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                    U.S. SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                   FORM 10-K

(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, 1997

|_| 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.
            -----------------------------------------------------
            (Exact Name of Registrant as Specified in Its Charter)

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

                5 East 80th Street, New York, New York                                         10021
---------------------------------------------------------------                 -----------------------------------------
               (Address of Principal Executive Offices)                                       (Zip Code)
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                                (212) 717-6544
             ----------------------------------------------------
             (Registrant's Telephone Number, Including Area Code)

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

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

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


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

90 days.

                            Yes   X            No

         Indicate by check mark if disclosure of delinquent filers in response
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.|_|

         As of March 26, 1998, 14,717,827 shares of Common Stock, par value
$0.001 per share (the "Common Stock") of the registrant were outstanding and the
aggregate market value of the voting stock (computed based on the average of the
last bid and asked price on such date) held by non-affiliates was approximately
$158,566,740.


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                               Table of Contents
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                                                      PART I
                                                                                                               Page
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Item 1.  Business...............................................................................................  1
Item 2.  Properties............................................................................................. 33
Item 3.  Legal Proceedings...................................................................................... 33
Item 4.  Submission of Matters to a Vote of Security Holders.................................................... 33

                                                      PART II

Item 5.  Market For the Company's Common Equity and Related Stockholder Matters................................. 33
Item 6.  Selected Financial Data................................................................................ 35
Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations.................. 36
Item 8.  Financial Statements and Supplemental Data............................................................. 41
Item 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure................... 52

                                                     PART III

Item 10. Directors and Executive Officers of the Company........................................................ 52
Item 11. Executive Compensation................................................................................. 56
Item 12. Security Ownership of Certain Beneficial Owners and Management......................................... 59
Item 13. Certain Relationships and Related Transactions......................................................... 60

                                                      PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................................ 61

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                                       i


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                                    PART I

         THIS ANNUAL REPORT ON FORM 10-K, INCLUDING ITEM 1 ("BUSINESS") AND ITEM
7 ("MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS"), CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934. WHEN USED IN THIS REPORT, THE WORDS "BELIEVE,"
"ANTICIPATE," "THINK," "INTEND," "PLAN," "WILL BE," "EXPECT" AND SIMILAR
EXPRESSIONS IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS REGARDING
FUTURE EVENTS AND/OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY ARE SUBJECT
TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED IN "RISK FACTORS"
BELOW AT PAGES 22 TO 33, WHICH COULD CAUSE ACTUAL EVENTS OR THE ACTUAL FUTURE
RESULTS OF THE COMPANY TO DIFFER MATERIALLY FROM ANY FORWARD-LOOKING STATEMENT.
SUCH RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHER THINGS, THE AVAILABILITY OF
ANY NEEDED FINANCING, THE COMPANY'S ABILITY TO IMPLEMENT ITS BUSINESS PLAN FOR
VARIOUS APPLICATIONS OF ITS TECHNOLOGIES, INCLUDING MEDICAL AND INDUSTRIAL
APPLICATIONS, THE OBTAINING OF AND COMPLIANCE WITH REGULATORY APPROVALS
APPLICABLE TO APPLICATIONS OF THE COMPANY'S TECHNOLOGY, THE IMPACT OF
COMPETITION, THE MANAGEMENT OF GROWTH, AND OTHER RISKS AND UNCERTAINTIES THAT
MAY BE DETAILED FROM TIME TO TIME IN THE COMPANY'S REPORTS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. IN LIGHT OF THE SIGNIFICANT RISKS AND
UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING STATEMENTS INCLUDED HEREIN, THE
INCLUSION OF SUCH STATEMENTS SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE
COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES AND PLANS OF THE COMPANY WILL BE
ACHIEVED.

Item 1.  Business

General

         Chromatics Color Sciences International, Inc. (the "Company") was
formed in 1984 to research and develop and to commercialize certain intellectual
property rights, proprietary technology and instrumentation in the field of
color science (collectively, the "Intellectual Properties") for marketing to a
variety of industries, including, but not limited to, the medical, dental,
biological, cosmetic, hair color, beauty-aid and fashion industries. The
Intellectual Properties relate to the application of color science technology to
the scientific measurement and analysis of human skin, tissue, fluid, hair,
teeth or biological subject, the classification of such measurements, the
detection and monitoring of conditions affecting the coloration of such human
skin, tissue, fluid, hair, teeth or biological subjects and the scientific
classification and color-oriented organization of various consumer-sensitive
products such as cosmetics, tooth enamel, hair color, hosiery, fashion,
textiles, etc. The Company has incorporated certain of the Intellectual
Properties into a proprietary color measurement system and software marketed for
various commercial applications as the Colormate(TM) System (the "Colormate(TM)
System").

         The Company has developed Intellectual Properties which it believes are
capable of detecting and monitoring certain chromogenic diseases and disorders
which are defined by the Company as those which are diagnosed or monitored by
the coloration of human skin, tissue or fluid being affected ("Chromogenic
Diseases"). In this regard, the Company developed a Colormate(TM)

device to measure the incremental change of the yellow content of the skin color
in newborns to monitor bilirubin infant jaundice.  On July 30, 1997 the Company
received U.S. Food and Drug Administration ("FDA") clearance for commercial
marketing of the Colormate(TM) device for the non-invasive detection and
monitoring of bilirubin infant jaundice in newborns by health care
professionals in the institutional, pediatricians office or home setting (the
"Colormate(TM) Bilirubin Device"). The Company's efforts are currently focused
on seeking to commercialize this medical application of its Intellectual
Properties for non-invasive detection and monitoring of bilirubin infant
jaundice.

<PAGE>

         The Company has also developed its own line of scientifically color
coordinated proprietary cosmetics ("My Colors by Chromatics(TM)") and
scientifically color coordinated proprietary color charts and material
swatchpacks for use in the cosmetics, beauty, dental and fashion industries. The
Company's Colormate(TM) System products, cosmetic line and material swatchpacks
are referred to herein, collectively, as the "Beauty-Aid Products."

         To date, the Company's marketing activities have principally involved
licensing the Intellectual Properties, including conducting laboratory product
chromaticity studies, leasing the Colormate(TM) System and marketing the
Beauty-Aid Products in the cosmetic, hair color, beauty aid and fashion
industries (i) in a national sales program 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 a current agreement
with Gordon Laboratories, Inc. ("Gordon Laboratories") and under certain leases
and licenses to beauty-related businesses and beauty salons. Although the
Company from time to time is engaged in preliminary discussions (including
limited consumer testing and laboratory chromaticity study activities) for use
of its technology in the cosmetics, medical, dental and beauty aid fields,
there can be no assurance that any final agreements will be reached. In this
regard, the Company has recently completed research and development for the
working prototype of a hand-held less expensive light-emitting diode ("LED")
model of the Colormate(TM) System which the Company anticipates will enhance its
marketing efforts (the "Colormate(TM) LED Device").

Color Science

         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. Over the years,
the Company has developed its Intellectual Properties and Colormate(TM) System

for the (i) scientific measurement and classification of human skin color, (ii)
scientific measurements of human hair, tooth, tissue and/or fluid color, (iii)
scientific color coordination of such skin, hair, tooth and/or fluid color
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, tooth
enamel, paint, and textiles, (iv) scientific color measurement in detecting and
monitoring Chromogenic Diseases such as hyperbilirubinemia, and (v) scientific
color coordination of products in relation to other products. The Company
determines such scientific product color classifications by conducting
laboratory product chromaticity studies (the "Chromaticity Studies").

Color Science Applications

         Medical Applications

         Chromogenic Diseases. The Company believes that its Intellectual
Properties are capable of detecting and monitoring various Chromogenic Diseases,
such as bilirubin infant jaundice. In this regard the Company has received U.S.
FDA clearance for commercial marketing of its Colormate(TM) Bilirubin Device
for detection and monitoring of bilirubin infant jaundice through the
non-invasive scientific color measurement of the skin of the newborn. The
Company has also completed feasibility studies pending IRB approval to commence
clinical trials of its Colormate(TM) System for dermatology applications in
determining the level of phototherapy to be used in treating certain skin
disorders and diseases, such as psoriasis, and the patients tolerance to such
phototherapy treatment for patients of all ages. This use of the Colormate(TM)
System most likely will require additional FDA clearance through submission of
a marketing application supported by clinical data.

                                       2
<PAGE>

         Bilirubin Infant Jaundice. Bilirubin infant jaundice occurs in most
newborns because of a combination of increased bilirubin production, a waste
product that is normally produced from the breakdown of red blood cells, and
decreased clearance of bilirubin by the liver. Bilirubin infant jaundice
primarily affects newborn infants within the first three to 10 days of life.
Almost all newborn babies develop some degree of bilirubin infant jaundice and,
very high bilirubin levels, if left untreated, may, in extreme cases, lead to
permanent brain damage or death (kernicterus). Prior to birth, the bilirubin in
an infant is processed by the mother's liver and excreted. Following its birth,
an infant must eliminate bilirubin independent of its mother, and it may take an
infant's system several days to begin eliminating the bilirubin faster than it
is produced. Infants who are born prematurely, who are underfed, or who belong
to certain ethnic groups are at increased risk of developing hyperbilirubinemia
(defined as bilirubin infant jaundice in a range above that which would be
considered average in a newborn). The initial screening of bilirubin infant
jaundice is the observation of the yellowing of the skin by professional care
providers, which is a subjective determination prone to errors due to differing
skin colors. If the initial clinical assessment suggests the possibility of
significant bilirubin infant jaundice, the current procedure requires that a
blood sample be obtained from the infant, usually by lancing the infant's heel
(heelstick). These laboratory measurements are time-consuming, costly and a

traumatic process for the infant. In addition, repeated blood drawing in very
low birth weight babies with extremely small blood volumes may result in the
need for blood transfusion. Since bilirubin infant jaundice normally presents in
infants 36 to 72 hours following birth, infants who are sent home after a short
hospital stay pursuant to managed care guidelines in the United States are at
risk because the condition may not have presented prior to release. Thus, the
Company believes a non-invasive instrument that monitors bilirubin infant
jaundice represents a significant improvement in patient care.

         The Company has developed a Colormate(TM) non-invasive transcutaneous
bilirubinometer device for monitoring bilirubin infant jaundice in newborns of
all races and when under phototherapy. This Colormate(TM) device received FDA
clearance for use in monitoring bilirubin infant jaundice by scientifically
measuring the color of the skin of the newborn and periodically monitoring
incremental changes in the skin color. The FDA-cleared device includes the
Colormate(TM) device for monitoring bilirubin infant jaundice when operated
using external power sources with a computer and printer, and when operated as a
battery-operated hand-held, optional computer assisted device (collectively,
with the Company's disposable calibration components, hereinafter referred to as
the "Colormate(TM) Bilirubin Device"). The Colormate(TM) Bilirubin Device is a
proprietary color measurement instrument containing a light source and optical
filters. Color measurements are obtained from an infant by placing the
Colormate(TM) Bilirubin Device on different physical sites of the newborn for
5-10 seconds. Accuracy of the color measurements are ensured by a proprietary
disposable color-calibration and verification standard used prior to each baby's
measurement. Each color measurement of the skin is analyzed by the Company's
proprietary technology to provide an estimate in mg./dl. correlating to the
newborn's serum bilirubin concentration within a clinically useful range.

         The Company also has recently completed development of the working
prototype for a less expensive hand-held, LED version of the Colormate(TM)
Bilirubin Device (the "Bilirubin LED Device") that could be used for monitoring
bilirubin infant jaundice, subject to additional clinical testing and further
FDA review and clearances. The Company recently received approval from Mt. Sinai
Hospital (New York City), Elmhurst Hospital (New York City) and William Beaumont
Hospital (Detroit) to commence such clinical trials of the Bilirubin LED Device.
The Company intends to begin the clinical testing of the Bilirubin LED Device in
the second quarter of 1998.

         The Bilirubin Project. Since 1988, the Company has been engaged with
Mt. Sinai Hospital, and more recently with Elmhurst Hospital in clinical
research studies (the "Bilirubin Project") involving the use of the
Colormate(TM) Bilirubin Device in the detection and monitoring of bilirubin
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) Bilirubin Device 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) Bilirubin Device 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

Hospital 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 disorder).

                                       3
<PAGE>

         In January 1997, the Company commenced multicenter studies of the
Colormate(TM) Bilirubin Device for monitoring bilirubin infant jaundice at Mt.
Sinai Hospital and Elmhurst Hospital, and in February 1998 commenced such
studies at William Beaumont Hospital. The Company also received institutional
review board ("IRB") approval to commence such studies at Parkland Hospital
(Dallas).

         FDA Clearances. In June 1996, the Company retained government
regulatory consultants and legal counsel to oversee compliance with applicable
federal and state regulations for commercialization of the Colormate(TM)
Bilirubin Device, and for complying with any applicable European Community and
other foreign government requirements. The initial clinical studies conducted at
Mt. Sinai Hospital were completed with positive results and on November 14,
1996, the Company filed its application with the FDA for the medical application
of its technologies, specifically, the non-invasive detection and monitoring of
bilirubin infant jaundice. On July 30, 1997, the Company received confirmation
of marketing clearance pursuant to a "substantial equivalence" determination
order from the FDA's Center for Devices and Radiological Health (the "CDRH"),
authorizing the Company to commercially distribute the Colormate(TM) Bilirubin
Device in the United States. The "substantial equivalence" order states that the
Company must comply with all relevant statutes enforced by and regulations
promulgated by the FDA, including Quality System Regulation ("QSR")
requirements, labeling, and the statutory prohibitions against adulteration and
misbranding. The order also states that the Colormate(TM) Bilirubin Device is a
"Class II device" which may be subject to additional "special controls." The
Company intends to comply with any applicable requirements and special controls
for purposes of commercial distribution. At this time, the Company is unaware of
any applicable special controls.

         The Company's FDA market clearance authorizes use of the Company's
technology as an aid to the physician in monitoring the status of newborn babies
for the development of hyperbilirubinemia. Following a physician's examination
of a newborn within the first hours of birth, newborn babies would be measured
initially and monitored periodically by the Colormate(TM) Bilirubin Device for
incremental changes in the yellow content of their skin color. Because the
Colormate(TM) Bilirubin Device can provide effective non-invasive monitoring of
bilirubin infant jaundice, 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, because the
medical community is relatively slow to adopt new technologies, there can be no
assurance that practitioners will perceive a need for, or accept, the Company's
technology, or be willing to commit funds to its development or the purchase of
any such completed technology. The Company intends to market the medical
application of its Intellectual Properties for the monitoring of bilirubin
infant jaundice through international medical distributors, to hospitals,
pediatricians and home health care facilities. See "Proposed Marketing Plan",

"Government Regulations" and "Risk Factors."

Potential Market for Colormate(TM) Bilirubin Device

         In September 1997, the Company released the results of market research
studies, which analyzed the existing market for methods currently used to
monitor hyperbilirubinemia in newborn infants in the United States and in the
developed countries of Europe, South America and Canada combined, and Asia. The
study indicated that the World Health Organization published current annual
birthrate is approximately 4,000,000 births in the United States, with
approximately 10% of these births being premature infants. The Company estimates
that individual bilirubin heelstick blood tests on newborn infants, which are
not part of a general panel blood test, total approximately 15,000,000 tests
performed annually in the United States, based on data made available by the
World Health Organization, the American Academy of Pediatrics, independent
market studies commissioned by the Company and business proposals from potential
marketing partners. Internationally, using the World Health Organization birth
rates, independent market studies and research obtained from companies currently
marketing neonatal medical devices in foreign countries, the Company estimates
that the current European market for infant bilirubin tests is approximately the
same size as the United States; South America and Canada combined represent
approximately 25% of the United States market size, and the Southern Chinese and
entire Japanese markets combined represent approximately the same size of market
as the United States.

         The Company believes that published fees charged for heelstick
bilirubin blood tests, not part of a panel test, range between $22-$34 per test
in the United States. Assuming a $22 fee, the Company estimates that
approximately $330 million was spent in 1996 on monitoring bilirubin infant
jaundice in the United States.

                                       4

<PAGE>

         In the United States, patients, hospitals and physicians who purchase
medical devices, generally rely on third-party payors, principally federal
Medicare, state Medicaid and private health insurance plans, to reimburse them
for all or a portion of the cost of the medical device. Reimbursement for
devices that have received FDA clearance has generally been available in the
United States. The Company has obtained confirmation from the Department of
Coding of the American Medical Association ("AMA") that the same code used for
the reimbursement of laboratory blood tests used to monitor bilirubin infant
jaundice is permissible for use in obtaining reimbursement for tests using the
Colormate(TM) Bilirubin Device. The Company believes this confirmation will be
an important factor in its pricing structure in the United States. The Company
is unable to predict what changes will be made in the reimbursement methods
utilized by third-party health care payors. Although the Company anticipates
that patients, hospitals and physicians will justify the use of the
Colormate(TM) Bilirubin Device by the attendant cost savings and clinical
benefits that the Company believes will be derived from the use of the
Colormate(TM) Bilirubin Device, there can be no assurance that this will be the
case. Furthermore, the Company would be adversely affected by changes in
reimbursement policies of governmental or private health care payors. See "Risk

Factors."

         In addition, since receiving FDA marketing clearance in the United
States, the Company has undertaken the procedures to obtain required
international regulatory clearances for its Colormate(TM) Bilirubin Device. If
the Company obtains the necessary foreign regulatory approvals, market
acceptance of the Company's products in international markets will be dependent
in part, upon the availability of reimbursement within prevailing health care
payment systems. See "Risk Factors."

         Once the Company's Colormate(TM) Bilirubin Device complies with all
laws of the FDA for marketing, including QSR manufacturing requirements and any
special controls, the Company actively will market its Colormate(TM) Bilirubin
Device to the medical field. See "Proposed Marketing Plan".

         Cosmetic, Fashion, Beauty Aid and Haircolor Applications

         In the early 1980s, a number of authors, fashion consultants and retail
companies promoted the concept of marketing cosmetics 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 product colors and of product colors to
other product colors, is not dependent on the popularity of any given fashion
style or trend. The Company's color measuring instrument permitted 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.

         Prior to June 1991, the Company's marketing activities principally
involved licensing the Intellectual Properties, including conducting
Chromaticity Studies, leasing the Colormate(TM) System and marketing the
Beauty-Aid Products primarily in the cosmetic, hair color, beauty aid and
fashion industries with nationally recognized cosmetics and textile companies,
such as the Company's national sales program with Avon Products, Inc. ("Avon"),
and limited test marketing programs with Clairol Inc. ("Clairol"), and Hanes
Hosiery Inc. ("Hanes"). In addition, from 1994 to 1996, the Company conducted a
limited consumer testing project for hair color analysis with Clairol and Regis
Corp., a U.S. beauty salon chain ("Regis"). See "Test Marketing History." The
Company also entered into leases and licensing agreements with respect to its
Colormate(TM) System with Gordon Laboratories Inc. ("Gordon Laboratories") and
IMS Cosmetics, Inc. ("IMS"), as well as with various beauty-related businesses
and beauty salons. In this regard, the Company recently completed its line of
custom blended foundations for Gordon Laboratories, and has completed with IMS
its new line of foundations, lipsticks and blushes.

         Although the Company from time to time has been engaged in preliminary
discussions (including limited consumer testing and Chromaticity Study

activities) for use of its technologies in the cosmetics and beauty aid fields,
until the Company completes successful marketing and distribution of its
Colormate(TM) Bilirubin Device, the Company does not expect to engage in
significant additional efforts in the cosmetic and beauty aid industry and has
temporarily
                                       5
<PAGE>

reduced active marketing of its cosmetics products. There can be no assurance
that the Company will continue such efforts, or that any final agreements will
be reached. However, the Company recently completed research and development for
a working prototype of a less expensive, hand-held, LED version of the
Colormate(TM) unit, the Colormate(TM) LED Device, which the Company anticipates
will enhance its eventual marketing efforts in these non-medical industries
once the prototype is available for review by potential licensees. See "Risk
Factors" and "Proposed Marketing Plan."

         Other Potential Medical and Dental Applications

         In addition to its FDA-cleared device for the monitoring of bilirubin
infant jaundice, the Company believes that the Intellectual Properties and
Colormate(TM) System have commercial applications in (i) health care relating to
the non-invasive detection and monitoring of certain Chromogenic Diseases, such
as skin diseases, tuberculosis and anemia, and (ii) dental care (i.e., the color
matching of teeth and tooth enamel). Additional medical applications for the
Intellectual Properties require extensive and lengthy clinical testing and will
be subject to various federal and state regulatory requirements, including FDA
clearances and approvals and may be subject to comparable foreign regulatory
approvals to the extent the Company markets such applications abroad. See "Risk
Factors" and "Government Regulations."

         The Company is engaged in ongoing research and development relating to
additional potential medical applications of its Intellectual Properties, has
completed feasibility studies with Dr. Mark Lebwohl, Professor and Chairman,
Department of Dermatology in New York City, and pending IRB approval from Mt.
Sinai Hospital intends to commence clinical trials of the Colormate(TM) System
for dermatological use in determining the appropriate levels of phototherapy to
treat various skin diseases and patient tolerance for such levels of
phototherapy by quantifying the amount of pigmentation and hence,
photo-protection in the skin of patients. This dermatological application of the
Company's proprietary technology and device would be for patients of all ages
and would be used in determining dosages of ultra violet light (phototherapy
treatment) used to treat patients for a variety of diseases including
psoriasis, excema, cutaneous T-cell lymphoma, vitiligo, and others. Post
inflammatory hyperpigmentation also would be a condition subject to monitoring
by the Colormate(TM) System. The noninvasive measurement of the skin by the
Company's Colormate(TM) System will be tested and verified against minimal
erythema dose-testing including the Fitzpatrick skin type test.

