Exhibit 3.2 to the
            Registration Statement).

 4.1        Specimen form of the Common Stock Certificate (incorporated by
            reference to Exhibit 4.1 to the Registration Statement).

 4.2        Specimen form of Warrant Certificate (incorporated by reference to
            Exhibit 4.2 to the Registration Statement).

 4.3        Form of Warrant Agreement (incorporated by reference to Exhibit 4.3 to
            the Registration Statement).

+4.3.1      Amendment to Warrant Agreement.




                                         49



<PAGE>


<CAPTION>


<S>         <C>                                                            
10.1*       Form of Employment Agreement between the Company and Darby Simpson
            Macfarlane (incorporated by reference to Exhibit 10.1 to the
            Registration Statement).

10.2*       Form of Employment Agreement between the Company and David Kenneth
            Macfarlane (incorporated by reference to Exhibit 10.2 to the
            Registration Statement).

10.3*       Form of Consulting Agreement between the Company and George
            Teichner; Letter Agreement between the Company and George Teichner
            in respect of Consulting Agreement (incorporated by reference to
            Exhibit 10.3 to the Registration Statement).

10.4*       Consulting Agreement, dated February 25, 1992, between the Company and
            Dr. Fred W. Billmeyer, Jr. (incorporated by reference to Exhibit 10.4
            to the Registration Statement).

10.6        Form of Indemnity Agreement between the Company and its directors
            and officers (incorporated by reference to Exhibit 10.6 to the
            Registration Statement).

10.12       Know-How Agreement, dated September 3, 1992, between the Company,
            Darby Simpson Macfarlane and David Kenneth Macfarlane (incorporated
            by reference to Exhibit 10.12 to the Registration Statement).

10.13       Assignment, dated September 3, 1992 from Darby Simpson Macfarlane to
            the Company regarding Intellectual Property (incorporated by
            reference to Exhibit 10.13 to the Registration Statement).

**10.14     Agreement, dated April 16, 1992, between the Company and IMS 
            Cosmetics, Inc. (incorporated by reference to Exhibit 10.14 to the
            Registration Statement).

10.15       Form of Consulting Agreement with Investors Associates, Inc.
            (incorporated by reference to Exhibit 10.15 to the Registration
            Statement).

10.16*      Consulting Agreement between the Company and Edmund Vimond
            (incorporated by reference to Exhibit 10.16 to the Registration
            Statement).

10.17       The Patent relating to Method for Selecting Personal Compatible
            Colors (incorporated by reference to Exhibit 10.18 to the
            Registration Statement).

10.18       The U.S. Patent relating to Method for Selecting Personal Compatible

            Colors.

10.19       The U.S. Patent relating to Method and Instrument of Selecting
            Personal Compatible Colors.

10.20       The Australian Patent relating to Method of Selecting Personal
            Compatible Color.

10.21       The European Community Patent relating to Method of Selecting 
            Personal Compatible Color.

10.22       Assignment, dated October 30, 1992, between Darby Simpson Macfarlane
            and the Company relating to the Avon litigation (incorporated by
            reference to Exhibit 10.19 to the Registration Statement).

10.23       Know-How Assignment, dated October 30, 1992, from Pink & Peach
            Computer Corp. to the Company (incorporated by reference to Exhibit 
            10.20 to the Registration Statement).

10.24       1992 Stock Option Plan (incorporated by reference to Exhibit 10.23 to
            the Registration Statement).

10.25       Form of Warrant Solicitation Agreement between the Company and
            Investors Associates, Inc. (incorporated by reference to Exhibit 10.24
            to the Registration Statement).

10.27       Consulting Agreement dated January 6, 1995, between the Company and
            Janssen-Meyers Associates, L.P.



                                         50


<PAGE>

<CAPTION>


<S>        <C>                             
10.28       Warrant Agreement dated January 6, 1995, between the Company and
            Janssen-Meyers Associates, L.P.

10.29       Warrant Agreement dated March 13, 195, between the Company and
            Janssen-Meyers Associates, L.P.

22          Subsidiaries of the Company (incorporated by reference to Exhibit 22 to
            the Company's Post Effective Amendment No. 1 on Form SB-1 to the
            Registration Statement filed on January 11, 1994).
</TABLE>





-----------------------------

*    Management contract or compensatory plan or arrangement required to be
     filed as an exhibit.

**   Confidential treatment has been requested with respect to certain
     information contained in this agreement.

+     Filed herewith.

(b)   Reports on Form 8-K:
      --------------------

      Form 8-K, dated March 22, 1996, announcing the Letter of Intent between
      the Company and Fiberoptic Medical Products, Inc.

      Form 8-K, dated April 9, 1996, announcing the expiration of the Letter of
      Intent between the Company and Fiberoptic Medical Products, Inc.

      Form 8-K, dated May 6, 1997, announcing the Company's filing of two
      Registration Statements on Form S-3 (Nos. 333-3818 and 333-3820).



                                         51

<PAGE>

                                     SIGNATURES

      In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

      CHROMATICS COLOR SCIENCES INTERNATIONAL, INC.

      By: /s/ Darby S. Macfarlane         Date: March 28 1997
          --------------------------            -------------
          Darby S. Macfarlane,
          Chief Executive Officer


      By: /s/ Leslie Foglesong            Date: March 28 1997
          --------------------------            -------------
          Leslie Foglesong,
          Treasurer
          (chief financial and 
          accounting officer)

      In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.

      By: /s/ Darby S. Macfarlane         Date: March 28 1997

          --------------------------            -------------
          Darby S. Macfarlane,
          CEO; Chairman of the Board;
          Director

      By: /s/ David K. Macfarlane         Date: March 28 1997
          --------------------------            -------------
          David K. Macfarlane,
          Vice President, Research & 
          Development; Director

      By: /s/ Leslie Foglesong            Date: March 28, 1997
          --------------------------            --------------
          Leslie Foglesong,
          Secretary; Treasurer; Director


                                       52