         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. The Company has no immediate plan to commence such studies for
the detection and monitoring of tuberculosis until commercialization of the
Colormate Bilirubin Device is complete. Clinical trials for FDA clearance will
be required for use of the Company's technology for the detection and monitoring
of tuberculosis, and there can be no assurance this application will have
commercial applications or generate revenue for the Company.

         In 1990, the Company concluded a feasibility study for Dentsply, Inc.,
a dental supply company, for use of the Intellectual Properties and
Colormate(TM) units in the color measurement and matching of human tooth color
and tooth enamel color for dentures, bonding, inlays and caps, for use by
dentists and dental laboratories. This study concluded that the Colormate(TM)
units could accurately and reproducibly measure the colors of both human teeth
and tooth enamels, but needed further design research and engineering studies to
develop a stabilized housing system for such a small area of measurement. The
project was discontinued by both companies at that time due to an inability to
agree on financial terms for the project. The Company is in preliminary
discussions with dental supply distribution companies with respect to the
possible development of housing prototypes for dental applications and the
marketing of such application. There can be no assurance that the Company will
reach agreement with respect to this 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) System for the color analysis of
tooth enamel, the Company has not test marketed the Colormate(TM) System or the
Intellectual Properties in any field other than the cosmetics industry. Except
in connection with the Bilirubin Project and certain related research conducted
at hospitals, the Company has not test marketed its Colormate Bilirubin Device
for medical application. There can be no assurance that the Colormate(TM) System
or the Intellectual Properties will be found to have commercial medical or
dental markets or commercial markets in other fields. See "Risk Factors."

         Other Potential Applications

                                       6

<PAGE>

         The Company believes that the Intellectual Properties and Colormate(TM)
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) 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)
System for such application, because the Company has been able to mass

manufacture its color measurement technology, thereby taking advantage of the
economies of scale. In addition, the Colormate(TM) System provides
machine-to-machine stability and reproducibility (i.e., that each machine will
achieve results consistent with that of other machines), whereas the competing
color measurement instruments available today generally cannot produce such
consistent machine-to-machine results without complex inter-machine calibration
adjustments. See "Manufacturing" and "Risk Factors."

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 1983, 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. See "Intellectual Properties, Patents and Patent
Applications Pending."

         Between 1984 and 1986, the Company developed the first version of the
Colormate(TM) unit, a color measuring instrument that incorporated a computer,
an industrial color measurement instrument, a printer and software incorporating
certain of the Intellectual Properties, including the Chromaticity Studies.
These Intellectual Properties and instrumentation would 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 constitute part of the
Company's Intellectual Properties for use in various commercial applications.
The skin color categories can, for non-medical 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 first Colormate(TM) unit 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) units 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 first Colormate(TM) 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) units in connection with the Avon
Project. See "Avon Project and Litigation," "Manufacturing," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" 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) System for skin color measurement for (i) medical
application in detecting and monitoring certain Chromogenic Diseases (such as
hyperbilirubinemia), defined by the Company as those where skin coloration is
symptomatic of disease or disorder and (ii) for skin color compatibility to
product colors, and (iii) for product color to product color compatibility in
the dental and printing industries.

                                       7
<PAGE>

         The Company has completed both the new housing and related packaging
for its Colormate(TM) Bilirubin Device. The Company also recently completed
development of the Bilirubin LED Device that could be used for monitoring
bilirubin infant jaundice, subject to additional clinical testing and possible
further FDA review and clearance. The Company recently received IRB approval
from Mt. Sinai Hospital, Elmhurst Hospital and William Beaumont Hospital to
commence clinical trials of the Bilirubin LED Device. The Company is also
engaged in ongoing research and development relating to additional potential
medical application of its Intellectual Properties, and is awaiting IRB approval
from Mt. Sinai Hospital, after completing feasibility studies to commence
clinical trials of the Colormate(TM) System for dermatological use in
determining the appropriate levels of phototherapy to treat various skin
diseases for patients of all ages, such as psoriasis, and patient tolerance for
phototherapy in treating various skin diseases.

         Since the IPO, research and development and technical expenses have
been primarily incurred in connection with (i) the Bilirubin Project, including
the preparation and prosecution of the FDA 510(k) submission, and regulatory
requirements for commercial distribution, (ii) conducting preliminary research
and, until June 1995, feasibility studies for clinical tests at Elmhurst
Hospital regarding use of the Intellectual Properties to diagnose tuberculosis,
(iii) applying the Intellectual Properties to develop custom blended cosmetic
foundations and hair color applications, (iv) conducting research for
development of working prototypes of the Colormate(TM) externally powered units
and mass-manufacture prototypes of the Colormate(TM) hand-held units for medical
application, (v) conducting research for development of a less expensive,
hand-held, LED version based on the Colormate(TM) portable units and (vi) the
potential dermatological application discussed above. 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 second quarter of 1998 under arrangements with
Gordon Laboratories. Although the Company does not believe that further basic
technological developments are required for the medical applications being
targeted by the Company, refinements of the Intellectual Properties embodied in
the software are required, and hardware housing manufacturing specifications
will need to be implemented, to conform with government regulated hospital
requirements. The Company believes that any such refinements will be within its
current technological expertise. There can be no assurance that the Company's
efforts will be successful or that all requisite federal, state or foreign
regulatory approvals or clearances will be obtained.

Intellectual Properties, Patents and Patent Applications Pending


         The Company owns U.S. Patent No. 4,909,632 expiring in 2007 entitled
"Method For Selecting Personal Compatible Colors," U.S. Patents Nos. 5,311,293
(expiring in 2007), 5,313,267 (expiring in 2011) both entitled "Method and
Instrument For Selecting Personal Compatible Colors" and 5,671,735 (expiring in
2014) entitled "Method and Apparatus for Detecting and Measuring Conditions
Affecting Color. The Company has developed intellectual property rights in color
analysis, calibration and verification in a number of fields including medical,
biological, dental, cosmetic and materials testing. The intellectual property
rights include trade secrets, know how and 14 pending United States patent
applications. The Company also has filed patent applications in a number of
foreign jurisdictions which correspond, at least in part, to the Company's
United States patents. The Company has been granted European Patent No. 0446512
entitled "Method for Selecting Personal Compatible Colors." That European Patent
has been nationalized in Austria, Belgium, France, Germany, Great Britain,
Italy, Luxembourg, The Netherlands, Spain, Sweden and Switzerland and
Liechtenstein and registered in Singapore. The Company also has Australian and
Mexican patents corresponding, at least in part, to its U.S. Patent No.
4,909,632, Taiwanese and Colombian patents corresponding, at least in part, to
its U.S. Patent No. 5,313,267 and two Taiwanese patents corresponding at least
in part to its U.S. Patent No. 5,671,735 (collectively, together with the United
States patents, the "Patents"). The Company has not yet been granted any other
foreign patents for its Intellectual Properties.

         The proprietary information claimed by the Patents includes, among
other things: (i) a method of detecting a medical condition that involves a
symptomatic, detectable change in a test subject's skin coloration, such as a
method of detecting and monitoring bilirubin infant jaundice in an infant test
subject, (ii) a method and instrument for identifying skin color and categories
of individuals, (iii) a method of determining color compatibility of an
individual's skin with non-skin matter and (iv) a method of assigning a skin
color compatibility classification to non-skin matter and color charts and
sample assemblages made by that method. Proprietary information claimed by the
Patents is incorporated in the proprietary software and measurement system used
in the Colormate(TM) units.

                                       8
<PAGE>

         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(TM)". Further, the Company believes it has copyright
protection for all of the software used in the Colormate(TM) System. After the
respective expiration date of each of the Company's patents, the proprietary
technology and instrumentation disclosed in each Patent will be available for
use by others without compensation to the Company, unless protected by the
claims of other U.S. patents that may be issued to the Company. The Company has
not applied for patent protection for many aspects of the Intellectual
Properties (i.e., its proprietary trade secrets and other confidential
information). The Company typically imposes on its consultants, key employees
and advisers confidentiality obligations in connection with their employment,
consulting or advisory relationship with the Company. See "Risk
Factors--Protection of Intellectual Property."


Colormate(TM) Products

         The Colormate(TM) units. The Colormate(TM) unit is principally a
scientific color measurement instrument to be held against a subject's skin,
hair, teeth, or sample, a series of filters and a computer and related
proprietary software all housed in a portable briefcase. The color measurement
instrument used within the Colormate(TM) unit or as a hand-held battery operated
instrument is a ubiquitous unit utilized in the Company's medical, cosmetic and
other applications. The instrument is held against the subject's skin, hair,
teeth or sample and performs scientific color measurement of coloration and
luminosity. In skin color analysis, the software then analyzes the color
measurements so obtained and assigns the subject to one of the approximately 200
scientific skin color categories identified by the Company through its research
and development effort. In the medical application for monitoring bilirubin
infant jaundice, the instrument measures the incremental yellow content of the
skin and provides a numerical index in milligrams/deciliter correlating to the
serum bilirubin concentration within a clinically useful range.

         In the beauty-related applications, the Colormate(TM) unit matches each
skin color type to a range of scientifically pre-tested compatible product
colors. The unit is equipped with a printer and can provide the subject with a
record of his or her skin color category and color compatible shades of specific
products (including the Company's cosmetic products) appropriate for that skin
color category and other product colors. The Colormate(TM) units also can be
used to perform Chromaticity Studies of various product lines in manufactured or
applied forms (e.g., tooth enamel, hair coloring, hosiery, other cosmetic lines)
on behalf of licensees. The Colormate(TM) unit was used in this capacity for
Avon, was test marketed in this capacity for Hanes, Clairol and Regis, and is
currently being used in this capacity in tests being conducted for IMS and under
contract with Gordon Laboratories. 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.

         The Company has completed the new housing and related packaging for its
Colormate Bilirubin Device for detecting and monitoring bilirubin infant
jaundice, which has FDA clearance for commercial marketing. Of the 2,000
Colormate(TM) units leased to Avon in 1988, the Company negotiated the return of
1,947 units to the Company during the Avon litigation in July 1991, of which
approximately 1,400 units are available for commercial use. Sixty-two of these
units are in commercial use in beauty salons or beauty-related installations
located in the United States and internationally. Of the 1,338 Colormate(TM)
units remaining, 300 units have been rehoused or repackaged and will be
available for use in monitoring bilirubin infant jaundice once all FDA marketing
regulatory requirements are met. The balance are being completed on an ongoing
basis. Thereafter, the Company will need to outsource the production of such
components by subcontracting to third-party manufacturers. See "Manufacturing."

         The Company has conducted research and development and developed
engineering specifications regarding a hand-held LED version of the
Colormate(TM) System. This version may be marketed for medical use after
conducting further clinical testing and is subject to FDA clearance for this
Bilirubin LED Device. The Company recently received approval from Mt. Sinai
Hospital, Elmhurst Hospital and William Beaumont Hospital to commence clinical

trials of the Bilirubin LED Device. For non-medical applications, the
Colormate(TM) LED Device may be marketed in various industries including the
dental, beauty aid and fashion industries and also may be marketed directly to
consumers for home and personal use. The Company expects the new LED versions
will also be capable of being manufactured at a cost substantially less than the
cost incurred in manufacturing the Company's existing Colormate(TM) units.

                                       9
<PAGE>

         Cosmetics Line. The Company previously marketed its cosmetics, My
Colors by Chromatics(R), through the use of the Colormate(TM) units. The
previous 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 a new line as discussed below. See Note 1 of
Notes to Financial Statements.

         The Company has developed 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. The Company anticipates marketing the new
line in the second quarter of 1998. The Company believes the new cosmetics line
will be comparable in quality and performance to cosmetics sold in leading
department stores, but generally will be priced lower than the cosmetics sold at
the prestige end of the market. In addition, in conjunction with the Gordon
Laboratories contract, the Company has completed 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," and Note 1 of
Notes to the Financial Statements. To date, the Company has received
insignificant revenues from cosmetics sales other than in connection with the
Avon Project. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."

         The Colormate(TM) 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) 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.

         Swatch Packs. The Company has marketed, through the use of the
Colormate(TM) units, 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 Avon. Sales
revenues from swatch packs in 1997 were insignificant.

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) units with Clairol, Hanes and Bloomingdales. However, the Clairol
test terminated as a result of failure to reach definitive agreement on
licensing terms, and the Hanes and Bloomingdales tests were terminated when the
Company entered into a license agreement with Avon, which required the Company
not to compete in the department store market.

         From the termination of its national marketing campaign with Avon 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, including Proctor & Gamble, Clairol, Regis and Mary
Kay. However, no definitive agreement was reached between the Company and

                                      10

<PAGE>

         any of the parties. The Company from time to time 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 1996 contract with Gordon
Laboratories. Under this contract, the Company has granted a license to Gordon
Laboratories for its Colormate(TM) units and related proprietary technology for
custom blended foundation cosmetic products in the retail specialty store
market. The Company and Gordon Laboratories recently completed the new custom
blended foundation line.

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

         Manufacturing


         Medical. One element of the Company's business strategy is to outsource
the production of the components and final assembly of the Colormate(TM)
Bilirubin Device (including the associated disposable calibration standard
components) by subcontracting under arrangements with third-party manufacturers.
The Company is presently negotiating with certain third-party manufacturers for
the production of the light sensors, disposable calibration standard components
and hardware components of the Colormate(TM) Bilirubin Device. The Company
believes, although there can be no assurance, that it will be able to outsource
the production and assembly of additional Colormate(TM) units, including for
custom application use, such as monitoring for bilirubin infant jaundice, at
commercially marketable prices. The Company has limited experience in
outsourcing the production of such products in the volumes that would be
necessary for the Company to achieve significant commercial sales, but
demonstrated its ability to do so when it arranged for mass manufacturing of its
Colormate(TM) units for Avon. The Company believes, based on discussions with
suppliers of components used in its Colormate(TM) Bilirubin Device and published
price lists, that the components can be purchased in quantities of 1,000 or more
on terms acceptable to the Company. However, there can be no assurance the
Company will be able to obtain such terms or order in such quantities, and
manufacture of limited quantities of the Colormate(TM) units would be
significantly more expensive.

         The Company may encounter various problems in establishing and
maintaining manufacturing relationships and/or operations, resulting in
inefficiencies and delays. Specifically, companies often encounter difficulties
in scaling up production, including problems involving production yield, quality
control and assurance, and shortages of qualified personnel. In addition, the
manufacturing facilities which the Company retains in anticipation that it may
manufacture its Colormate(TM) products for medical applications in the future
will be subject to FDA QSR requirements and other regulatory requirements, and
international quality standards (such as ISO 9001) and other regulatory
requirements. Difficulties encountered by the Company in subcontracting to
third-party manufacturers, scaling up production or failure by the Company to
utilize manufacturing facilities in accordance with FDA requirements,
international quality standards or other regulatory requirements, could result
in a delay or termination of production or regulatory enforcement action, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Risk Factors."

         The Company believes that its relations with the parts manufacturers
and assemblers of the Colormate(TM) units held in its inventory are good and the
Company believes that it will be able to obtain any necessary parts
manufacturers or assemblers on terms acceptable to the Company. The Company
intends initially to retain the services of one medical device manufacturer in
order to subcontract production of the Colormate(TM) Bilirubin Device. To the
extent the Company does so it will be reliant on this sole source manufacturer.
Although the Company believes that a number of manufacturers are capable of
manufacturing and assembling the Colormate(TM) Bilirubin Device, any change in
manufacturers, or the retention of additional subcontractors, following
selection of the initial manufacturer could result in additional costs and
delays. See "Risk Factors."

         To the extent the Company successfully markets the Colormate(TM)
Bilirubin Device for medical application, the Company initially will use the

nonproprietary and proprietary components of a portion of the existing
Colormate(TM) units in its possession for the production of a limited number of
such devices for early stage marketing and sales efforts and for commercial use.
Thereafter, the Company will outsource the production of such components of the
Colormate(TM) Bilirubin Device by subcontracting with third-party manufacturers,
subject to QSR requirements. To the extent the Company obtains any required FDA
clearance for and markets the Bilirubin LED Device or markets the Colormate (TM)
LED Device, the Company will need to outsource the production and assembly of
the components of the Bilirubin LED Device and the Colormate (TM) LED Device to
third-party

                                       11
<PAGE>

manufacturers and assemblers. One of the components of the Bilirubin LED Device
and the Colormate(TM) LED Device is available from only one supplier. The
Company would be reliant on that one source of supply and these products would
require a major redesign in order to incorporate any substitute components. For
medical application, while ultimately responsible itself for overall compliance,
the Company intends to require that the third-party manufacturers follow all
relevant manufacturing regulatory requirements, including QSR requirements
applicable to their day-to-day manufacturing operations. See "Risk Factors,"
"Proposed Marketing Plan," and Note 1 of Notes to the Financial Statements.

         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) units. These engineers currently are primarily engaged in
developing the mass manufacture prototypes of the Bilirubin LED Device and the
Colormate(TM) LED Device.

         Cosmetics. 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.

         The Company expects that the new versions of its Colormate(TM) System
will also be capable of being manufactured at a cost substantially less than the
cost incurred in manufacturing the Company's original Colormate(TM) units. See
"Risk Factors," Proposed Marketing Plan," and Note 1 of Notes to the Financial
Statements.

License and Lease Arrangements

         Medical. The Company currently is in negotiations to reach a definitive
agreement with potential partners with respect to the marketing and distribution
of its Colormate(TM) Bilirubin Device for the monitoring of bilirubin infant
jaundice. See "Risk Factors."

         Cosmetics and Beauty Aid. The Company has current leases and licenses
for its Colormate(TM) units and Intellectual Properties for the sale of its
Beauty-Aid Products at 24 beauty salons/beauty-related installations in the

United States. Twelve of these leases expired, but were renewed in 1997, and the
balance proceed, on a month-to-month basis. Outside the United States, the
Company conducts business in Israel and South Africa. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note 1 to Notes to the Financial Statements. 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."

         In April 1992, the Company entered into an agreement with IMS, a
cosmetic marketing, manufacturing and distribution company based in Israel, for
the license of the Intellectual Properties and the lease of 24 Colormate(TM)
units for use in marketing in Israel, the Company's swatch packs and those of
IMS's chromatically balanced cosmetic products developed by the Company through
Chromaticity Studies utilizing the Intellectual Properties. The Company has
continued to extend, on a month-to-month basis, IMS's 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) 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) units. In 1997, the Company did not generate
any lease, license and service contract revenues from IMS, compared to 39% in
1996. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and Note 1 to Notes to Financial Statements.

         Other than the units provided to IMS and Gordon Laboratories, the
Company has leased or intends to lease the Colormate(TM) units for cosmetic use
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 Beauty-

                                       12

<PAGE>

Aid Products for resale to the public to persons leasing the Colormate(TM) units
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) units, in order to stimulate cosmetic sales. The Company's
marketing plan currently anticipates that the skin color analysis capability of
the Colormate(TM) units will be marketed in conjunction with the Beauty-Aid
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 Beauty-Aid Products for at least $25. However, the
Company does not intend to conduct significant marketing efforts in the
cosmetics or beauty aid field until after it has successfully commercialized its
technologies for the detection and monitoring of bilirubin infant jaundice.

Proposed Marketing Plan


         Medical Application. The Company will be introducing its Colormate(TM)
Bilirubin Device at the Pediatric Academic Society Annual International
Exposition in New Orleans in May 1998. The Colormate(TM) Bilirubin Device will
be introduced to the pediatric and neonatal medical community in the "New
Products Section" of the conference featuring only those products newly given
FDA clearances for commercial marketing. Dr. Ian Holzman, Chief of Newborn
Medicine at Mt. Sinai Hospital, will be presenting to the conference his medical
papers on the positive results of the Colormate(TM) Bilirubin Device in
extensive clinical trials conducted on infants of all races and under
phototherapy at Mr. Sinai Hospital and Elmhurst Hospital. The results of
multicenter clinical studies of the Colormate(TM) Bilirubin Device recently
commenced at William Beaumont Hospital in Detroit under Dr. Jeffrey Maisels as
principal investigator will also be presented. There can no assurance that the
medical community will accept the results of the various studies or that they
will recommend or use the Colormate(TM) Bilirubin Device unless medical
practitioners determine, based on experience, clinical data, relative cost, and
other factors, that the Colormate(TM) Bilirubin Device is an attractive
alternative to current traumatic blood tests that have a long history of safe
and effective use. See "Risk Factors."

         The Company intends to exploit the primary markets for its FDA-cleared
Colormate(TM) Bilirubin Device in the detection and monitoring of bilirubin
infant jaundice, which include hospitals, other medical institutions and
pediatricians' offices and home health care facilities in the United States and
other countries around the world. In order to successfully market and sell its
Colormate(TM) Bilirubin Device for monitoring of bilirubin infant jaundice, the
Company must either develop a marketing and sales force or enter into
arrangements with third parties to market and sell this product. Foreign
marketing clearances or approvals also may be necessary. These arrangements
could take the form of lease/license arrangements, marketing and distribution
arrangements, joint ventures or acquisitions. Since the Company lacks
significant experience in the marketing and distribution of medical products,
the Company has elected to focus the sales and distribution of its Colormate(TM)
Bilirubin Device through collaborative partners. The Company believes that by
aligning with larger, more established partners, in specific market segments, it
can utilize its partners' already developed strengths and more effectively and
quickly penetrate the marketplace. The Company's primary efforts to date have
been to build the skill and information base to identify and quantify market
segments to which the Company's technologies can be economically developed and
marketed. The Company believes that selectively establishing strategic
relationships with leading medical companies who have established themselves in
the medical community for the development, introduction, commercialization and
distribution of its products is the appropriate method to begin its efforts in
penetrating the medical market. There can be no assurance that the Company will
be able to successfully enter into marketing and sales agreements with third
parties on acceptable terms.

         If the Company enters into a marketing arrangement with a third party
for the marketing and sale of its Colormate(TM) Bilirubin Device for monitoring
bilirubin infant jaundice, any revenues to be received by the Company from these
products will be dependent on this third party. There can be no assurance that
the efforts of these third parties for the marketing and sale of the
Colormate(TM) Bilirubin Device will be successful. See "Risk Factors -- Need for

Arrangements with Third Parties."

         Cosmetics and Beauty Aid

         The Company will seek to market its Beauty-Aid Products by establishing
relationships with national distributors or other companies that it believes
could effectively market and/or utilize the Company's technology and

                                      13

<PAGE>

Intellectual Property. These relationships could take the form of lease/license
arrangements, marketing and distribution arrangements, joint ventures or
acquisitions. Presently, as the result of its efforts to market commercially the
Colormate(TM) Bilirubin Device for its medical application, the Company has not
initiated any new relationships to distribute its Beauty-Aid Products and has
reduced its marketing efforts in the cosmetics and beauty aid industry. Once the
Colormate(TM) Bilirubin Device is commercially distributed, the Company will
renew its efforts to seek new commercial distribution of its Beauty-Aid
Products.

         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, which, will likely result in lower operating margins on such sales
than on sales effected through commissioned sales representatives. 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) units 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) 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 completed its inventory of a new line of chromatically
balanced and color coordinated cosmetics, which factors the Company believes
(although there can be no assurance) may enhance revenues from the
beauty-related installations once marketing efforts in these sectors are
renewed.

         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, particularly in the medical industry, the Company will need to
develop additional marketing skills, and continue to incur significant expenses

for sales and marketing activities and in order to hire finders, distributors
and new personnel, including consultants. There can be no assurance the
Company's marketing plans will be successful. See "Competition" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

Competition

         Medical Industry

         The medical device industry in general is intensely competitive. Once
the Company completes its compliance with FDA manufacturing requirements and
begins to market and distribute its Colormate(TM) Bilirubin Device for detecting
and monitoring bilirubin infant jaundice, the Company will compete with other
providers of bilirubin infant jaundice diagnostic and monitoring products.

         As the Company implements its business plan to commercialize the
medical application for its Intellectual Properties, it will be entering a field
characterized by rapidly changing technology, intense competition and extensive
research and development. The Company will be competing with established
companies which have greater financial, technical, manufacturing, marketing,
research and development and management resources, including companies such as
Minolta Co., Ltd. ("Minolta"), Respironics, Inc., which recently acquired
Healthdyne Technologies, Inc. ("Healthdyne") and SpectRx, Inc. ("SpectRx"),
among others, which the Company understands have actively pursued development of
non-invasive detection and monitoring devices for bilirubin infant jaundice. In
addition, the invasive laboratory blood test detection and monitoring methods
currently in use for bilirubin infant jaundice, have already achieved acceptance
by and are in widespread use in the medical community, unlike the Company's
proposed methods. See "Risk Factors."

         The Company believes that Minolta has developed a screening device to
measure the amount of bilirubin in the skin of a newborn infant and whether a
serum bilirubin measurement is required. The Company believes that the
measurements obtained by the Minolta device, unlike the Colormate(TM) Bilirubin
Device, are not used when the

                                       14

<PAGE>

infant is being treated by phototherapy for hyperbilirubinemia, and are affected
by the infant's race and skin color, which the Company believes significantly
limits its use in a heterogeneous population. As a result, the Company believes
that the Minolta device is currently in limited use in the United States and
that it is not used at all for infants who are receiving phototherapy. There can
be no assurance that Minolta will not effect improvements to its device in the
future to overcome these apparent limitations. See "Risk Factors."

         Based on public filings, the Company believes that in June 1996,
SpectRx entered into a collaborative arrangement with Healthdyne in which
Healthdyne is responsible for regulatory approval and sales of SpectRx's device
for detecting bilirubin infant jaundice in the United States and Canada. Based
on these filings SpectRx's bilirubin infant jaundice device is intended to be a

hand-held instrument, which incorporates a microspectrometer to collect
spectroscopic information from the infant's skin. As of September 1997, SpectRx
reported that it had only tested prototypes of its device and expected to begin
clinical testing to eventually file 510(k) premarket notification with the FDA
for clearance to market its device in the near future. There can be no assurance
that SpectRx and Healthdyne will not complete clinical testing of their infant
jaundice devices in the near future, receive FDA clearance and begin to
commercially market its device in the United States. See "Risk Factors".

         The Company's success depends in large part on the acceptance by the
medical community of the Company's new technology. There can be no assurance
that the Colormate(TM) Bilirubin Device will replace any currently used
detection methods. Furthermore, many of the Company's competitors have
substantially greater financial, research, technical, manufacturing, marketing
and distribution resources than the Company and have greater name recognition
and lengthier operating histories in the health care industry. There can be no
assurance that the Company will be able to effectively compete against these and
other competitors, including those competitors who intend to promote their
versions of non-invasive devices. Furthermore, there can be no assurance that
the Company's competitors will not succeed in developing, either before or after
the development and commercialization of the Company's products, devices and
technologies that permit more efficient, less expensive non-invasive monitoring
of bilirubin infant jaundice. It is also possible that one or more
pharmaceutical or other health care companies will develop therapeutic drugs,
treatments or other products that will substantially reduce the prevalence of
bilirubin infant jaundice or otherwise render the Company's products obsolete.
Such competition could have a material adverse effect on the Company's business,
financial condition and results of operation.

         The Company's ability to compete is affected by its product
development and innovation capabilities, its ability to obtain regulatory
clearances, its marketing and manufacturing capabilities, its ability to protect
the proprietary technology of its products, its ability to attract and retain
skilled employees, and, for products sold in managed care environments, its
ability to maintain current distribution relationships and establish new
distribution relationships.

         Cosmetics Industry

         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. Additionally, competition in the cosmetics industry is diverse and
fragmented, but is nevertheless dominated in certain markets by a number of
large, established, well-known companies. 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, 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

                                       15

<PAGE>

questionnaires, material draping techniques and "white card to wrist"
techniques. With these subjective techniques, 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) units
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 with Avon. 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 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) units are easy to
use and virtually automatic, the units do not rely on the operator's color
analysis expertise or require extensive operator training, thereby resulting in
training cost savings.

         Other Applications

         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 had limited experience in marketing
the Intellectual Properties and Colormate(TM) System in other fields, such as
the dental industry. Although the Company intends to retain consultants who will
be able to assist the Company in marketing in such fields, as well as the
medical industry, 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 newer companies that may have developed non-invasive detection and
monitoring devices but that may not have obtained FDA marketing clearance,
already have established certain relationships with large distribution companies
based on other products they have developed and manufactured to date. In
addition, 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) units. These components
employ the same color measurement technology and methodology as do the
Colormate(TM) units when they are equipped with standard non-proprietary
software for industrial application. However, when the Colormate(TM) units are
equipped with certain of the Company's proprietary software programs, they
provide 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)
units 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) units can be marketed at prices less
than those currently charged by such competitors for comparable color
measurement instruments, even in standard industrial applications.

                                       16

<PAGE>

Government Regulations

         Product Regulation. The Company's advertising, sales practices,
cosmetic products and medical products (including the labeling and packaging
thereof) are and will be subject to applicable federal, state and local
regulation (including regulation by the FDA, the Federal Trade Commission, and
the Federal Communications Commission, under 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) units and products abroad. In addition, the research, development,
testing, production and marketing of the Company's medical products are subject
to extensive governmental regulation in the United States at the federal, state
and local levels, and in certain other countries. Non-compliance with applicable
requirements may result in recall or seizure of products, total or partial
suspension of production, refusal of the government to allow clinical testing or
commercial distribution of products, civil monetary penalties, injunction and
criminal prosecution.


         The FDA regulates the development, production, distribution and
promotion of medical devices in the United States. The medical products being
developed for manufacture and sale by the Company will be subject to regulation
as medical devices by the FDA. Pursuant to the Federal Food, Drug and Cosmetic
Act (the "Act"), a medical device is classified as a Class I, Class II or Class
III device. Class I devices are subject to general controls, including
establishment registration, device listing, premarket notification (510(k))
clearance (in some cases), labeling requirements, QSR requirements, prohibitions
on adulteration and misbranding, and reporting of certain adverse events (known
as medical device reporting or "MDR"). In addition to general controls, Class II
devices may be subject to special controls that could include performance
standards, postmarket surveillance, patient registries, guidelines,
recommendations and other actions as the FDA deems necessary to provide
reasonable assurance of safety and effectiveness of the device. Class III
devices must meet the most stringent regulatory requirements and must be
approved as safe and effective by the FDA before they can be marketed. Such
premarket (PMA) approval can involve extensive preclinical and clinical testing
to prove safety and effectiveness of the device and generally is more costly and
time consuming than a 510(k) submission.

         Unless otherwise exempt, all medical devices introduced to the market
since 1976 are required by the FDA, as a condition of marketing, to secure
510(k) clearance or premarket approval through a PMA. A product will be cleared
by the FDA under a 510(k) if it is found to be substantially equivalent in terms
of safety, effectiveness, technology and intended use to another legally
marketed medical device that was on the market prior to May 28, 1976 (that
subsequently did not require a PMA application) or to a product that has
previously received a 510(k) and is lawfully on the market. If a product is not
substantially equivalent to such a medical device, and not otherwise exempt, the
FDA must first approve a PMA application before it can be marketed. An approved
PMA indicates that the FDA has determined the product has been proven, through
the submission of clinical data and manufacturing and other information, to be
safe and effective for its labeled indications. The PMA process typically takes
more than a year and typically requires the submission of significant quantities
of clinical data and supporting information. The process of obtaining a 510(k)
currently takes, on average, approximately four to five months from the date of
submission (based on FDA's fiscal year 1997 figures). However, the review
process for a particular product may be shorter or substantially longer
depending upon the circumstances. Moreover, there can be no assurance that a
510(k) will be cleared. A 510(k) must include submission of supporting
information, including design details and draft labeling, and may be required to
contain safety and efficacy data, possibly from clinical trials. Product
modifications intended to be made to a cleared device also may require filing
and clearance of a new 510(k) submission or filing and approval of a PMA
supplement, during which time the modified product cannot be commercially
distributed.

         The 510(k) clearance order obtained from the FDA's CDRH indicates that
the Company's Colormate(TM) Bilirubin Device is a Class II device, subjecting it
to "general controls" and "special controls." Currently, the Company is unaware
of any special controls applicable to the Colormate(TM) Bilirubin Device. The
Company is not currently developing, manufacturing or distributing any Class III
devices, although it may do so in the future. The Company also is subject to
additional FDA and foreign statutes and regulations and/or may be subject to

additional clearances or approvals to the extent the Company continues its
efforts to test, manufacture and license the Intellectual Properties and lease
the Colormate(TM) units in the medical industries. The Company will also be
subject to regulation by various governmental agencies that regulate direct
selling activities. See "Risk Factors."

                                       17

<PAGE>

         The Company filed its marketing 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. On April 25, 1997 (and confirmed by a April 27,
1997 letter), the Company received a response from the FDA requesting
supplemental information and clarification on its 510(k) submission regarding
the Company's Colormate(TM) Bilirubin Device for the non-invasive monitoring of
bilirubin infant jaundice. On May 23, 1997, the Company filed its response to
such request. Finally, on July 30, 1997, the Company received confirmation of
marketing clearance pursuant to a "substantial equivalence" determination order,
in the form of a letter dated July 24, 1997, authorizing the Company to
commercially distribute its Colormate(TM) Bilirubin Device for non-invasive
monitoring of bilirubin infant jaundice in the United States. While its 510(k)
submission was pending at the FDA, as with any normal 510(k) submission,
commercial marketing of the Colormate(TM) Bilirubin Device in the United States
for the Company's medical application was prohibited. Since receiving its
marketing clearance, the Company has been in the process of ensuring that its
medical device complies with the requisite FDA general controls. Although the
Company has filed its U.S. marketing application and received clearance from the
FDA, with the exception of the 510(k) application, there can be no assurance
that all regulatory clearances or approvals will be obtained for any of the
Company's further proposed medical applications of the Colormate(TM) units.
Delays in obtaining such clearances or approvals could materially adversely
affect the Company's ability to successfully market any such proposed
application. Once the Company complies with the FDA general controls, the
Company will attempt to market its product in the U.S. for the 510(k)-cleared
use.

         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 also must register its facilities as a device
establishment, list its devices with the FDA, and label its devices in
accordance with FDA law. Any third-party manufacturers with which it may reach
agreement must comply with certain QSR requirements and other relevant laws and
regulations in the processing or manufacture of the Products as medical devices.
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 seek civil monetary
fines and criminal penalties.

         Future products developed by the Company and products currently under

development may require FDA clearance through either the 510(k) or PMA
application procedures. There can be no assurance that marketing clearances or
approvals will be obtained on a timely basis or at all. Delays in receiving such
clearances or approvals could have a material adverse effect on the Company.

         The FDA also regulates the commencement and conduct of clinical
investigations to determine the safety and effectiveness of unapproved
investigational devices, including investigations involving new intended uses of
previously cleared or approved devices. Clinical investigations are regulated by
the FDA under the Investigational Device Exemptions ("IDE") regulations. The IDE
regulations include significant requirements that must be met, including but not
limited to informed patient consent, IRB review and approval of research
protocols, reporting obligations to the FDA, recordkeeping requirements and
prohibitions against commercialization of investigational devices. A sponsor
must obtain FDA approval of an IDE application before starting the
investigation, unless the device is found to be a non-significant risk (NSR)
device by the sponsor and each IRB that reviews and approves the study. The FDA,
however, has the authority to determine that a study designated as involving an
NSR device by the sponsor and IRBs involves a significant risk device, and to
require that an IDE application be submitted and approved before the study can
resume. In addition, a study of an NSR device must still comply with the
above-referenced and certain other IDE requirements. A violation of the IDE
regulations can result in a variety of sanctions, such as warning letters,
prohibition against additional clinical research, the refusal to accept data and
criminal prosecution. The Company also may provide devices for use in FDA
approved or recognized clinical trials as a contract manufacturer.

         There can be no assurance that any clinical study will comply with all
elements of the FDA's IDE regulations, that a study will provide evidence of the
safety or effectiveness of the device, or that a study will ultimately result in
the approval of the device.

                                       18

<PAGE>

         It is intended that devices the Company has manufactured in the United
States will be exported by the Company to other countries. Such devices, if not
approved for sale in the United States, are subject to the FDA export
requirements, including restriction on prior distribution of the units for
export in the United States. In order for the Company to market its products in
Europe and certain other foreign jurisdictions, the Company and its distributors
and agents must obtain required regulatory registrations or approvals and
otherwise comply with extensive regulations regarding safety, efficacy and
quality in those jurisdictions. Specifically, certain foreign regulatory bodies
have adopted various regulations governing product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements which differ from or are in addition to those
mandated in the United States. These regulations vary from country to country.
After mid-1998, the Company will be prohibited from selling its Colormate(TM)
Bilirubin Device in Europe until such time as the Company receives the right to
affix the CE mark, which is a symbol of quality and compliance with applicable
European medical device directives. ISO 9001/EN 46001 certification is one
option for pursuing the CE mark under the CE mark certification procedure

requirements. There can be no assurance that the Company will be successful in
obtaining ISO 9001/EN 46001 certification or CE mark rights. Among other things,
the EC Medical Device Directives require reporting of serious injuries or deaths
which may be associated with the use of a medical device to the competent
authority in the country where the incident occurred. Failure to receive ISO
9001/EN 4600 certification, CE mark rights, or other foreign regulatory
approvals could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
the Company will obtain any other required regulatory registrations or approval
in such countries or that it will not be required to incur significant costs in
obtaining or maintaining such regulatory registrations or approvals. Delays in
obtaining any registrations or approvals required to market the Company's
products, failure to receive these registrations or approvals, or future loss of
previously obtained registration or approvals could have a material adverse
effect on the Company's business, financial condition and results of operations.

         The Company plans to outsource its manufacturing responsibilities to a
contract manufacturer, to appropriately register its establishment with the FDA,
and to comply with applicable QSR requirements. The FDA will and state agencies
may inspect the Company periodically to determine whether the Company is in
compliance with the Act and regulations, including, but not limited to,
regulations relating to MDR reporting, product labeling and promotion, and
medical device QSR requirements governing design, manufacturing, testing,
quality control, product packaging and storage practices. The FDA revised the
QSR requirements in 1996 which will increase the cost of regulatory compliance
for the Company.

         A determination that the Company is in material violation of the Act or
FDA regulations could lead to the issuance of warning letters, imposition of
civil or criminal sanctions against the Company, its officers and employees,
(including fines), recalls and product repair, replacement or cost refund to the
user of such products. In addition, if the FDA believes any of the Company's
products violate the law and present a potential health hazard, the FDA, among
other things, could seek to detain and seize products, to require the Company to
cease distribution and to notify users to stop using the product. The FDA could
also seek to close some or all of the Company's manufacturing facilities. Such
actions also could result in an inability of the Company to obtain additional
marketing clearances or approvals.

         Anti-Remuneration Laws. The sale of the Company's products for medical
applications will be subject to the illegal remuneration/"anti-kickback"
provisions of the Social Security Act of 1935, as amended (the "Social Security
Act"), which, among other things, prohibits knowingly and willfully offering,
receiving or paying any remuneration, whether directly or indirectly, in return
for inducing or to induce the purchase of items or services, or patient
referrals to providers of services, for which payment may be made in whole or in
part by Medicare, Medicaid or similar state programs. Violations of the statute
are punishable by civil and criminal penalties and exclusion of the provider
from future participation in the Medicare and Medicaid programs. The Social
Security Act contains exceptions to these prohibitions for, among other things,
properly reported discounts and payment of certain administrative fees to group
purchasing organizations ("GPOs"). Because of the breadth of the statutory
prohibitions, the Secretary of Health and Human Services published regulations
creating "safe harbors" identifying certain practices that will not be treated

as violating the "anti-kickback" provisions of the Social Security Act. While
failure to satisfy all of the criteria for a safe harbor does not necessarily
mean that an arrangement is unlawful, engaging in a business practice for which
there is a safe harbor may be regarded as suspect if the practice fails to meet
each of the

                                       19

<PAGE>

prescribed criteria of the appropriate safe harbor. The enumerated safe harbors
include safe harbors which implement, and further refine, the statutory
exceptions for discounts and payments to GPOs. Because the Company sells some of
its products to customers at prices below list price and in various
combinations, the Company is engaged in giving discounts within the meaning of
the Social Security Act. The regulations require sellers to fully and accurately
report all discounts and inform buyers of their obligations to report such
discounts. The Company also pays administrative fees to certain purchasing
agents within the meaning of the Social Security Act. In order to qualify for
the GPO safe harbor, certain requirements must be met including disclosure of
the existence of the GPO fee arrangement to GPO members and that members are
neither wholly owned by the GPO nor subsidiaries of a parent corporation that
wholly owns the GPO. While the Company believes it is in compliance, there is no
guarantee that the Office of the Inspector General, Department of Health and
Human Services, would view all of the Company's discounts and arrangements with
purchasing agents as meeting all the requirements of the appropriate safe
harbors.

         Several states also have statutes or regulations prohibiting financial
relationships with referral sources that are not limited to services for which
Medicare, Medicaid or other state health care program payment may be made. A
finding of non-compliance with these anti-remuneration laws by federal or state
regulatory officials, including non-compliance with appropriate safe harbors,
could have a material adverse effect on the Company.

         Coverage and Reimbursement. The Company's products are intended to be
purchased or leased by health care providers or suppliers which submit claims
for reimbursement for such products to third-party payors such as Medicare,
Medicaid and private health insurers. Although the Company has no knowledge that
third-party payors will adopt measures that would limit coverage of, or
reimbursement for, its products, any such measures that were applied to the
Company's products could have a material adverse effect on the Company. The
Company has obtained confirmation from the Department of Coding of the AMA that
the same code used for the reimbursement of laboratory blood tests used to
monitor hyperbilirubinemia is permissible for use in obtaining reimbursement for
tests using the Colormate(TM) Bilirubin Device. The Company believes this
confirmation will be an important factor in its pricing structure in the United
States. The Company is unable to predict what changes will be made in the
reimbursement methods utilized by third-party health care payors. Although the
Company anticipates that hospitals and physicians will justify the use of the
Colormate(TM) Bilirubin Device by the attendant cost savings and clinical
benefits that the Company believes will be derived from the use of the
Colormate(TM) Bilirubin Device, there can be no assurance that this will be the
case. Furthermore, the Company would be adversely affected by changes in

reimbursement policies of governmental or private health care payors.

         Health Care Reform. Because the cost of health care delivery has been
rising steadily and because the cost of a significant portion of medical care in
the United States and other countries is typically funded by governmental
insurance programs, there have been a number of government initiatives to reduce
health care costs. Congress and various state legislatures have proposed changes
in laws and regulations that, if ever enacted, could effect major restructuring
of the health care industry. Although many of these proposals may seek to
maintain or expand access to health care services, the common objective of the
proposed legislation is to achieve cost containment in the health care sector.
Changes in governmental support of health care services, the methods by which
such services are delivered, the prices for such services or the regulations
governing such services or mandated benefits all may have a material adverse
effect on the Company. Even if the ultimate impact of any such changes on net
sales is positive, no assurance can be given that the costs of complying with
possible new requirements would not have a negative impact on the Company's
future earnings. No assurance can be given that any such legislation will not
have a material adverse effect on the Company.

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) units, which contributed to the development of the portable
Colormate(TM) units marketed by Avon. On October 15, 1987, the Company entered
into an exclusive master license 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) units, (ii) conducted
proprietary Chromaticity Studies

                                       20

<PAGE>

of Avon's cosmetics line in order to develop Avon's "Avon Color" cosmetics line,
and (iii) granted an exclusive United States license for use of its Intellectual
Properties in certain retail areas. 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) units was paid by the Company from the proceeds of the license
agreement with Avon.

         Avon Litigation. In April 1990, the Company commenced a suit 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 litigation, and
the Company and Avon entered into a stipulation dismissing the Company's case
with prejudice.

Year 2000


         Like many corporations, the Company is reliant on technology. As the
millennium approaches, the Company is preparing all of its computer systems to
be Year 2000 compliant and is reviewing all systems to ensure that they do not
malfunction as a result of Year 2000. In this process, the Company expects to
both upgrade some systems and replace others. The Company currently is
evaluating the total cost of this effort and expects that most of these costs
will be expensed as incurred in compliance with generally accepted accounting
principles. The Company does not expect these costs to be material.

Employees

         The Company currently employs 17 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 of Financial Condition and
Results of Operations."

Recent Developments

         In February 1998, at a special meeting of shareholders held at the
Company's offices in New York, New York (the "Special Meeting"), the
shareholders approved, among other things, a revision to the Company's capital
structure to effect a three-for-two forward stock split of the Company's issued
and outstanding shares of Common Stock (the "Stock Split"). The Stock Split is
effective as of February 13, 1998.

         Additionally, at the Special Meeting, the shareholders approved an
amendment to the Company's Certificate of Incorporation (i) to extend for two
years from December 31, 1998 to December 31, 2000 the expiration date of the
period during which the Company's outstanding Class A Convertible Preferred
Stock can become convertible into Common Stock upon the Company's achieving
certain stock performance or earnings goals, (ii) to extend the date by which
the Company is to call the Class A Convertible Preferred Stock for redemption
from December 31, 1998 to December 31, 2000, (iii) to revise the market price
conversion feature of the Class A Convertible Preferred Stock to provide for
adjustment upon the occurrence of certain events involving the Common Stock,
including stock splits, reclassifications and the payment of stock dividends,
and (iv) to delete from the formula for the calculation of the earnings goal
that needs to be satisfied to trigger the conversion feature of the Class A
Convertible Preferred Stock, extraordinary items and revenues generated by
businesses acquired by the Company.

         Lastly, at the Special Meeting, the shareholders approved an amendment
to the Company's 1992 Stock Option Plan, as amended (the "1992 Plan") to
increase the number of shares of Common Stock with respect to which options may
be granted from 2,000,000 to 3,000,000.

                                       21

<PAGE>


Risk Factors

         Limited Operating History. Until 1986, the Company was principally
engaged in research and development relating to the Intellectual Properties,
Colormate(TM) units and the Company's Beauty-Aid Products. From early 1986
through October 1987, the Company was engaged in limited test-marketing of
certain of the Intellectual Properties and Beauty-Aid Products through its
former licensees. From October 1987 until June 1991, the Company was principally
engaged in the Avon Project. Since 1991, the Company has been engaged in the
research and development of its Colormate(TM) device for the monitoring of
bilirubin infant jaundice, the development of prototypes of additional versions
of the Colormate(TM) unit and the refinement of its technologies for other
applications. From October 1990 to date, the Company has not conducted any
material revenue producing operations and there can be no assurance it will be
able to do so in the future. The Company's business is subject to the risks
inherent in the development of new products using new technologies and
approaches. There can be no assurance that unforeseen problems will not develop
with these technologies or applications, that the Company will be able to
successfully address technological challenges it encounters in its research and
development program or that commercially feasible products will ultimately be
developed and marketed by the Company.

         Operating Losses. The Company has incurred significant losses from
operations for the years ended December 31, 1997 and 1996 ($5,053,100 and
$4,442,300, respectively). The Company anticipates incurring increased operating
expenses as the Company attempts to expand its marketing and sales activity and
otherwise continues to implement its business plan, including its business plan
for medical applications involving the monitoring of hyperbilirubinemia. There
can be no assurance the Company will not continue to incur such losses or will
ever generate revenues at levels sufficient to support profitable operations.

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

         No Assurance of Successful Commercialization of Colormate(TM) Bilirubin
Device. The Company's current ability to generate revenues and to achieve

profitability and positive cash flow in the immediate future substantially will
depend on the successful introduction of the medical application of its
technology to monitor bilirubin infant jaundice. The Colormate(TM) Bilirubin
Device provides a new alternative for the monitoring and screening of bilirubin
infant jaundice, but there can be no assurance that it will gain market
acceptance. There is no assurance that the Company's Colormate(TM) Bilirubin
Device for monitoring bilirubin infant jaundice, or other future medical
applications of the Company's technology, will be capable of being produced in
commercial quantities at acceptable costs, or even if all regulatory and
reimbursement approvals are obtained, be successfully marketed or achieve any
significant degree of market acceptance among physicians, health care payors and
others. To date, except for the FDA clearances, clinical studies and related
information regarding the Company's Colormate(TM) Bilirubin Device for
monitoring bilirubin infant jaundice, the medical community generally has had no
exposure to the Company or its proposed medical application. Because the medical
community is generally relatively slow to adopt new technologies, procedures or
devices, the Company might be unable to gain access to potential customers in
order to attempt to demonstrate the operation and efficacy of its Intellectual
Properties in the medical field. Even if the Company gains access to potential
customers, no assurance can be given that members of the medical community will
perceive a need for or accept the Company's proposed medical application.

                                       22

<PAGE>




         Physicians and other health care professionals will not recommend or
use the Colormate(TM) Bilirubin Device unless they determine, based on
experience, clinical data, relative cost, and other factors, that the
Colormate(TM) Bilirubin Device is an attractive alternative to current traumatic
blood tests that have a long history of safe and effective use. The Company may
need to conduct additional independent studies in order to achieve acceptance in
the medical community. The Company believes that recommendations by physicians
and clinicians will be essential for the market acceptance of these products,
and there can be no assurance that any such recommendations will be obtained. To
the extent the Company is able to market and distribute its Colormate(TM)
Bilirubin Device for non-invasive monitoring of bilirubin infant jaundice, broad
market acceptance of the Company's device may require the training of numerous
physicians and clinicians, and the time required to complete such training could
result in a delay of such market acceptance. Moreover, continued health care
payors' approval of reimbursement for the Company's products will be an
important factor in establishing market acceptance. In addition, purchase
decisions for the device will be greatly influenced by health care
administrators who are subject to increasing pressures to reduce costs. Some
purchasers, such as hospitals, pediatricians and home health care facilities,
also might be reluctant to purchase products from a company that has not
demonstrated the ability to satisfy ongoing delivery requirements. In addition,
hospitals, clinics and pediatricians may be unwilling or unable to commit funds
to the purchase of the Company's proposed medical applications due to
institutional budgetary constraints.


         User acceptance of these products will depend on many factors,
including physician recommendations, the degree, rate and severity of potential
complications, the cost and benefits compared to competing products or
alternative medical treatments, available reimbursement and other
considerations. In addition, the Company's pricing policies could adversely
impact market acceptance of these products as compared to competing products and
alternative treatments. If any of the Company's marketing or development
programs are not successfully completed, required regulatory approvals or
clearances are not obtained, or products for which approvals or clearances are
obtained are not commercially successful, the Company's business, financial
condition and results of operations would be materially adversely affected.

         Presently, the Company conducts its research and development through
its Spokane, Washington office. There can be no assurance that the Company will
be able to successfully address any problems that may arise during the
commercialization process of its Colormate(TM) Bilirubin Device. In addition,
there can be no assurance that any of the Company's products will be
successfully developed, continue to meet applicable regulatory standards, be
capable of being produced in commercial quantities at acceptable costs, continue
to be eligible for third-party reimbursement from governmental or private
insurers, be successfully marketed or achieve market acceptance. If any of the
Company's products for which regulatory approvals or clearances are obtained are
not commercially successful, the Company's business, financial condition and
results of operations would be materially adversely affected.

         Early Stage of Development of Other Potential Medical Applications.
Although the Company has received FDA clearance to commercially market its
Colormate(TM) Bilirubin Device, and has conducted early stage research with
respect to certain other Chromogenic Diseases identified by the Company, the
Company's clinical and research development programs for other medical
applications of its technology have not effectively commenced, and substantial
additional research and development and clinical trials will be necessary before
commercial prototypes of any additional proposed products are FDA-cleared and
produced for other such medical applications. The Company could encounter
unforeseen problems in the development of such other products such as delays in
conducting clinical trials, delays in the supply of key components or delays in
overcoming technical hurdles. There can be no assurance that the Company will be
able to successfully address the problems that may arise during the
development/commercialization process. In addition, there can be no assurance
that any of the Company's products for any such other medical application will
be successfully developed, proven safe and efficacious in clinical trials or
meet applicable regulatory standards and requirements.

         Lack of Medical Marketing and Sales Experience. In order to
successfully market and sell its Colormate(TM) units, including the
Colormate(TM) Bilirubin Device, the Company must either develop a marketing and
sales force or enter into arrangements with third parties to market and sell the
devices. There can be no assurance that the Company will be able to successfully
develop a marketing and sales force or that it will be able to enter into
marketing and sales agreements with third parties on acceptable terms. If the
Company develops its own marketing and sales capabilities, it will compete with
other companies that have experienced and well-funded

                                       23


<PAGE>

marketing and sales operations. In addition, the Company's Colormate(TM)
Bilirubin Device, as well as any future medical applications marketed by the
Company, will compete with existing devices, technologies and methods in
achieving acceptance in the medical community and in attracting support from
independent medical device distribution organizations which sell medical
equipment to the anticipated target market (i.e., hospitals, pediatricians and
home health care services). While the Company believes its Colormate(TM)
Bilirubin Device for monitoring bilirubin infant jaundice is superior to the
existing devices, technologies and methods, no assurance can be given that the
medical community will accept and support the Company's medical device. If the
Company enters into a marketing arrangement with a third party for the marketing
and sale of its Colormate(TM) Bilirubin Device, any revenues to be received by
the Company from these products will be dependent on this third party.

         Lack of Market Penetration in Other Industries. The Company has not yet
achieved commercial market penetration in any industry, and there can be no
assurance the Company will be able to do so in the future. The Company currently
has a limited number of Colormate(TM) units in commercial use. The Company has
not achieved significant levels of cosmetics sales from its Colormate(TM)-unit
locations, and expects based on the cosmetics sales levels achieved per location
to date, that it will have to greatly increase the number of Colormate(TM) unit
installations to achieve significant levels of cosmetics sale revenues. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The Company also believes, based on its operating history since
February 1993, that obtaining such increased cosmetic sales revenue will take
significantly longer to achieve than was originally anticipated. At December 31,
1997, most of the inventory of the Company's cosmetics products was in excess of
requirements based on the recent level of sales. After giving effect to the
$100,000 write off in 1996 and the $75,000 write off in 1997, management
believes no further significant loss will be incurred on the disposition of
inventory. No estimate can be made of a range of amounts of loss that are
reasonably possible should the Company's expectations not be met. There can be
no assurance that no such loss will be incurred upon the disposition of
inventory. However, the Company completed its inventory of a new line of
chromatically balanced and color coordinated cosmetics in the first quarter of
1998, and although there can be no assurance, expects to commence marketing
through Gordon Laboratories its new line of custom blended foundations in 1998.
Although there can be no assurance, the Company believes these factors may
enhance revenues from its beauty-related operations. In order to implement its
marketing plans in the United States and abroad, including in industries in
which the Company does not have prior experience, the Company will have to
develop additional marketing skills and spend proceeds from additional financing
and from the exercise of its Warrants on sales and marketing activities,
including hiring finders and new personnel including consultants, and entering
into arrangements with distribution companies having a national presence. There
can be no assurance the Company's marketing plan will be successful.

         Potential International Operations. The Company believes that sales of
products to customers outside of the United States represents a significant
potential source of growth. Following compliance with applicable foreign
regulatory requirements, the Company expects to market its medical products

internationally through affiliates and distributors. The primary targeted
markets for the Company's products outside the United States are Western Europe,
Canada, Asia and South America. The Company also expects to contract with a
number of foreign manufacturers to provide certain of its sourcing needs for its
medical device.

         Foreign operations are subject to special risks that can materially
affect potential sales, including currency exchange rate devaluations and
fluctuations, the impact of inflation, exchange controls, labor unrest,
political instability, export duties and quotas, domestic and international
customs and tariffs, unexpected changes in regulatory environments, potentially
adverse tax consequences and other risks. Changes in certain exchange rates
could have a material adverse effect on the Company.

         Prior Marketing Attempts. Other than the Company's marketing efforts
with Avon, its current arrangements with IMS and its beauty salon placements,
the Company's own attempts to license and/or lease its Intellectual Properties
and the Colormate(TM) units and to market its Beauty-Aid Products independently
and/or through licensees never proceeded beyond the test marketing stage. There
can be no assurance the Company will in the future achieve commercial leasing of
its Colormate(TM) units and commercial licensing of the Intellectual Properties
or the sale of the Beauty-Aid Products. In addition, other than its installation
of Colormate(TM) units in beauty salons and beauty-related businesses, 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

                                       24

<PAGE>

advertising support. There can be no assurance that without the support of a
marketing partner with financial resources, an advertising budget, market
presence and consumer recognition, the Company will be able to achieve
successful operations. Further, there can be no assurance the Company will ever
develop a commercial market for the licensing or leasing of its Colormate(TM)
units and Intellectual Properties, for the sale of the Beauty-Aid Products or
for any medical applications of its technologies.

         Competition. To the extent the Company implements its business plan to
commercialize a medical application for its Intellectual Properties, it will be
entering a field characterized by rapidly changing technology, intense
competition and extensive research and development. The medical products market
in general is highly competitive. The Company's ability to compete in the
bilirubin infant jaundice market depends primarily on the acceptance by the
medical community of the Company's new technology, which can be influenced by
factors such as price, product quality and features, technical capability,
breadth of product line and distribution capabilities. The Company will be
competing with established companies which have greater financial, technical,
manufacturing, marketing, research and development and management resources
(including companies such as Minolta, Healthdyne and SpectRx, among others),
which have actively pursued development of non-invasive monitoring of bilirubin
infant jaundice. In addition, there will be other companies with which the
Company will compete regarding other potential medical applications which the

Company may pursue. Furthermore, the monitoring methods currently in use for
bilirubin infant jaundice, dermatological diseases and tuberculosis, the
principle diseases for which the Company intends to market or 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.

         Furthermore, many of the Company's competitors have substantially
greater financial, research, technical, manufacturing, marketing and
distribution resources than the Company and have greater name recognition and
lengthier operating histories in the health care industry. There can be no
assurance that the Company will be able to effectively compete against these and
other competitors, including those competitors who intend to promote their
versions of non-invasive devices. Additionally, there can be no assurance that
the Company's competitors will not succeed in developing, either before or after
the development and commercialization of the Company's products, devices and
technologies that permit more efficient, less expensive non-invasive detection
and monitoring of bilirubin infant jaundice. It is also possible that one or
more pharmaceutical or other health care companies will develop therapeutic
drugs, treatments or other products that will substantially reduce the
prevalence of bilirubin infant jaundice or otherwise render the Company's
products obsolete. There can be no assurance that the Company will be able to
upgrade its medical applications and devices to compete with such competitors or
with persons who may in the future develop products or detection methods
competitive with the Company's proposed medical applications and devices.

         Independent medical supply distributors who may be retained by the
Company will distribute other products which may compete with those of the
Company or which would provide greater revenues to such distributors than would
be provided by the Company's products. In addition, many medical supply
companies with which the Company's proposed medical application and device will
compete, and which have significantly greater financial research, technical,
manufacturing, and distribution resources and broader product lines than the
Company, have their own in-house marketing and distribution capabilities and
have established relationships with potential customers for the Company's
proposed medical application, such as pediatricians and hospitals. In addition,
many of the Company's competitors offer broader product lines than the Company,
which may be a competitive advantage in obtaining contracts with health care
purchasing groups. No assurance can be given that the Company will successfully
and effectively market its medical products against these and other competitors
or contract with health care providers.

         The cosmetics industry and fashion industry are particularly sensitive
to changing consumer preferences and demands, which are difficult to predict and
beyond the Company's control. Competition in the cosmetics industry is diverse
and fragmented, but is nevertheless dominated by a number of large, established,
well-known corporations having, among other things, significantly greater
financial, marketing and human resources than the Company. Virtually all of such
companies have in the past marketed, and continue to market, their 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


                                       25
<PAGE>

facilities, unlike the Company. There can be no assurance that consumers will
prefer products based on the Company's scientifically based color
determinations, rather than the products sold by the Company's competitors based
on subjective techniques.

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

         Protection of Intellectual Property. The Company's success may depend
in part on its ability to obtain patent protection for its products and
processes, to preserve its trade secrets, and to operate without infringing upon
the proprietary rights of third parties. The validity and breadth of claims
covered in medical technology patents involve complex legal and factual
questions and therefore, may be highly uncertain. No assurance can be given that
the scope of any patent protection under the Company's current patents, or under
any patent the Company might obtain in the future, will exclude competitors or
provide competitive advantages to the Company; that any of the Company's patents
will not be held invalid if subsequently challenged; or that others will not
claim rights in or ownership of the patents and other proprietary rights held by
the Company.

         The Company's U.S. Patents Nos. 4,909,632 and 5,311,293 expire in 2007;
the Company's U.S. Patent No. 5,313,267 expires in 2011; the Company's U.S.
Patent No. 5,671,735 expires in 2014; after the respective expiration date of
each, the proprietary technology and instrumentation disclosed in each Patent
will be available for use by others without compensation to the Company, unless
protected by the claims of other U.S. patents that may be issued to the Company.
The Company has developed intellectual property rights in color analysis,
calibration and verification in a number of fields including medical,
biological, dental, cosmetic and materials testing. The intellectual property
rights include trade secrets, know how and 14 pending United States patent
applications. These rights also include various foreign patent applications
corresponding, at least in part, to the U.S. Patents and the U.S. patent
applications. There can be no assurance that patents will issue based on these
patent applications or that any patent claims will provide sufficient protection
to exclude others from the Company's proprietary technology and instrumentation.
There can be no assurance that the Company will not be involved in litigation to
protect its trade secrets and know how or that the Company will prevail in such
litigation. There can be no assurance that challenges will not be instituted
against the validity or enforceability of any patents owned by or issued in the
future to the Company, or that such challenges will not be successful. There can

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

         There can be no assurance that the Company's Intellectual Properties
will provide it with a competitive advantage in that it may be possible for a
competitor independently to develop non-infringing technologies, independently
duplicate the Company's unpatented technology through reverse engineering,
design around the patented aspects of the Company's technology, or otherwise
independently develop scientifically accurate processes,

                                       26

<PAGE>

instruments or color charts to measure skin coloration, skin tone color
categories and conduct comparative color analysis without infringing the
Company's Patents.

         The Company's U.S. Patents apply only to the United States. The Company
has filed patent applications in a number of foreign jurisdictions which
correspond, at least in part, to the Company's U.S. Patents. The Company has
been granted European Patent No. 0446512, nationalizations of that European
Patent in Austria, Belgium, France, Germany, Great Britain, Italy, Luxembourg,
The Netherlands, Spain, Sweden and Switzerland and Liechtenstein, a Singapore
registration of that European Patent, as well as Australian and Mexican Patents
corresponding, at least in part, to its U.S. Patent No. 4,909,632, Taiwanese and
Colombian Patents corresponding, at least in part, to its U.S. Patent No.
5,313,267 and two Taiwanese Patents corresponding, at least in part, to its U.S.
Patent No. 5,671,235. The Company has not yet been granted any other foreign
patents for its Intellectual Properties and there can be no assurance it will be
granted any such patents. Consequently, wherever the Company does not have
foreign patents, third parties currently could exploit, outside the United
States, the technology disclosed in the U.S. Patents, thereby increasing
competition in such foreign markets. In addition, persons gaining access to the
Company's unpatented proprietary information and technology and who are not
bound by confidentiality agreements with the Company would have the ability to
exploit the Company's unpatented proprietary information and technology both
inside and outside the United States, thereby increasing competition.


         There can be no assurance that one or more of the Patents held by the
Company will not be successfully challenged or circumvented or that the Company
will otherwise be able to rely on such Patents. In addition, there can be no
assurance that competitors, many of whom have substantial resources and have
made substantial investments in competing technologies, will not seek to apply
for and obtain patents that prevent, limit or interfere with the Company's
ability to make, use and sell its products either in the United States or in
foreign markets. If the Company's right or ability to manufacture its products
were to be proscribed or limited, the Company's ability to continue to
manufacture and market its Products could be adversely affected, which would
likely have a material adverse effect upon the Company's business, financial
condition and results of operations.

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

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

         The medical device industry has been characterized by extensive
litigation regarding patents and other intellectual property rights,
particularly with respect to newly developed technology. In addition, the United
States Patent and Trademark Office ("USPTO") may institute re-examination or
interference proceedings. There can be no assurance that the Company will not
become subject to patent infringement claims brought by third parties, or
re-examination of previously issued patents by the USPTO or interference
proceedings instituted by the USPTO to determine the priority of inventions. The
defense and prosecution of intellectual property suits, USPTO re-examination and
interference proceedings and related legal and administrative proceedings are
both costly and time consuming. Litigation may be necessary to enforce patents
issued to the Company, to protect trade secrets or know-how owned by the Company
or to determine the enforceability, scope and validity of the proprietary rights
of the Company and others. Any litigation or interference proceedings brought
against, initiated by or otherwise involving the Company may require the Company
to incur substantial legal and other fees and expenses and may require some

                                       27


<PAGE>

of the Company's employees to devote all or a substantial portion of their time
to the prosecution or defense of such litigation or proceedings. An adverse
determination in litigation or interference proceedings to which the Company may
become a party, including any litigation that may arise against the Company,
could subject the Company to significant liabilities to third parties, disputed
rights to be licensed from such third parties or prevent the Company from
selling its products in certain markets, or at all. If third-party patents
containing claims affecting the Company's technology were issued, and such
claims were determined to be valid, there can be no assurance that the Company
would be able to obtain licenses to such patents at costs reasonable to the
Company, if at all, or be able to develop or obtain alternate technology.
Although patent and intellectual property disputes regarding medical devices are
often settled through licensing or similar arrangements, there can be no
assurance that the Company would be able to reach a satisfactory settlement of
such a dispute that would allow it to license necessary patents or other
intellectual property. Even if such a settlement were reached, the settlement
process may be expensive and time consuming, and the terms of the settlement may
require the Company to pay substantial royalties. An adverse determination in a
judicial or administrative proceeding or the failure to obtain a necessary
license could prevent the Company from manufacturing and selling its products,
which would have a material adverse effect on the Company's business, financial
condition and results of operations.

         The Company is aware that others have obtained or are pursuing patent
protection for various aspects of the design, production and manufacturing of
bilirubin infant jaundice products. There can be no assurance that the Company's
technology, current or future products or activities will not be deemed to
infringe upon the rights of others.

         Need for Arrangements with Third Parties. The Company's business
strategy for the commercialization of its medical products depends upon the
Company's ability to selectively enter into and maintain arrangements with
leading marketing and distribution companies in the medical field. There can be
no assurance that the Company will be able to do so. The obligation of any
potential third party to fund or undertake the marketing, distribution and/or
sale of the product covered by any arrangements with the Company may be
dependent upon the satisfaction of certain goals or "milestones" by certain
specified dates, some of which are outside the Company's control. To the extent
that the obligations of any third party to fund or undertake the foregoing
activities are not contingent upon the satisfaction of certain goals or
milestones, a third party may retain a significant degree of discretion
regarding the timing of these activities and the amount and quality of
financial, personnel and other resources that they devote to these activities.
Furthermore, there can be no assurance that disputes will not arise between the
Company and any third party regarding their respective rights and obligations
under the arrangements. Finally, there can be no assurance that a third party
will not be unable, due to financial, regulatory or other reasons, to satisfy
its obligations under its collaborative arrangement with the Company or will not
intentionally or unintentionally breach its obligations under the arrangement.

         There can be no assurance that any third party will not, for

competitive reasons, support, directly or indirectly, a company or product that
competes with the Company's business. Furthermore, any dispute between the
Company and a third party might require the Company to initiate or defend
expensive litigation or arbitration proceedings.

         Any significant dispute with or breach, inability to perform, or
termination of any arrangement with such third party would likely require the
Company to seek and reach an agreement with another third party or to assume, to
the extent possible and at its own expense, all the responsibilities being
undertaken by the first such third party. There can be no assurance that the
Company would be able to reach an agreement with a replacement third party. If
the Company were not able to find a replacement third party, there can be no
assurance that the Company would be able to perform or fund the activities for
which the first such third party would be responsible. Even if the Company were
able to perform and fund these activities, the Company's capital requirements
would increase substantially. In addition, the further development and
marketing, distribution and sale of the product covered by such arrangement
would be significantly delayed.

         Any of the foregoing circumstances could have material adverse effect
upon the Company's business, financial condition and results of operations.


                                       28
<PAGE>

         The Company does not itself manufacture the Colormate(TM) units, the
Colormate(TM) Bilirubin Device or the Beauty-Aid Products, and in the past has
been wholly dependent on third-party OEMs of parts, assemblers, cosmetics
suppliers and textile suppliers. The Company will have to establish
relationships with such third-party suppliers, manufacturers and assemblers, for
the production of its devices. Although the Company is negotiating with certain
manufacturers/assemblers, the Company does not have any current arrangements
with such suppliers, parts manufacturers or assemblers for the mass production
of any additional Colormate(TM) devices, and there can be no assurance the
Company will be able to enter into future arrangements with these or other parts
manufacturers or assemblers on terms satisfactory to the Company. The
manufacturer's warranties covering certain parts incorporated in the
Colormate(TM) units are renewable but, if not renewed for any reason, the costs
of any repairs of such parts, or of any uncovered parts, would be borne by the
Company.

         The Company's costs of parts for the Colormate(TM) units are based on
original mass manufacturing costs for the devices manufactured in connection
with the Avon Project. Costs of parts in manufacturing smaller quantities of
Colormate(TM) units could involve significantly greater costs to the extent the
Company does not use existing components from its existing inventory of
Colormate(TM) units.

         In connection with any future manufacturing of the Colormate(TM) units,
the Company could be required to make significant advance payments, obtain
letters of credit, cause potential customers or licensees to advance funds under
their agreements entered into with the Company or otherwise secure its payment
obligations to third-party manufacturers. There can be no assurance the Company

will be able to enter into such agreements on acceptable terms, be able to
secure its payment obligations itself or by having customers and/or licensees
advance funds, or otherwise be able to manufacture the Colormate(TM) units or
obtain further manufacture of the Colormate(TM) units or its Products.

         Failure to Maintain Third-Party Reimbursement. In the United States and
elsewhere, sales of medical products are dependent, in part, on the ability of
consumers of these products to obtain reimbursement for all or a portion of
their cost from third-party payors, such as government and private insurance
plans. Third-party payors are increasingly challenging the prices charged for
medical products and services. If the Company succeeds in bringing its
Colormate(TM) Bilirubin Device or other products to market, there can no
assurance that such products will be considered cost effective and that
reimbursement to the consumer will continue to be available, pursuant to the
Company's recent permission from the AMA for third-party reimbursement under PCT
8220, or sufficient to allow the Company to sell its medical device products on
a competitive basis. The Company is unable to predict what changes will be made
in the reimbursement methods utilized by third-party health care payors.
Furthermore, the Company could be adversely affected by changes in reimbursement
policies of governmental or private health care payors.

         Since receiving FDA marketing clearance in the United States, the
Company has undertaken the procedures to obtain required international
regulatory clearances for its monitoring technology for bilirubin infant
jaundice. If the Company obtains the necessary foreign regulatory approvals,
market acceptance of the Company's products in international markets will be
dependent in part, upon the availability of reimbursement within prevailing
health care payment systems. Reimbursement and health care payment systems in
international markets vary significantly by country and include both government
sponsored health care and private insurance. Although the Company intends to
seek international reimbursement approvals, there can be no assurance that such
approvals will be obtained in a timely manner, if at all.

         Failure to maintain third-party reimbursement coverage for use of the
Colormate(TM) Bilirubin Device will have a material adverse effect on the
Company's ability to commercialize its technology for medical applications.

         Future Developments; Further Development and Marketing Activities
Required. Prior to licensing the Company's Intellectual Properties in any
industry including the cosmetic, beauty aids and fashion industries, the Company
will be required to develop additional marketing skills relevant to such
industries and conduct significant further marketing activity, and in certain of
these industries, overcome regulatory hurdles, professional skepticism and
develop specific practical applications therefor, 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

                                       29

<PAGE>

of failure inherent in the commercialization of products based on innovative
technologies, many of which are beyond the Company's control, such as
unanticipated development, manufacturing and regulatory delays and expenses. The

Company expects that additional financing will be required to commercialize any
medical application of its technologies.

         Government Regulations. The Company's advertising, sales practices and
cosmetics and medical products (including the labeling and packaging thereof)
are and will be subject to applicable federal, state and local regulation
(including regulation by the FDA, the Federal Trade Commission, and the Federal
Communications Commission, under the Fair Packaging and Labeling Act and/or any
comparable state authority, agency or statute) and will be subject to regulation
by comparable foreign authorities if the Company markets its products abroad.
The Company will also be subject to regulation by various governmental agencies
that regulate direct selling activities.

         Although the Company has received FDA clearance on its Colormate(TM)
Bilirubin Device pursuant to a "substantial equivalence" determination order, in
the form of a letter dated July 24, 1997 from the FDA's CDRH, authorizing the
Company to commercially distribute its Colormate(TM) Bilirubin Device for
monitoring bilirubin infant jaundice in the United States, the Company also must
comply with the other applicable rules and regulations, promulgated by the FDA,
in order to legally market the device. The "substantial equivalence" order
states that the Company must comply with the medical device general controls,
e.g., device establishment registration, medical device listing, good
manufacturing practices (QSR requirements), labeling, and the statutory
prohibitions against adulteration and misbranding. The order also states that
the Colormate(TM) Bilirubin Device is a Class II device which may be subject to
additional special controls. The Company intends to comply with any applicable
general controls and special controls for purposes of commercial distribution.
The Company is unaware of any applicable special controls at this time.

         In the United States, the FDA regulates the introduction of medical
devices as well as, among other things, manufacturing, labeling and
recordkeeping procedures for such products. The process of obtaining marketing
clearance for new medical products from the FDA can be costly and time
consuming, and there can be no assurance that such clearance will be granted for
the Company's future products on a timely basis, if at all, or that FDA review
will not involve delays that would adversely affect the Company's ability to
commercialize additional products or to expand permitted uses of existing
products. Regulatory clearance to market a product from the FDA may entail
limitations on the indicated uses of the product. Marketing clearance can also
be withdrawn by the FDA due to failure to comply with regulatory standards or
the occurrence of unforeseen problems following initial clearance. The Company
may be required to file further marketing applications with the FDA under
certain circumstances, such as the addition of product claims or product
redesign. The FDA also could limit or prevent the manufacture or distribution of
the Company's products, and has the power to require the recall of such
products, given certain circumstances. FDA regulations depend heavily on
administrative interpretation, and there can be no assurance that future
interpretation made by the FDA or other regulatory bodies, will not adversely
affect the Company. The FDA will and various state agencies may inspect the
Company and its facilities from time to time to determine whether the Company is
in compliance with regulations relating to medical device manufacturing
companies, including regulations concerning manufacturing, testing, quality
control and product labeling practices. A determination that the Company is in
material violation of such regulations could lead to the imposition of civil

penalties, including fines, product recalls, product seizures, or, in extreme
cases, criminal sanctions.

         In order for the Company to market its products in Europe and certain
other foreign jurisdictions, the Company and its distributors and agents must
obtain required regulatory registrations or approvals and otherwise comply with
extensive regulations regarding safety, efficacy and quality in those
jurisdictions. Specifically, certain foreign regulatory bodies have adopted
various regulations, among other things, governing product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. These regulations vary from country to country.
After mid-1998, the Company will be prohibited from selling its Colormate(TM)
Bilirubin Device in Europe until such time as the Company receives the right to
affix the CE mark, which is a symbol of quality and compliance with applicable
European medical device directives. ISO 9001/EN 46001 certification is one
option for pursuing the CE mark under the CE mark certification process
requirements. There can be no assurance that the Company will be successful in
obtaining ISO 9001/EN 46001 certification or CE

                                       30

<PAGE>

mark rights. Failure to receive ISO 9001/EN 46001 certification, CE mark rights
or other foreign regulatory approvals could have a material adverse effect on
the Company's business, financial condition and results of operations. There can
be no assurance that the Company will obtain any other required regulatory
registrations or approval in such countries or that it will not be required to
incur significant costs in obtaining or maintaining such regulatory
registrations or approvals. Delays in obtaining any registrations or approvals
required to market the Company's products, failure to receive these
registrations or approvals, or future loss of previously obtained registration
or approvals could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company may rely on its
third-party foreign distributors to comply with certain foreign regulatory
requirements. The inability or failure of the Company or such foreign
distributors to comply with varying foreign regulations or the imposition of new
regulations could restrict the sale of the Company's products internationally
and thereby adversely affect the Company's business, financial condition and
results of operations.

         The Company and any third party with which it has made arrangements
will be required to adhere to applicable FDA regulations, including the QSR
requirements and similar regulations in other countries, which include testing,
control, and documentation requirements. Ongoing compliance with QSR
requirements and other applicable regulatory requirements will be strictly
enforced in the United States through periodic inspections by federal and
possibly state agencies, including the FDA, and in foreign jurisdictions by
comparable agencies. Failure to comply with applicable regulatory requirements
could result in, among other things, warning letters, injunctions, civil
monetary penalties, recall or seizure of products, total or partial suspension
of production, refusal of the government to grant premarket clearance or
premarket approval for devices, rescission or withdrawal of clearances or
approvals previously obtained and criminal prosecution. The restriction,

suspension or revocation of regulatory clearances or approvals or government
enforcement actions due to any other failure to comply with regulatory
requirements would have a material adverse effect on the Company's business,
financial condition and results of operations.

         If the FDA believes that any of its legal requirements have not been
fulfilled, it has extensive enforcement powers, including but not limited to the
ability to bar or seize products from the market, to prohibit the operation of
manufacturing facilities, to require recalls of devices from customer locations
and to seek civil monetary or criminal penalties.

         Product Liability and Malpractice. The medical products industry is
subject to substantial product liability litigation, and the Company faces an
inherent business risk of exposure to product liability claims in the event that
the use of its products is alleged to have resulted in adverse effects to a
patient or product user. Any such claims could have a material adverse effect on
the Company, including on market acceptance of its Colormate(TM) Bilirubin
Device. When the Company implements its business plan for its medical
application for its Intellectual Properties, it will be entering a field where
it may become subject to product liability claims by patients and/or users and
might become a defendant in product liability and/or malpractice litigation. The
Company does not have malpractice insurance for such applications and does not
intend to obtain such insurance prior to achieving commercialization of such
proposed medical application. Even if the Company obtains such insurance, there
can be no assurance that it could retain such insurance or that such insurance
would be sufficient to protect the Company against any such liabilities.

         The Company maintains its own product liability insurance with respect
to cosmetic and beauty aid applications. There can be no assurance that such
insurance will be adequate to protect the Company from claims that may be
brought against it by users of the Colormate(TM) units or its Beauty-Aid
Products.

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

         Control; Dependence on Management. Darby Simpson Macfarlane, Chief
Executive Officer of the Company, owns shares of Common Stock and preferred
stock, par value $0.001 per share (the "Preferred Stock") aggregating 2,266,220
(excluding currently exercisable stock options) of the shares eligible to vote
on matters

                                       31

<PAGE>

presented to the shareholders which amount is sufficient to permit her to
significantly influence the election of directors or to approve any matter
submitted to a vote of shareholders, and otherwise be in control of the Company.

The Company is dependent primarily on the services of Darby Simpson Macfarlane
and David Kenneth Macfarlane, Vice President, Research and Development. The loss
of either of their services could have a material adverse effect on the Company.
Although the Company has purchased key-man life insurance policies in the
amounts of $1,000,000 on the lives of both Mrs. and Mr. Macfarlane, there can be
no assurance that the proceeds from such policies would enable the Company to
retain suitable replacements for them.

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

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

         Outstanding Voting Preferred Stock. The Company has outstanding
1,380,000 shares of 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 for any two consecutive calendar years
ending on December 31, 2000 exceed $20,000,000 or (ii) the closing bid price of
the Common Stock has been at least $46.67 ($[31.11] after giving effect to the
Stock Split) on 30 consecutive trading days at any time ending on December 31,
2000. Further, the Preferred Stock has a $13,800 liquidation preference and
earns an annual non-cumulative dividend of $0.001 per share. The voting rights,
conversion rights, dividend rights and liquidation preference of the Preferred
Stock may adversely affect the trading value or the market price of the Common
Stock.

         Additional Authorized Preferred Stock. The Company's Amended
Certificate of Incorporation (the "Certificate of Incorporation") authorizes the

Board of Directors to issue, without shareholder approval, up to 10,000,000
shares of Preferred Stock with voting, conversion and other rights and
preferences that could adversely affect the voting power or other rights of the
holders of Common Stock. The issuance of Preferred Stock or of rights to
purchase Preferred Stock could be used to discourage an unsolicited acquisition
proposal. In addition, the possible issuance of Preferred Stock could discourage
a proxy contest, make more difficult the acquisition of a substantial block of
the Company's Common Stock or limit the price that investors might be willing to
pay in the future for shares of the Company's Common Stock.

                                       32
<PAGE>

Item 2.  Properties

         The Company's executive offices are located in New York, New York and
are leased pursuant to a renewable sublease the initial term of which expired in
March 1998. The Company is currently renegotiating the lease renewal rental
terms. Rentals under such sublease (including storage facilities) currently are
being paid at the rate of $13,000 per month, plus occupancy costs. Additionally,
the Company leases space in Spokane, Washington pursuant to a one year lease,
such lease is renewable annually. Rentals under such lease are $2,018 per month.

         The Company also occupies office space located in Riverdale, New York,
at a cost of $1,620 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 $19,400 for such space in 1997. The
Company also maintains office space at 10 Old Jackson Avenue,
Hastings-on-Hudson, New York, at the residence of Mrs. Macfarlane. The Company
paid Mrs. Macfarlane approximately $10,300 for such space in 1997.

Item 3.  Legal Proceedings

         None.

Item 4.  Submission of Matters to a Vote of Security Holders

         None.


                                     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 of 1934, as
amended (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.

         There can be no assurance that an active public trading market for the
Common Stock will continue. Prior to February 8, 1993, the date on which the
Common Stock was approved for quotation on the Nasdaq Stock Market SmallCap
Market System ("NASDAQ"), 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 26,
1998, the last reported bid price for the Common Stock was $12.75 per share. The
Warrants expired on November 5, 1997, subject to limited waivers granted by the
Company in respect of obtaining state regulatory clearance for the issuance of
shares underlying the warrants. There were 98 holders of record of the Common
Stock as of March 26, 1998, including nominees for an unknown number of
beneficial holders.

                                       33

<PAGE>

         The following tables set forth the high and low bid prices for the
Common Stock and the Warrants for each of the periods indicated, after giving
retroactive effect to the Company's February 1998 three-for-two forward Stock
Split:

Common Stock

                  Period                                      Price
                  ------                              ------------------------
                                                        High             Low
                                                        ----             ---
January 1, 1996 to March 31, 1996                     $7.012           $2.557
April 1, 1996 to June 30, 1996                         8.745            4.620
July 1, 1996 to September 30, 1996                     4.908            1.815
October 1, 1996 to December 31, 1996                   3.877            2.310

January 1, 1997 to March 31, 1997                      6.352            2.805
April 1, 1997 to June 30, 1997                         5.610            1.980
July 1, 1997 to September 30, 1997                     9.900            4.455
October 1, 1997 to December 31, 1997                  12.540            8.002
January 1, 1998 to March 26, 1998                     17.375            7.172


Warrants

                  Period                                      Price
                  ------                             ------------------------
                                                       High             Low
                                                       ----             ---
January 1, 1996 to March 31, 1996                     $3.712           $0.495
April 1, 1996 to June 30, 1996                         5.527            1.980
July 1, 1996 to September 30, 1996                     2.145            0.618
October 1, 1996 to December 31, 1996                   1.608            0.453

January 1, 1997 to March 31, 1997                      3.413            0.624
April 1, 1997 to June 30, 1997                         3.247            0.749
July 1, 1997 to September 30, 1997                     6.993            1.830
October 1, 1997 to November 5, 1997                    9.490            4.662

Dividend Policy

         The Company has not paid, during the two fiscal years ended December
31, 1997, 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 the 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.

                                       34


<PAGE>



Item 6.  Selected Financial Data

         The following information has been derived from the Company's
consolidated financial statements. The selected consolidated financial data
should be read in conjunction with the Consolidated Financial Statements and the
notes thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" elsewhere in this report.

<TABLE>
<CAPTION>

                                                                          Years Ended December 31,
                                                1997               1996               1995               1994               1993
                                                ----               ----               ----               ----               ----
<S>                                          <C>                 <C>                <C>                <C>                <C>
Total Assets                                 10,752,600          6,747,500          3,489,900          2,436,300          2,218,900
Total Liabilities                               842,500            791,500            599,700            804,100            490,400
Stockholders' Equity                          9,896,300          5,942,200          2,876,400          1,618,400          1,714,700
Lease, license and service
  contract revenues                              10,500             66,100            167,000            193,600             50,500
Interest Income                                 238,900            220,800            117,800             26,900             48,700
Loss                                         (5,053,100)        (4,442,300)        (2,494,300)           (96,300)        (1,951,800)
Loss per share--Basic and diluted (*)             (0.40)             (0.51)             (0.39)             (0.02)             (0.49)
</TABLE>

(*) Loss per share was retroactively adjusted to reflect the three for two
    split.

                                       35
<PAGE>

Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations

         THIS ANNUAL REPORT ON FORM 10-K, INCLUDING ITEM 1 ("BUSINESS") AND ITEM
7 ("MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS"), CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934. WHEN USED IN THIS REPORT, THE WORDS "BELIEVE,"
"ANTICIPATE," "THINK," "INTEND," "PLAN," "WILL BE," "EXPECT" AND SIMILAR
EXPRESSIONS IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS REGARDING
FUTURE EVENTS AND/OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY ARE SUBJECT
TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED IN "RISK FACTORS"
ABOVE AT PAGES 21 TO 32, WHICH COULD CAUSE ACTUAL EVENTS OR THE ACTUAL FUTURE
RESULTS OF THE COMPANY TO DIFFER MATERIALLY FROM ANY FORWARD-LOOKING STATEMENT.
SUCH RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHER THINGS, THE AVAILABILITY OF
ANY NEEDED FINANCING, THE COMPANY'S ABILITY TO IMPLEMENT ITS BUSINESS PLAN FOR
VARIOUS APPLICATIONS OF ITS TECHNOLOGIES, INCLUDING MEDICAL AND INDUSTRIAL
APPLICATIONS, THE OBTAINING OF AND COMPLIANCE WITH REGULATORY APPROVALS

APPLICABLE TO PROPOSED APPLICATIONS OF THE COMPANY'S TECHNOLOGY, THE IMPACT OF
COMPETITION, THE MANAGEMENT OF GROWTH, AND OTHER RISKS AND UNCERTAINTIES THAT
MAY BE DETAILED FROM TIME TO TIME IN THE COMPANY'S REPORTS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. IN LIGHT OF THE SIGNIFICANT RISKS AND
UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING STATEMENTS INCLUDED HEREIN, THE
INCLUSION OF SUCH STATEMENTS SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE
COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES AND PLANS OF THE COMPANY WILL BE
ACHIEVED.

Overview

         The Company was formed in 1984 to research and develop and to
commercialize Intellectual Properties for marketing to a variety of industries,
including, but not limited to, the medical, dental, biological, cosmetic, hair
color, beauty-aid and fashion industries. The Intellectual Properties relate to
the application of color science technology to the scientific measurement and
analysis of human skin, tissue, fluid, hair, teeth or biological subject, the
classification of such measurements, the detection and monitoring of conditions
affecting the coloration of such human skin, tissue, fluid, hair, teeth or
biological subjects and the scientific classification and color-oriented
organization of various consumer-sensitive products such as cosmetics, tooth
enamel, hair color, hosiery, fashion, textiles, etc. The Company has
incorporated certain of the Intellectual Properties into a proprietary color
measurement system and software marketed for various commercial applications as
the Colormate(TM) System. The Company has developed Intellectual Properties
which it believes are capable of detecting and monitoring Chromogenic Diseases.
In this regard, the Company developed the Colormate(TM) Bilirubin Device to
measure the incremental increase of the yellow content of the skin color in
newborns to monitor bilirubin infant jaundice. On July 30, 1997 the Company
received FDA clearance for commercial marketing of the Colormate(TM) Bilirubin
Device for the non-invasive monitoring of bilirubin infant jaundice in newborns.
The Company's efforts are currently focused on seeking to commercialize this
medical application of its Intellectual Properties for non-invasive detection
and monitoring of bilirubin infant jaundice.

         The Company has also developed its own line of scientifically color
coordinated proprietary cosmetics (My Colors by Chromatics(TM)) and
scientifically color coordinated proprietary color charts and material
swatchpacks for use in the cosmetics, beauty and dental and fashion industries.

         To date, the Company's marketing activities have principally involved
licensing the Intellectual Properties, including conducting laboratory product
chromaticity studies, leasing the Colormate(TM) System and marketing the
Beauty-Aid Products in the cosmetic, hair color, beauty aid and fashion
industries (i) in a national sales program with Avon, and in limited test
markets with Clairol and Hanes, all conducted prior to June 1991, (ii) under
current agreement with Gordon Laboratories and certain leasing and licenses to
beauty-related businesses and beauty salons.

                                       36
<PAGE>

Although the Company from time to time is engaged in preliminary discussions
(including limited consumer testing and laboratory chromaticity study

activities) for use of its technology in the cosmetics, dental and beauty aid
fields, there can be no assurance that any final agreements will be reached. In
this regard, the Company has recently completed research and development for the
working prototype of a hand-held less expensive LED model of the Colormate(TM)
System (the Colormate(TM) LED Device) which the Company anticipates will enhance
its marketing efforts.

         In 1997, the Company furthered implementation of its long-range plans
to exploit certain medical applications for its technology. In this regard, the
Company submitted a marketing application for its Colormate(TM) unit for a
certain medical applications with the FDA on November 14, 1996. The application,
known as a premarket notification or 510(k) submission, was accepted officially
for filing and review by the FDA on November 18, 1996. The application
requested, and on July 30, 1997, the Company received from the FDA's CDRH,
marketing clearance pursuant to a "substantial equivalence" determination order,
in the form of a letter dated July 24, 1997, authorizing the Company to
commercially distribute its Colormate(TM) Bilirubin Device for non-invasive
detection and monitoring of bilirubin infant jaundice in the United States. See
"Business," and "Risk Factors."

         Since inception the Company has financed its operations through (i)
private placements of its securities, (ii) collaborative research and
development arrangements with licensees, (iii) cash receipts from lease and
licensing agreements, (iv) loans from private investors and certain
shareholders, (v) the February 1993 initial public offering (the "IPO") and (vi)
the proceeds of exercise of stock options and warrants. Over the past two years,
the Company has used substantial portions of the proceeds of such exercise and
from the private placement in 1995 and 1996 of its securities to further its
long-range business plan with respect to the medical application of its
technologies and for the development of the Colormate(TM) units, including a
transcutaneous bilirubinometer.

         The Company has incurred significant research and development and
marketing expenses since inception, resulting in losses from operations since
1990 and, prior to its IPO, negative shareholders' equity. In particular, over
the past two years, the Company has incurred significant FDA related expenses
and research and development and marketing start-up expenses relating to the
bilirubin infant jaundice medical application. The Company also has not achieved
significant operating revenues from marketing its Intellectual Properties
Products and Colormate(TM) units in the cosmetic and beauty aid industries since
termination of the Avon Project in 1991, and has never generated any revenue
from licensing its Intellectual Properties or the Colormate(TM) System in any
industry other than the cosmetics, haircolor, beauty aid and fashion industries.
See Note 1 of Notes to Financial Statements. The foregoing factors raise
substantial doubt as to the Company's ability to generate profitable operations.
See "Risk Factors."

         Since 1990 limited revenues have been derived from licenses, leases,
service contracts and Beauty-Aid Product sales to several beauty-related
businesses, testing and laboratory fees from potential licensees evaluating the
Company's technology, and from an exclusive licensing and lease contract with
IMS. In 1997, the Company did not generate any 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) units, such as the clinical research studies for
medical applications, and (c) obtaining additional financing to support
marketing of the Company's Intellectual Properties, systems, Beauty-Aid Products
and related services.

         The Company's ability to generate revenues in the future will depend on
its success in marketing its Intellectual Properties, the related Chromaticity
Studies capabilities, the Colormate(TM) Bilirubin Device, the Colormate(TM)
units and the Beauty-Aid Products. If such marketing is not successful in the
future, the principal effect would be a write-down of the book value of the
Colormate(TM) units and an impairment of the Company's ability to  obtain future
financing, which could result in a 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 2 of Notes to
Financial Statements.

                                       37

<PAGE>

Results of Operations

Fiscal Year 1997 Compared to Fiscal Year 1996

         The Company incurred net losses of $5,053,100 and $4,442,300 for fiscal
years 1997 and 1996, respectively, as revenues received have not been
significant relative to the Company's expenses incurred in implementing its
business plan. The $610,800 increase in such losses in 1997 as compared to 1996
is primarily attributable to expenses incurred in 1997 in respect of increased
patent applications costs, write-offs of certain inventory, non-cash expenses
relating to the grant of options to consultants, and increased research and
development expense. The Company incurred research and development expenses
primarily consisting of compensation of officers, employees and consultants of
$435,300 and $194,400 for fiscal years 1997 and 1996, respectively. The 1997
loss was mitigated by the capitalization of $124,200 of software development
costs, decreased FDA medical application costs, and a decrease in other expenses
described below. See Note 1 of Notes to Financial Statements for a discussion of
the effect on net losses and net losses per share attributable to (i) the
Company's outstanding convertible securities and (ii) accounting for stock-based
compensation on the intrinsic value method, rather than the fair market value
method.

         The Company believes that the level of expenses relating to the FDA
application and related patent applications will not be recurring in the future
at previous levels and that any future expenses incurred in connection therewith
will be significantly less than the amount incurred in 1997, although no
assurance can be given of such result.

         Bad debt expense decreased to ($5,000) in 1997 from $257,700 in 1996
primarily attributable to the adjustment of amounts due from IMS IN 1996.
Depreciation and amortization expense decreased to $80,500 in 1997 from $178,600
in 1996, primarily attributable to the amortization of deferred legal expenses
incurred in 1996 in respect of financing activities. Compensation expense for

employees, officers and directors decreased to $729,300 in 1997 from $810,500 in
1996, primarily attributable to increased use of consultants. Bonuses were not
paid to executive officers during 1997.

         Assets increased to $10,752,600 in 1997 from $6,747,500 in 1996
primarily attributable to increased cash and cash equivalents from the proceeds
received from the exercise of Warrants and interest income, as well as the
capitalization of software development costs. See Notes 1 and 5 of Notes to
Financial Statements.

         Revenues from lease, license and service contracts decreased in 1997 as
the Company continued to focus its resources on implementation of its long range
business plan for medical applications of its technologies. The Company receives
payments from licensees, distributors or other sources sporadically during the
year. Accordingly, these payments have had, and payments that may be received in
the future will have, a significant impact on quarter-to-quarter comparisons
inasmuch as the Company has not developed stable recurring revenues.

         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.

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.

                                       38

<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 $538,700 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 5 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 $194,400
and $237,800 for fiscal years 1996 and 1995, respectively.

Liquidity and Capital Resources

Fiscal Year 1997 Compared to Fiscal Year 1996

         In 1997, the Company continued to experience significant negative net
cash flows from operating activities. Net cash outflows from operating
activities increased by $509,200 in 1997 as compared to 1996, primarily due to
the increase in net loss in 1997 and the non-cash expense of options granted to
consultants.

         Cash flows from financing activities increased to $8,386,700 from
$7,387,800 in 1997 as compared to 1996, primarily attributable to $8,424,800
proceeds from the exercise of Warrants.

         The Company has applied a substantial portion of the proceeds of the
1995 Private Placement and Debenture Financing to continue its implementation of
its long-range business plan for commercialization of its technologies for
medical applications in diagnosing certain diseases, including the completion of
the FDA application and the related patent applications. In this regard, the
Company hired FDA and governmental regulatory consultants (in addition to legal
counsel) to assist in obtaining marketing regulatory clearances for such medical
applications and is currently applying for foreign regulatory approvals of
commercial use of its technology for the detection and monitoring of bilirubin
infant jaundice. The Company anticipates that any initial penetration of the
medical marketplace will be accomplished through the 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) units, sales of swatch packs, consulting fees, and sales of
cosmetics, although there can be no prediction or assurance as to which or any
of these potential revenue sources will be successful. However, since
consummation of the IPO, the Company's marketing of its Intellectual Properties,

Beauty-Aid Products and Colormate(TM) units in the beauty aid industry have
resulted in immaterial revenues.

         As of December 31, 1997, management expects that the Company will have
sufficient liquidity at least until December 31, 1998, even if no revenues from
operations are generated. If the Company is able to profitably market its
Intellectual Properties, the Colormate(TM) units, the Colormate(TM) Bilirubin
Device and Beauty-Aid Products, the Company would use any cash flow obtained
from operations, and may seek additional debt or equity financing, to

                                       39

<PAGE>

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.

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 outflows from operating
activities increased 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. In this regard, the
Company has hired FDA and governmental regulatory consultants (in addition to
legal counsel) to assist in obtaining marketing regulatory clearances for such
medical applications and is currently applying for foreign regulatory approvals
of commercial use of its technology for the monitoring of bilirubin infant
jaundice.

                                       40


<PAGE>

Item 8.  Financial Statements and Supplemental Data

                                    INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                                               Page

<S>                                                                                                             <C>
         Independent Auditors' Report............................................................................42

         Consolidated Balance Sheets as of December 31, 1997 and 1996............................................43

         Consolidated Statements of Operations for the years ended
          December 31, 1997, 1996 and 1995.......................................................................44

         Consolidated Statements of Changes in Shareholders' Equity for the years ended
          December 31, 1997, 1996 and 1995.......................................................................45

         Consolidated Statements of Cash Flows for the years ended
          December 31, 1997, 1996 and 1995.......................................................................46

         Notes to Consolidated Financial Statements..............................................................47
</TABLE>

                                       41

<PAGE>
                          INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholders 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, 1997 and 1996 and
the related consolidated statements of operations, changes in shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Chromatics
Color Sciences International, Inc. and subsidiary as of December 31, 1997 and
1996, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.


                                                WISS & COMPANY, LLP


Livingston, New Jersey
February 17, 1998

                                       42

<PAGE>

          CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>

                                                                                                    December 31,
                                                                                            ---------------------------
                                                                                               1997             1996
                                                                                             ----------       -----------
                                ASSETS
<S>                                                                                           <C>             <C>
CURRENT ASSETS:
    Cash and equivalents                                                                      $9,225,400      $ 5,352,400
    Accounts receivable, less allowance for doubtful accounts of $0
       in 1997 and $10,000 in 1996                                                                92,400           87,400
    Inventories                                                                                  148,100          223,400

       Prepaid expenses and other current assets                                                  76,400           89,200
                                                                                             -----------     ------------
         Total Current Assets                                                                  9,542,300        5,752,400


COLORMATE(TM) UNITS, LESS ACCUMULATED
    DEPRECIATION OF $32,800 (1997) and $26,000 (1996)                                            715,700          674,000

PROPERTY AND EQUIPMENT, LESS ACCUMULATED
    DEPRECIATION OF $224,600 (1997) and $155,300 (1996)                                          344,900          293,700

SOFTWARE DEVELOPMENT COSTS                                                                       124,200               --

OTHER ASSETS                                                                                      25,500           27,400
                                                                                             -----------     ------------
                                                                                             $10,752,600      $ 6,747,500
                                                                                             ===========      ===========
                  LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
    Notes payable - collateralized by equipment                                               $    4,700      $    10,000
    Amounts payable to related party                                                             293,200          326,000
    Accounts payable and accrued expenses:
       Attorneys and accountants                                                                 361,900          269,700
       Consultants                                                                                54,900           65,600
       Trade                                                                                     127,800          109,700

    Security Deposits                                                                                 --           10,500
                                                                                             -----------     ------------
         Total Current Liabilities                                                               842,500          791,500

COMMITMENTS AND CONTINGENCIES


REDEEMABLE CLASS A PREFERRED STOCK,
    PAR VALUE $.01 PER SHARE:
    Authorized - 1,400,000 shares
    Issued and outstanding - 1,380,000 shares
       at par and redemption value                                                                13,800           13,800
                                                                                             -----------     ------------

SHAREHOLDERS' EQUITY

    Undesignated Class B Preferred Stock, No Par Value:
       Authorized - 10,000,000 shares
       Issued and Outstanding - None                                                                   -                -

    Common Stock, par value $.001 per share:
       Authorized - 50,000,000 shares
       Issued and outstanding - 13,814,859 (1997) and 10,753,096
         (1996) shares                                                                            13,800           10,800
    Capital in excess of par value                                                            24,370,900       15,366,700
    Accumulated deficit                                                                      (14,488,400)      (9,435,300)
                                                                                             -----------     ------------
       Total Shareholders' Equity                                                              9,896,300        5,942,200
                                                                                             -----------     ------------
                                                                                             $10,752,600       $6,747,500
                                                                                             ===========       ==========

</TABLE>

                 See accompanying notes to financial statements.

                                       43

<PAGE>
          CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>

                                                                                               Year End December 31,
                                                                                  --------------------------------------------
                                                                              1997                   1996                  1995
                                                                         ------------           ------------           ------------
<S>                                                                      <C>                    <C>                    <C>
REVENUES:
    Lease, license and service contracts                                 $     10,500           $     66,100           $    167,000
    Interest income                                                           238,900                220,800                117,800
                                                                                1,000                    500                  3,100
    Other                                                                     250,400                287,400                287,900
                                                                         ------------           ------------           ------------
COSTS AND EXPENSES:
    Food and Drug Administration ("FDA")
      medical application expenses                                          1,148,600              1,281,500                481,300
    Patent application costs                                                  691,200                382,300                111,000
    Research and development costs                                            435,300                194,400                237,800
    General and administrative:
       Compensation - officers and employees                                  729,300                810,500                538,700
       Consultants                                                            780,700                205,900                257,500
       Legal fees                                                             288,100                296,300                188,200
       Accounting fees                                                         35,100                 51,600                 51,100
       Rent and storage                                                       199,900                195,400                179,800
       Insurance                                                              220,600                195,800                175,500
       Travel and entertainment                                                17,900                 25,900                 42,200
       Repairs and maintenance                                                122,100                 85,100                 57,000
       Depreciation and amortization                                           80,500                178,600                 52,900
       Bad debt expense (recovery)                                             (5,000)               257,700                 42,900
       Payroll taxes                                                           84,900                 80,000                 61,700
       Stock administrative fees                                               53,300                 52,500                 28,300
       Interest                                                                26,800                 65,900                 28,600
       Other                                                                  394,200                370,300                247,700
                                                                         ------------           ------------           ------------
                                                                            5,303,500              4,729,700              2,782,200
                                                                         ------------           ------------           ------------
NET LOSS                                                                 $ (5,053,100)          $ (4,442,300)          $ (2,494,300)
                                                                         ============           ============           ============

WEIGHTED AVERAGE NUMBER OF COMMON
    SHARES OUTSTANDING                                                     12,601,430              8,737,509              6,347,400
                                                                         ============           ============           ============

BASIC AND DILUTED LOSS PER SHARE                                         $      (0.40)          $      (0.51)          $      (0.39)
                                                                         ============           ============           ============
</TABLE>
                 See accompanying notes to financial statements.
                                      44

<PAGE>

          CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

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

<S>                                                                     <C>          <C>             <C>              <C>
BALANCES, DECEMBER 31, 1994                                              4,175,850    $      4,200    $  4,112,900     $ (2,498,700)

Year Ended December 31, 1995:
    Net Loss                                                                  --              --              --         (2,494,300)
    Exercise of options to purchase 78,468 shares at $1.02
       per share each by CEO and Vice President less
       aggregate payment of 54,882 shares                                  102,054             100            (100)            --
    Exercise of options to purchase 15,000 shares                           15,000            --            22,500             --

    Proceeds from private placement offering, less offering
       costs of $770,200
                                                                         2,700,000           2,700       3,727,100             --
                                                                      ------------    ------------    ------------     ------------

BALANCES, DECEMBER 31, 1995                                              6,992,904           7,000       7,862,400       (4,993,000)

Year Ended December 31, 1996:
    Net Loss                                                                  --              --              --         (4,442,300)
    Exercise of stock options and warrants                               1,073,678           1,100       2,945,600             --
    Conversion of convertible debentures into common stock               2,686,514           2,700       4,328,300             --
    Contribution of "short swing" profits under SEC rules                     --              --           230,400             --
                                                                      ------------    ------------    ------------     ------------

BALANCES, DECEMBER 31, 1996                                             10,753,096          10,800      15,366,700       (9,435,300)


Year Ended December 31, 1997:
    Net Loss                                                                  --              --              --         (5,053,100)
    Exercise of stock options and warrants                               3,061,763           3,000       8,405,500
    Compensation cost relating to options granted to
       consultants                                                            --              --           582,400             --

    Contribution of "short swing" profits under SEC rules                     --              --            16,300             --
                                                                      ------------    ------------    ------------     ------------


BALANCES, DECEMBER 31, 1997                                             13,814,859    $     13,800    $ 24,370,900     $(14,488,400)
                                                                      ------------    ------------    ------------     ------------
                                                                      ------------    ------------    ------------     ------------
</TABLE>

                 See accompanying notes to financial statements.

                                       45

<PAGE>

          CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>

                                                                                               Year Ended December 31,
                                                                                   -------------------------------------------------
                                                                                         1997            1996               1995
                                                                                    -----------       -----------       -----------
<S>                                                                                 <C>               <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net loss                                                                        $(5,053,100)      $(4,442,300)      $(2,494,300)
      Adjustments to reconcile net loss to
        net cash flows from operating activities:
        Depreciation and amortization                                                    80,500           178,600            52,900
        Provisions for losses on accounts receivable                                    (10,000)            7,800            42,900
        Provision for slow moving inventories                                            75,000           100,000              --
        Compensation cost relating to options granted to consultants                    582,400              --                --
        Changes in operating assets and liabilities:
         Accounts receivable                                                              5,000           220,500          (146,400)
         Inventories                                                                        300           (31,800)          (10,500)
         Prepaid expenses and other current assets                                       12,800             9,600            (5,500)
         Other assets                                                                     1,900            34,400           (27,300)
         Accounts payable and accrued expenses                                           95,200           207,400           (93,300)
         Other                                                                          (10,500)            4,500               500
                                                                                    -----------       -----------       -----------

               Net cash flows from operating activities                              (4,220,500)       (3,711,300)       (2,681,000)
                                                                                    -----------       -----------       -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
    Software Development Costs                                                         (124,200)             --                --
    Purchases of property and equipment                                                (169,000)         (151,500)         (123,700)
                                                                                    -----------       -----------       -----------

               Net cash flows from investing activities                                (293,200)         (151,500)         (123,700)
                                                                                    -----------       -----------       -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
    Proceeds from issuance of common stock net of related costs                       8,424,800         7,407,100         3,864,100
    Payments of accounts payable from related parties                                   (32,800)          (14,900)          (86,400)
    Payments of notes payable                                                            (5,300)           (4,400)           (3,900)
                                                                                    -----------       -----------       -----------

               Net cash flows from financing activities                               8,386,700         7,387,800         3,773,800
                                                                                    -----------       -----------       -----------

NET CHANGE IN CASH AND EQUIVALENTS                                                    3,873,000         3,525,000           969,100

CASH AND EQUIVALENTS, BEGINNING OF PERIOD                                             5,352,400         1,827,400           858,300
                                                                                    ===========       ===========       ===========


CASH AND EQUIVALENTS, END OF PERIOD                                                 $ 9,225,400       $ 5,352,400       $ 1,827,400
                                                                                    ===========       ===========       ===========

SUPPLEMENTAL CASH FLOW INFORMATION
    Interest paid                                                                   $    33,737       $    39,600       $    28,600
                                                                                    ===========       ===========       ===========
    Income taxes paid                                                               $      --         $      --         $      --
                                                                                    ===========       ===========       ===========

</TABLE>

                 See accompanying notes to financial statements.

                                       46

<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 color science technology research and development and
            licensing activities, seeking mass market applications for its
            proprietary technology and instrumentation. The Company's business
            encompasses all of the risks inherent in the establishment of a new
            business enterprise, including a limited operating history with
            significant competition possessing substantially greater resources.
            Current and future operations also depend upon the continued
            employment of certain key executives, the ability to further
            commercialize its proprietary technology and products and the
            Company's ability to obtain sufficient revenues and/or outside
            financing.

            Estimates and Uncertainties - The preparation of financial
            statements in conformity with generally accepted accounting
            principles requires management to make estimates and assumptions
            that affect the reported amounts of assets and liabilities and
            disclosure of contingent assets and liabilities at the date of the
            financial statements and the reported amounts of revenues and
            expenses during the reporting period. Actual results, as determined
            at a later date, could differ from those estimates.

            At December 31, 1997, 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 of manufacturing difficulties in 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 second quarter of 1998.
            Management estimates that no more than a $175,000 loss will be
            incurred on the disposition of this inventory and has provided
            $75,000 in 1997 and $100,000 in 1996 for such loss.

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

            Colormate(TM) Systems - In connection with a license with Avon
            Products, Inc. ("Avon"), Avon paid approximately $4,600,000 to
            purchase color measurement instruments and related equipment for its
            use during the term of the license period. Due to missing and
            damaged units, Avon and the Company executed mutual releases at the
            termination of the lease on June 24, 1991 with the principal effect
            that Avon returned 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) 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.

            Following the FDA approval in 1997 (see Note 2), the Company has
            decided to use certain components from the existing Colormate(TM)
            units for use in the Colormate(TM) Bilirubin Device. The costs will
            be expensed as incurred, remaining components will not be valued and
            the cost currently assigned to the existing Colormate(TM) units
            ($500 per unit) will be assigned to the Colormate(TM) Bilirubin
            Device, as the current replacement cost of these components exceeds
            the book value of the Colormate(TM) units.

            Depreciation - Depreciation on a straight-line basis over 5 years
            commences upon initial rental of the Colormate(TM) 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.


                                       47

<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.

            Software Development Costs - Once technological feasibility is
            established, the costs of developing software to be marketed as part
            of a product is capitalized and is amortized on the basis of
            estimated future revenues with annual minimum charges equal to the
            straight line basis over the estimated remaining useful life.

            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, 1997. 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 with financial institutions insured by the Federal
            Deposit Insurance Corporation to a maximum of $100,000. At December
            31, 1997, the Company had uninsured cash balances including, a money
            market fund, of approximately $9,200,000. The Company generated
            approximately 0%, 39% and 17% of its revenues from IMS in 1997, 1996
            and 1995, respectively, and 31% of its 1995 revenues from Perfect
            Look.

            Loss Per Share - Loss per common share is based upon the number of
            common shares and equivalents outstanding after giving retroactive
            effect to the stock split described in Note 5. Options and Warrants
            are excluded as losses have been incurred. Accordingly, basic and
            diluted loss per share is the same for all periods reported. The
            1,350,000 common shares into which the preferred shares may be
            convertible are being excluded from basic and diluted earnings
            (loss) per share until the beginning of the year if and when either
            of the contingencies are met (Note 5).

            There was no effect upon prior years' reported loss per share in
            adopting Statement of Financial Accounting Standards No. 128.

            Stock-Based Compensation - Statement of Financial Accounting
            Standards No. 123 "Accounting for Stock-Based Compensation," ("FAS
            123") encourages, but does not require, companies to record
            compensation cost at fair value for stock-based employee
            compensation plans. The Company has chosen to continue to account

            for stock-based compensation using the intrinsic value method
            prescribed in Accounting Principles Board Opinion No. 25,
            "Accounting for Stock Issued to Employees," and related
            Interpretations. Accordingly, compensation cost for

                                       48

<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):

            options granted by the Company is measured as the excess, if any, of
            the quoted market price of the Company's stock at the date of the
            grant over the amount an employee must pay to acquire the stock. 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 $5,597,400 ($0.45 per share) in 1997,
            $4,866,000 ($0.56 per share) in 1996 and $2,633,800 ($0.42 per
            share) in 1995.

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

            Since 1989, the Company has incurred losses from operations and net
            cash outflows from operations and has owned Colormate(TM) 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) 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.

            On July 31, 1997, the Company was granted marketing clearance by the
            FDA. Since that date, the Company has had discussions with several
            companies interested in distributing the Colormate Bilirubin Device
            and is currently negotiating with certain of those companies to
            reach a definitive agreement. It is not possible at the present time
            to determine the impact of this development on future cash flows.

            Management expects that the Company will have sufficient liquidity
            at least until December 31, 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) 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  --  Related Party Transactions, Commitments and Contingencies:


            Related Party Transactions - In connection with the Avon Settlement
            and her employment agreement, Mrs. Macfarlane is to receive a bonus
            of $361,200, of which $98,800 has been paid. The remaining $262,400
            accrues interest at the rate of 10% per annum. In December 1997,
            Mrs. Macfarlane agreed to delay demand for payment until January
            1999. In addition, Mrs. Macfarlane is due $12,100 for unpaid salary
            which is currently payable without interest.

            Employment Agreements - In December 1997, the Company agreed with
            Mrs. Macfarlane to extend her employment at an annual salary of
            $175,000 through December 31, 2000.

            On April 10, 1995, the Company hired Arthur Guiry as its new
            president at an annual salary of $200,000 through April 10, 2000. In
            addition, Mr. Guiry received an aggregate of 300,000 incentive and
            non-qualified options at an exercise price of $2.25, expiring April
            10, 2000. The options vest at the rate of 100,000 per year
            commencing April 10, 1996 and are now fully vested.

            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.

                                       49
<PAGE>

          CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 4  --  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) Systems commencing July 1, 1991
            using the declining balance method (cumulative temporary differences
            at December 31, 1997 were $175,000).

            At December 31, 1997, the Company had net operating loss
            carryforwards of approximately $14,600,000 for Federal income tax
            purposes which expire through December 31, 2012. SFAS 109 requires
            the recording of a deferred tax asset of approximately $6,500,000
            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. In
            addition, the Company had research and development tax credit
            carryforwards of approximately $50,000 at December 31, 1997
            available to offset future Federal income taxes.


Note 5  --  Capital Stock and Options:


            Stock Split - In February 1998, the Company effected a three-for-two
            split (the "Stock Split"). All share and per share data included in
            this report have been restated to reflect the stock split.

            Preferred Stock - The Company's shares of Class A Convertible
            Preferred Stock are entitled to non-cumulative dividends, if
            declared, at $.001 per annum. In February 1998, the shareholders
            approved an amendment to the Class A Convertible Preferred Stock to
            provide that in the event either the Company's earnings before
            interest, income taxes and extraordinary items exceed $20,000,000
            for two consecutive calendar years, or the closing bid price exceeds
            $31.11 for 30 consecutive trading days at any time through December
            31, 2000, each share of Class A Preferred Stock shall be convertible
            into .979 shares of Common Stock. Such shares shall otherwise be
            called for redemption during 120 days following December 31, 2000 at
            $.01 per share plus any declared but unpaid dividends.

            In addition, the shareholders approved an amendment to the Company's
            Certificate of Incorporation to (1) revise the market price
            conversion feature of the Class A Convertible Preferred Stock to
            provide for adjustment upon the occurrence of certain events
            involving the Common Stock, and (2) revise the calculation of the
            earnings goal needed to trigger the conversion feature of the Class
            A Convertible Preferred Stock by deleting the exclusion therefrom of
            extraordinary items and revenues and earnings generated by
            businesses acquired by the Company.

            The Company also has 10,000,000 shares of undesignated Class B
            preferred stock which may be issued with such rights and preferences
            as the Board of Directors may determine upon issuance. Therefore,
            the undesignated Class B preferred stock may be issued with
            liquidation, dividend, voting and other rights superior to those of
            existing shareholders, including the right as a class to elect a
            controlling number of directors.

            Stock Option Plan - The Company has a Stock Option Plan which
            currently provides for options to purchase up to 3,000,000 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

                                       50

<PAGE>

          CHROMATICS COLOR SCIENCES INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 5 -- Capital Stock and Options (continued):

            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 Stock Option Plan are summarized as
            follows:

<TABLE>
<CAPTION>
                                                                                       Year Ended December 31,
                                                                          ------------------------------------------------
                                                                              1997              1996              1995
                                                                          ----------        ----------        ----------
                     <S>                                                   <C>              <C>                <C>
                     Outstanding options at beginning
                     of year                                               1,972,500         1,023,750           374,436
                     Options granted                                         791,250         1,136,250           821,250
                     Options exercised                                      (671,500)         (187,500)         (171,936)
                                                                          -----------      ------------      ------------
                     Options outstanding at year end                       2,092,250         1,972,500         1,023,750
                                                                          ===========      ============      ============
                     Option price per share                           $5.00 to $10.00     $2.75 to $2.92     $1.67 to $2.96
                                                                      ===============     ==============     ==============
                     Expiration dates                                             June 1999 to December 2002
            </TABLE>



            For the year ended December 31, 1997, compensation cost of $582,400
            has been recognized for options granted to consultants of the
            Company. The fair value of the options were estimated at the date of
            grant using the Black-Scholes option pricing model with the
            following weighted-average assumptions, respectively: risk-free
            interest rates of 5.0%, dividend yield of 0.0%, volatility factor
            equal to 76% and an expected life equaling the options exercise
            periods.

            At December 31, 1997 Warrants to purchase 1,887,051 shares of Common
            Stock at $1.67 per share were outstanding. These Warrants, issued to
            a Placement Agent, expire as follows: (i) 773,672 Warrants issued on
            January 6, 1995 expire January 6, 2002; (ii) 41,283 Warrants issued
            on March 13, 1995 expire March 13, 2002; (iii) 556,128 Warrants
            issued on May 4, 1995 expire May 4, 2002; and (iv) 515,969 Warrants
            issued on June 8, 1995 expire June 8, 2002.


                                       51

<PAGE>

Item 9.  Changes in and Disagreements With Accountants on Accounting and
         Financial Disclosure


         None.

                                    PART III

Item 10. Directors and Executive Officers of the Company

         Certain information concerning directors and executive officers of the
Company is set forth below:

<TABLE>
<CAPTION>

         Name                                 Age                           Position
         ----                                 ---                           --------
<S>                                           <C>                 <C>
Darby Simpson Macfarlane                      53                  Director, Chairperson of the Board of
                                                                  Directors, Chief Executive Officer,
                                                                  Assistant Treasurer

Arthur Guiry                                  58                  President

David Kenneth Macfarlane                      51                  Director, Vice President, Research and
                                                                  Development

Leslie Foglesong*                             42                  Director, Secretary and Treasurer

Edmund Vimond*+                               62                  Director

Edward Mahoney*+                              47                  Director
</TABLE>

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

*        Member of the Audit Committee of the Board of Directors.

+        Member of the Compensation Committee of the Board of Directors.

         Directors are elected annually by the shareholders and hold office
until the next annual meeting and until their respective successors are elected
and qualified. Executive officers are elected by the Board of Directors, serve
at the direction of the Board of Directors and hold office until their
respective successors are elected and qualified. There is no arrangement or
understanding between any director or executive officer and any other person
pursuant to which such person was or is to be selected as a director or
executive officer of the Company except that the Company has agreed with the
placement agent of the Company's 1995 Private Placement that it 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 has agreed to 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.

         Set forth below is certain additional information with respect to the
directors, executive officers and certain consultants of the Company.

         Mrs. Macfarlane co-founded the Company in March 1984 and is one of the
primary inventors of the patented technologies used in the Colormate(TM) units.
She has been Chairperson of the Board of Directors, 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 Mr. Macfarlane led and directed the
Company's research and development and mass-manufacturing efforts of the
Company's color science technology, instrumentation and cosmetic and related
products.

                                       52
<PAGE>

         Mr. Macfarlane co-founded the Company and is also one of the primary
inventors of the patented technologies used in the Colormate(TM) units. In
addition, Mr. Macfarlane developed the manufacturing, technical and engineering
specifications necessary to have miniaturized and mass manufactured the
Colormate(TM) units. 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 Development, Ltd.,
and Trumach, Inc.

         Ms. Leslie Foglesong has been the Secretary, Treasurer and a director
of the Company since its formation.

         Mr. Arthur Guiry provided consulting services to the Company from
January 1, 1995 to March 1995, in connection with the marketing of the Company's
medical application for its technology. On April 10, 1995, Mr. Guiry commenced
his duties as President of the Company. 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.

         Mr. Edmund Vimond has previously provided consulting services to the
Company. On December 1, 1997, Mr. Vimond was appointed to the Company's Board of
Directors. From 1991 to 1997, Mr. Vimond was the President and Chief Executive
Officer of Ocurest Laboratories, Inc. Mr. Vimond was responsible for managing
all functions of the business, including marketing, sales, contract
manufacturing, personnel and finance and systems. Prior to 1991, Mr. Vimond held
positions in various executive capacities with RJR Nabisco Inc., American
Cyanamid Co., Johnson & Johnson and Warner-Lambert Companies Inc. Mr. Vimond
received B.S.B.A. and M.B.A. degrees from Northwestern University.

         On January 26, 1998, Edward Mahoney, a certified public accountant, was
appointed to the Board of Directors and currently acts as Chairman of the
Company's Audit Committee. Since January 1998, Mr. Mahoney has owned and
operated a certified public accounting firm and was a tax partner with the
accounting firm of BDO Seidman from 1994 to 1997 and Price Waterhouse from 1973
to 1994. Mr. Mahoney received a Bachelor of Science in Accounting degree from
Brooklyn College of the City University of New York.

         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. No family relationship exists between any director or executive officer of
the Company.
                                       53
<PAGE>

Medical Advisory Board

         The Company recently established a Medical Advisory Board consisting of
Dr. Fred W. Billmeyer, Dr. Ian Holzman and Dr. Jeffrey Maisels, independent
consultants/advisors to the Company.

         Dr. Fred 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, has been a consultant to the Company since
1984 and is a member of the Company's Medical Advisory Board.  Dr. Billmeyer has
published numerous books and articles in the field of color science. The
consulting agreement with Dr. Billmeyer provides that he will provide color
consulting services to the Company at a fee of $125 per hour. Such services
include providing advice and supervisory assistance in connection with any
further research and development, modification, enhancement or marketing
activity relating to the Colormate(TM) System and Intellectual Properties in
specific applications and assisting in obtaining patent protection for the
unpatented Intellectual Properties. In addition, Dr. Billmeyer is entitled to
receive a royalty in the amount of 2% of the selling price less the cost of
manufacture of any device sold by the Company. In 1997, the Company paid Dr.
Billmeyer $21,700.

         Dr. Ian Holzman, a physician with the Department of Pediatrics,
Division of Newborn Medicine, Mt. Sinai Medical Center, is a member of the
Medical Advisory Board. Dr. Holzman is presently the Chief of the Division of
Newborn Medicine at Mt. Sinai Medical Center and a member of the Attending Staff
at each of Mt. Sinai Medical Center and City Hospital Center at Elmhurst. In
addition, Dr. Holzman is a Professor of Pediatrics, Obstetrics and Gynecology
and Reproductive Medicine, at Mt. Sinai School of Medicine. Dr. Holzman has
published numerous journal articles, book chapters and medical abstracts in the
field of pediatric treatment and medicine.

         Dr. Jeffrey Maisels, a physician with the Department of Pediatrics,
William Beaumont Hospital, is a member of the Medical Advisory Board. Dr.
Maisels is presently the Chief of the Department of Pediatrics at William
Beaumont Hospital and is also a Clinical Professor of Pediatrics at Wayne State
University School of Medicine. Dr. Maisels has published numerous journal
articles, book chapters and medical abstracts in the field of pediatric
treatment and medicine including, publications relating to bilirubin infant
jaundice and phototherapy.

Consultants

         The Company relies on the services of certain other consultants and
advisors. The consultants are not executive officers of the Company but make or
are expected to make significant contributions to the business of the Company.

         Mr. Frederick Frank, Vice Chairman of Lehman Brothers, an investment
banking firm, has been an advisor to the Company since December 1, 1997,

providing financial, strategic and business advisory services. The consulting
agreement with Mr. Frank expires December 1, 1998 but is renewable upon the
mutual agreement of the Company and Mr. Frank.

         The Company from time to time also employs certain other consultants
and temporary personnel for various purposes such as FDA and regulatory matters,
the Bilirubin Project and marketing, engineering, research and development
associated with the Intellectual Properties, Beauty-Aid Products, the
Colormate(TM) Bilirubin Device and Colormate(TM) units. The Company has also
retained consultants to provide public relations, shareholder relations,
financial, licensing and investment banking services. In 1997, these consultants
and temporary personnel were paid an aggregate of $905,200 and were granted

                                       54

<PAGE>

options to purchase an aggregate of 622,500 shares (giving effect to the Stock
Split) of the Company's Common Stock under the 1992 Plan. All consultants may be
reimbursed by the Company for reasonable out-of-pocket expenses incurred by them
in connection with the services each consultant provides to the Company.

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, 1997, 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.

         Edmund Vimond, a director of the Company, failed to file on a timely
basis a Form 3 with respect to his initial beneficial ownership of the Company's
securities at the time Mr. Vimond was elected a director of the Company. A
filing on Form 3, with respect to this transaction, has since been made for Mr.
Vimond.


                                      55
<PAGE>

Item 11. Executive Compensation

Summary Compensation Table


         The following table summarizes all plan and non-plan compensation
awarded to, earned by or paid to the Company's Chief Executive Officer and its
three other executive officers who were serving as such during and at the end of
fiscal 1997 for services rendered in all capacities to the Company in the last
three fiscal years.

<TABLE>
<CAPTION>
                                                                                                  Long-Term
                                                                                                Compensation
                                                             Annual Compensation                    Awards
                                                   ----------------------------------------     --------------
                                                                                                   Securities
                                                                                                   Underlying
                                                                                                    Options             All Other
Name and Principal Position                         Year           Salary           Bonus            (#)(1)             Compensation
----------------------------                        ----           ------           -----         -----------           ------------
<S>                                                 <C>          <C>                 <C>               <C>                  <C>
Darby Simpson Macfarlane,                           1995        $125,037           $      0                  0           $ 26,689(2)
  Chief Executive Officer                           1996         125,000             20,000            450,000              5,617(3)
                                                    1997         175,000                  0                  0                  0


Arthur Guiry, President                             1995         168,101(4)               0            300,000                  0
                                                    1996         200,000                  0                  0                  0
                                                    1997         200,000                  0                  0                  0


David Kenneth Macfarlane,                           1995         114,034(5)               0                  0                  0
  Vice President,                                   1996         125,000              4,500            300,000              5,950(3)
  Research and Development                          1997         125,000                  0                  0                  0


Leslie Foglesong,                                   1995          75,000                  0             75,000                  0
  Secretary and Treasurer                           1996          75,000            103,650(6)         150,000                  0
                                                    1997         100,000                  0                  0                  0

</TABLE>

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

(1)  In February 1998, the Company effected a three-for-two forward Stock
     Split. The number of shares issuable upon the exercise of stock
     options granted under the 1992 Plan presented above give effect to
     the Stock Split.

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

(3)  Includes premiums paid by the Company on the term life insurance
     policies and disability insurance policies of Mrs. and Mr.
     Macfarlane.

(4)  Includes $23,000 of fees paid to Mr. Guiry in 1995 as a consultant

     prior to his employment as President.

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


                                       56

<PAGE>

(6) Includes 1995 bonus not paid until 1996.

Option/SAR Grants in Last Fiscal Year

         No stock options were granted under the 1992 Plan to any of the
executive officers of the Company during the fiscal year ended December 31,
1997.

Aggregated Option/SAR Exercises in Last Fiscal Year and
Fiscal Year End Option/SAR Value Table

         The following table sets forth information with respect to stock
options exercised during the fiscal year ended December 31, 1997 and the value
at December 31, 1997 of unexercised stock options held by the Chief Executive
Officer and the other executive officers of the Company. The number of shares
presented gives effect to the Stock Split:

<TABLE>
<CAPTION>
                                                                               Number of
                                                                              Securities              Value of
                                                                              Underlying             Unexercised
                                                                              Unexercised           In-the-Money
                                                                              Options at               Options
                                                                                Fiscal                at Fiscal
                                                                               Year-End               Year-End(2)
                                         Shares                             --------------        ----------------
                                      Acquired on                            Exercisable/
                                        Exercise            Value            Unexercisable         Exercisable/
Name                                      (#)            Realized(1)              (#)              Unexercisable
---------------------------          -------------       -----------        --------------        --------------
<S>                                        <C>                                 <C>     <C>          <C>
Darby Simpson Macfarlane                   0                  --               450,000/0            $3,187,500

Arthur Guiry                            195,000           $1,240,500           105,000/0            $  813,750

David Kenneth Macfarlane                    0                 --               300,000/0            $2,125,000

Leslie Foglesong                         75,000           $  639,375           150,000/0            $1,250,000
</TABLE>

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

(1)  The value realized on the exercise of options was calculated by
     multiplying the number of underlying shares by the difference

     between the closing price of the Common Stock on the date of
     exercise (as quoted on the Nasdaq SmallCap Market published in The
     Wall Street Journal) and the option exercise price.

(2)  The value of unexercised in-the-money options was calculated by
     multiplying the number of underlying shares held by the difference
     between the closing price of the Common Stock on December 31, 1997
     ($15.00 per share, as originally quoted on the Nasdaq SmallCap
     Market published in The Wall Street Journal) and the option exercise
     price, but after giving effect to the Stock Split.

Compensation of Directors

         Directors who are officers of the Company do not receive additional
compensation for serving on the Board of Directors. Each of Messrs. Vimond and
Mahoney receive a monthly director's fee of $4,000. In addition, Mr. Vimond and
Mr. Mahoney received options to purchase 22,500 and 37,500 shares of the
Company's Common Stock under the 1992 Plan, respectively, and giving effect to
the Stock Split. The stock options granted to Mr. Vimond and

                                       57
<PAGE>

Mr. Mahoney vest in equal installments on the first, second and third
anniversaries of the date of grant and are exercisable at $9.71 and $9.25 per
share, respectively. In addition, Mr. Vimond received 15,000 stock options,
which options are fully exercisable on July 15, 1998, expire on July 15, 2002
and are exercisable at $5.42 per share.

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 in 1997 of $175,000
and $125,000, respectively, subject to annual increases at the discretion of the
Board. In addition, Mrs. Macfarlane's agreement provides for a bonus payment of
33% of the first million of the Company's net recovery in excess of $2,000,000
from the Avon Litigation. Accordingly, Mrs. Macfarlane 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. However, repayment of this amount
is subject to Mrs. Macfarlane's agreement to defer repayment until January 1999
in connection with the amendment to the Company's Certificate of Incorporation
which amendment modified certain terms of the Class A Preferred Stock, including
the following: (i) extension to December 31, 2000 of the expiration date of the
conversion feature and redemption period, (ii) revision of the market price
conversion feature to provide for adjustment upon the occurrence of certain
events involving the Common Stock, and (iii) revision of the calculation of the
earnings goal needed to trigger the conversion feature by including
extraordinary items and revenues and earnings generated by businesses acquired
by the Company. In connection with Mrs. Macfarlane's agreement to defer
repayment (as described herein), the Company and Mrs. Macfarlane have also
agreed to extend the term of her employment with the Company until December 31,

2000 and forgo any discretionary performance bonus under her employment
agreement. Under the employment agreements, the Company is obligated to provide
Mr. Macfarlane with a $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 employment agreements also provide for the payment of termination
benefits by the Company if employment thereunder is terminated (i) by the
Company for any reason other than death, 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 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, plus
options to purchase an aggregate of 300,000 shares of Common Stock at an
exercise price of $2.25 per share under the 1992 Plan, giving effect to the
Stock Split. Mr. Guiry shall be entitled to an annual bonus subject to the
discretion of the Board. 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

                                       58

<PAGE>

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 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.

Compensation Committee Interlocks and Insider Participation

         The Company did not establish a compensation committee in 1997. The
entire Board of Directors determined each executive officer's compensation, with
the relevant executive officer, who was also a director, abstaining from any
decision made with respect to that executive officer's compensation. The Board
of Directors for the fiscal year ended December 31, 1997 consisted of Darby S.
Macfarlane, David Kenneth Macfarlane, Leslie Foglesong and Edmund Vimond. There
are no reportable compensation committee (Board of Directors) interlocks or
insider participation transactions. The Company's compensation committee,
established in January 1998, consists of Edmund Vimond and Edward Mahoney.

Item 12. Security Ownership of Certain Beneficial Owners and Management

         The following table sets forth, as of March 26, 1998, the beneficial
ownership of the Common Stock: (i) by each stockholder known by the Company to
beneficially own more than 5% of the Common Stock; (ii) by each director of the
Company; (iii) by the Company's Chief Executive Officer; and (vi) by all
executive officers and directors of the Company as a group. Amounts presented
give effect to the February 1998 three-for-two forward Stock Split (including
shares issuable upon the exercise of stock options and/or warrants). Except as
otherwise indicated below, each named beneficial owner has sole voting and
investment power with respect to the shares of Common Stock listed.

<TABLE>
<CAPTION>

Name and Address of
Beneficial Owner                                                Number of Shares                  Percent of Class
---------------------                                          -----------------                  ----------------
<S>                                                            <C>                                <C>
Darby Simpson Macfarlane (1)                                        3,016,220                            17.9%
10 Old Jackson Avenue, #28
Hastings-on-Hudson, NY 10706

David Kenneth Macfarlane (2)                                        3,016,220                            17.9%
5 E. 80th Street
New York, New York 10021


Leslie Foglesong (3)                                                  165,000                             1.1%
116 Lafayette Avenue
Brooklyn, NY 11217

Edmund Vimond                                                               0                           --
6967 Country Lakes Circles
Sarasota, FL  34243

</TABLE>

                                       59

<PAGE>

<TABLE>

<S>                                                            <C>                                <C>
Edward Mahoney                                                              0                          --
2044 Palisades Drive
Pacific Palisades, CA 90272

Mellon Bank Corporation (4)                                         1,875,000                            12.7%
One Mellon Bank Center
Pittsburgh, PA 15258

Janssen-Meyers Associates, L.P.(5)                                  1,442,427                             8.9%
17 State Street
New York, NY 10001

All directors and executive officers                                3,181,220                            18.7%
as a group (6 persons) (6)
</TABLE>

----------

(1)      Includes all of the 1,380,000 issued and outstanding shares of
         the Class A Preferred Stock owned by Mrs. Macfarlane, 450,000
         shares issuable upon the exercise of options granted to Mrs.
         Macfarlane and 300,000 shares issuable upon the exercise of
         options granted to Mr. Macfarlane which options are currently
         exercisable. Mrs. Macfarlane disclaims beneficial ownership of
         the shares and/or options owned by Mr. Macfarlane.

(2)      Includes the 1,380,000 issued and outstanding shares of the
         Class A Preferred Stock owned by Mrs. Macfarlane, 886,220 issued
         and outstanding shares of the Common Stock beneficially owned by
         Mrs. Macfarlane, 450,000 shares issuable upon the exercise of
         options granted to Mrs. Macfarlane and 300,000 shares issuable
         upon the exercise of options granted to Mr. Macfarlane which
         options are currently exercisable. Pursuant to a separation
         agreement dated December 13, 1995, Mr. Macfarlane has given Mrs.
         Macfarlane sole voting power and power of disposition over all
         Common Stock or options to acquire Common Stock acquired by Mr.

         Macfarlane after such date. Upon sale of any Common Stock or
         options to acquire Common Stock of the Company by Mrs.
         Macfarlane or Mr. Macfarlane, Mrs. Macfarlane can elect to
         allocate and/or distribute specified portions of the proceeds
         from such sale in specified amounts to herself and to Mr.
         Macfarlane and/or to trusts established for her daughter and her
         step-daughter. Mr. Macfarlane disclaims beneficial ownership of
         the shares and/or options owned by Mrs. Macfarlane.

(3)      Includes 150,000 shares issuable upon the exercise of options which are
         currently exercisable.

(4)      Based on Amendment No. 5 to a Form 13G filed with the
         Commission, dated January 12, 1998 and giving effect to the Stock
         Split. Includes indirect beneficial ownership of the holdings of two
         subsidiaries, Mellon Bank N.A. and the Dreyfus Corporation.

(5)      Based on a representation letter from Janssen-Meyers Associates,
         L.P. dated March 31, 1998, and includes 569,750 warrants held
         by Peter Janssen, 261,750 warrants held by Bruce Meyers (each an
         affiliate of Janssen-Meyers Associates, L.P.) and 592,927
         warrants held by Janssen-Meyers Associates, L.P. which, in each
         case, are currently exercisable. Bruce Meyers also holds 18,000 shares
         of Common Stock.

(6)      Includes 900,000 shares issuable upon the exercise of options which are
         currently exercisable and 1,380,000 issued and outstanding shares of
         the Class A Preferred Stock.

Item 13. Certain Relationships and Related Transactions

         In December 1997, Mrs. Macfarlane agreed to (i) delay payment to
January 1999 on the note she received under her employment agreement in respect
of the Avon Settlement, (ii) extend the term of her employment with the Company
until December 31, 2000, and (iii) forego any discretionary performance bonus
under her employment agreement for 1999 in connection with the Company's Board
agreeing to modify certain features of the Company's Class A Preferred Stock.
The changes to the Class A Preferred Stock, approved by the Company's
shareholders on February 13, 1998, provide that, if (i) the Company's earnings
for any two consecutive calendar years during the period ending on December 31,
2000 exceeds $20,000,000 or (ii) the closing bid price of the Common Stock has
been at least $46.67 ($31.11 giving effect to the Stock Split) on 30 consecutive
trading days at any time prior to December 31, 2000, each outstanding share of
Preferred Stock shall be converted into .979 shares of Common Stock, subject to
adjustment for stock-splits, including the Stock Split, stock dividends,
reclassification or other combinations or subdivisions. If neither condition is
satisfied by December 31, 2000, 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 Mrs. Macfarlane $1,620 per month
under the lease (representing her actual lease cost for such

                                       60
<PAGE>


premises). For the year ended December 31, 1997, the Company paid Mrs.
Macfarlane $19,400 in connection with such lease. In addition, the Company also
paid Mrs. Macfarlane approximately $10,300 for the year ended December 31, 1997,
for the use of her residence as offices of the Company.

         Accrued royalties under certain prior license arrangements between the
Company and Pink & Peach Computer Corp. (an affiliate of Mrs. Macfarlane) 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 was paid in 1997.

         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. See
"Employment Agreements." 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.

                                     PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) and (d)1.     Financial Statements

                  The following Financial Statements of the Company are
                   included in Part II, Item 8 of this report:

                  Independent Auditors' Report
                  Consolidated Balance Sheets as of December 31, 1997 and 1996
                  Consolidated Statements of Operations for the years
                  ended December 31, 1997, 1996 and 1995 Consolidated
                  Statements of Changes in Stockholders' Equity as of
                  December 31, 1997, 1996 and
                   1995
                  Consolidated Statements of Cash Flows for the years
                  ended December 31, 1997, 1996 and 1995 Notes to
                  Consolidated Financial Statements

(a) and (d)2.     Financial Statements Schedules

                  All schedules have been omitted because they are not
                  applicable, are not required or because the required
                  information is included in the Financial Statements or
                  notes thereto.

(b)               Reports on Form 8-K:

                  Form 8-K, dated December 19, 1997, announcing the Board
                  of Directors' adoption of certain proposals to be
                  presented at the shareholders' meeting subsequently
                  held on February 13, 1998.


(c)               The following exhibits are included in this report:

Number            Description of Document
------            -----------------------
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 of Common Stock and increasing the
                  authorized number of shares of Preferred Stock

                  (incorporated by reference to Exhibit 3.1.2 to the
                  Company's Annual Report on Form 10-KSB for the fiscal
                  year ended December 31, 1996).


                                       61

<PAGE>

Number            Description of Document
------            -----------------------
3.1.3+            Certificate of Amendment to the Certificate of
                  Incorporation of the Company dated February 13, 1998
                  effecting the three-for-two Stock Split and certain
                  changes to the Class A Convertible 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).

9.1               Voting Proxy dated December 13, 1995, of David Kenneth
                  Macfarlane to Darby Simpson Macfarlane (incorporated by
                  reference to Exhibit 2 to Schedule 13D of Darby Macfarlane and
                  Ken Macfarlane dated February 12, 1996).

9.2               Voting Trust Agreement dated December 13, 1995, between David
                  Kenneth Macfarlane and Darby Simpson Macfarlane (incorporated
                  by reference to Exhibit 3 to Schedule 13D of Darby Macfarlane
                  and Ken Macfarlane dated February 12, 1996).

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

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

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

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

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

10.6              Assignment, dated September 3, 1992 from Darby Simpson

                  Macfarlane to the Company regarding Intellectual
                  Property (incorporated by reference to Exhibit 10.13 to
                  the Registration Statement).

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

10.8              U.S. Patent No. 4,909,632 relating to Method for Selecting
                  Personal Compatible Colors (incorporated by reference to
                  Exhibit 10.17 to the Company's Annual Report on Form 10-KSB
                  for the fiscal year ended December 31, 1994).

10.9              U.S. Patent No. 5,311,293 relating to Method and
                  Instrument for Selecting Personal Compatible Colors
                  (incorporated by reference to Exhibit 10.18 to the
                  Company's Annual Report on Form 10-KSB for the fiscal
                  year ended December 31, 1994).

10.10             U.S. Patent No. 5,313,267 relating to Method and
                  Instrument for Selecting Personal Compatible Colors
                  (incorporated by reference to Exhibit 10.19 to the
                  Company's Annual Report on Form 10-KSB for the fiscal
                  year ended December 31, 1994).

10.11             The Australian Patent relating to Method of Selecting Personal
                  Compatible Color (incorporated by reference to Exhibit 10.20
                  to the Company's Annual Report on Form 10-KSB for the fiscal
                  year ended December 31, 1994).

10.12             European Community Patent No. 0446512 relating to
                  Method for Selecting Personal Compatible Colors
                  (incorporated by reference to Exhibit 10.21 to the
                  Company's Annual Report on Form 10- KSB for the fiscal
                  year ended December 31, 1994).

                                       62

<PAGE>

Number            Description of Document
------            -----------------------

10.13             U.S. Patent No. 5,671,735 relating to Method and Apparatus for
                  Detecting and Measuring Conditions Affecting Color (to be
                  filed supplementally).

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

10.15             Know-How Assignment, dated October 30, 1992, from Pink & Peach
                  Computer Corp. to the Company (incorporated by reference to

                  Exhibit 10.20 to the Registration Statement).

10.16             1992 Stock Option Plan (incorporated by reference to Exhibit
                  10.23 to the Registration Statement). file owed.

10.17             Consulting Agreement dated January 6, 1995, between the
                  Company and Janssen-Meyers Associates, L.P. (incorporated by
                  reference to Exhibit 10.27 to the Company's Annual Report on
                  Form 10-KSB for the fiscal year ended December 31, 1994).

10.18             Warrant Agreement dated January 6, 1995, between the Company
                  and Janssen-Meyers Associates, L.P. (incorporated by reference
                  to Exhibit 10.28 to the Company's Annual Report on Form 10-
                  KSB for the fiscal year ended December 31, 1994).

10.19             Warrant Agreement dated March 13, 1995, between the Company
                  and Janssen-Meyers Associates, L.P. (incorporated by reference
                  to Exhibit 10.29 to the Company's Annual Report on Form 10-
                  KSB for the fiscal year ended December 31, 1994).

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).

23+               Consent of Independent Auditors.

27+               Financial Data Schedule
-----------------------------

*    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.

                                       63

<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.
<TABLE>

        <S>                                                   <C>
         By: /s/ Darby S. Macfarlane                          Date:    March 30, 1998
             ----------------------------------------                  --------------
                  Darby S. Macfarlane,
                  Chief Executive Officer


         By: /s/ Leslie Foglesong                             Date:    March 30, 1998
                  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 30, 1998
             ----------------------------------------                  --------------
                  Darby S. Macfarlane,
                  CEO; Chairman of the Board;
                  Assistant Treasurer; Director


         By: /s/ David K. Macfarlane                          Date:    March 30, 1998
             ----------------------------------------                  --------------
                  David K. Macfarlane,
                  Vice President, Research & Development;
                  Director


         By: /s/ Leslie Foglesong                             Date:    March 30, 1998
             ----------------------------------------                  --------------
                  Leslie Foglesong,
                  Secretary; Treasurer; Director


         By: /s/ Edmund Vimond                                Date:    March 30, 1998
             ----------------------------------------                  --------------
                  Edmund Vimond,
                  Director


         By: /s/ Edward Mahoney                               Date:    March 30, 1998
             ----------------------------------------                  --------------
                  Edward Mahoney,
                  Director

</TABLE>

<PAGE>

                                  Exhibit Index

Number            Description of Document
------            ------------------------
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 of Common Stock and increasing the
                  authorized number of shares of Preferred Stock
                  (incorporated by reference to Exhibit 3.1.2 to the
                  Company's Annual Report on Form 10-KSB for the fiscal
                  year ended December 31, 1996).

3.1.3+            Certificate of Amendment to the Certificate of
                  Incorporation of the Company dated February 13, 1998
                  effecting the three-for-two Stock Split and certain
                  changes to the Class A Convertible 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).

9.1               Voting Proxy dated December 13, 1995, of David Kenneth
                  Macfarlane to Darby Simpson Macfarlane (incorporated by
                  reference to Exhibit 2 to Schedule 13D of Darby Macfarlane and
                  Ken Macfarlane dated February 12, 1996).

9.2               Voting Trust Agreement dated December 13, 1995, between David
                  Kenneth Macfarlane and Darby Simpson Macfarlane (incorporated
                  by reference to Exhibit 3 to Schedule 13D of Darby Macfarlane
                  and Ken Macfarlane dated February 12, 1996).

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

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


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

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

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

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

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

10.8              U.S. Patent No. 4,909,632 relating to Method for Selecting
                  Personal Compatible Colors (incorporated by reference to
                  Exhibit 10.17 to the Company's Annual Report on Form 10-KSB
                  for the fiscal year ended December 31, 1994).


<PAGE>

Number            Description of Document
------            ------------------------
10.9              U.S. Patent No. 5,311,293 relating to Method and
                  Instrument for Selecting Personal Compatible Colors
                  (incorporated by reference to Exhibit 10.18 to the
                  Company's Annual Report on Form 10-KSB for the fiscal
                  year ended December 31, 1994).

10.10             U.S. Patent No. 5,313,267 relating to Method and
                  Instrument for Selecting Personal Compatible Colors
                  (incorporated by reference to Exhibit 10.19 to the
                  Company's Annual Report on Form 10-KSB for the fiscal
                  year ended December 31, 1994).

10.11             The Australian Patent relating to Method of Selecting Personal
                  Compatible Color (incorporated by reference to Exhibit 10.20
                  to the Company's Annual Report on Form 10-KSB for the fiscal
                  year ended December 31, 1994).

10.12             European Community Patent No. 0446512 relating to
                  Method for Selecting Personal Compatible Colors
                  (incorporated by reference to Exhibit 10.21 to the
                  Company's Annual Report on Form 10-KSB for the fiscal
                  year ended December 31, 1994).

10.13             U.S. Patent No. 5,671,735 relating to Method and Apparatus for
                  Detecting and Measuring Conditions Affecting Color (to be
                  filed supplementally).

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

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

10.16             1992 Stock Option Plan (incorporated by reference to Exhibit
                  10.23 to the Registration Statement). file owed.

10.17             Consulting Agreement dated January 6, 1995, between the
                  Company and Janssen-Meyers Associates, L.P. (incorporated by
                  reference to Exhibit 10.27 to the Company's Annual Report on
                  Form 10-KSB for the fiscal year ended December 31, 1994).

10.18             Warrant Agreement dated January 6, 1995, between the Company
                  and Janssen-Meyers Associates, L.P. (incorporated by reference
                  to Exhibit 10.28 to the Company's Annual Report on Form 10-
                  KSB for the fiscal year ended December 31, 1994).

10.19             Warrant Agreement dated March 13, 1995, between the Company

                  and Janssen-Meyers Associates, L.P. (incorporated by reference
                  to Exhibit 10.29 to the Company's Annual Report on Form 10-
                  KSB for the fiscal year ended December 31, 1994).

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).

23+               Consent of Independent Auditors.

27+               Financial Data Schedule
-----------------------------
*    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.